Value-based pricing means charging for the value you provide. It requires sizing and bundling work and also understanding the buyer’s motivations. But how do you go about actually setting value-based prices?
In the previous two posts in this series on setting value-based prices, we covered the importance of pricing your work in chunks (or bundles) and the factors that motivate buyers and influence their price-sensitivity.
So far so good. But how do you come up with a value-based price based on all that?
Figuring out what that number should be isn’t straight-forward. While setting value-based prices isn’t trivial, it’s not rocket science either. You can learn it.
In this article I’ll present two approaches for setting value-based prices:
- Setting value-based prices based on knowledge and insights about a buyer and their industry.
- Looking at what’s available and setting value-based prices by considering the second-best alternatives available to the buyer using a spreadsheet (provided below).
Can you really calculate a value-based price using only formulas?
That’s a good question! In most cases you can’t. I want to emphasize the importance of a conceptual agreement. It doesn’t matter how spot-on your calculation is. If the buyer doesn’t believe it, they’ll just consider your price too expensive. The buyer must believe in the value you provide before you present a price. One way of doing that is leading a conversation towards the buyer stating the cost of not solving this problem. Once the buyer has stated the cost, any price will be viewed in light of that. The spreadsheet below is just a tool and way to think about value-based prices, not a way to arrive at one that the buyer will accept.
First, let’s talk a bit about the problem of self-diagnosis.
Handling Self-Diagnosed Buyers Through Consultative Conversations
We’ve all been there. A promising lead just showed up in the mailbox. A company needs an app, website or campaign. They also seem like a great fit. Reason to celebrate?
Leads such as these may appear promising. However, as long as the client hasn’t revealed the problem they need to be solved, you might as well put on your skeptic’s spectacles. As long as you do not know their goal, you cannot set a value-based price.
Why Self-Diagnosis Prevents Actual Problem-Solving
It’s vitally important it is that you have an understanding of your buyer’s goals before you start pricing based on value. Yet, most projects start at the other end: the buyer self-diagnoses themselves and approaches you believing they know exactly what they need.
Sometimes they’re right but most of the time their diagnosis is faulty and they need something else. To understand what, you need to focus on what they’re trying to achieve. By not discussing the desired outcome, you set up the project to fail by hedging all your bets on a specific solution. Consequently, the conversation will end up revolving around a specific set of tactics or implementation rather than the problem that needs to be solved. That’s why discussing a “definition of success” should be at the top of your agenda when meeting a new client.
A discussion about outcomes may lead you to draw the conclusion that their best option isn’t something you can provide. If you’re serious about being consultative, you tell them so.
The best way to gain this understanding is through a conversation with the buyer. Try to roll back the tape and ask them to walk you through the background of their request. Once you have a handle of the bigger picture, inquire about the goals.
Gaining a Glimpse of the Numbers
It’s near impossible for a buyer to discuss goals without revealing a thing or two about numbers. This information is critically important for when you calculate the value-based price you put in your quote or proposal (discussed later).
Building Trust By Acting in the Interest of Your Buyer
The benefits of consultative conversations are many. The buyer will reveal more information than they would answer a direct question. If it turns out there’s an off-the-shelf product that solves their need, you can point it out. By doing so you will have helped them which means you have already provided value.
Such acts might at glance seem to go counter to your own self-interest. In reality, they build trust and increase the chance that this buyer will turn to you again should the need arise.
Method 1: The Research, Gut and Instinct Approach to Setting Value-Based Prices
The most common way companies are setting value-based prices is by learning as much as possible about the buyer, their industry, situation and goals and then make educated guesses about budgets and spending in order to arrive at a price. This is what most agencies and consultants do. It’s effective but it can take years to get good at it.
In his book, Implementing Value-Pricing, author Ron Baker recommends looking for answers to pointed questions such as:
- What is the customer’s cost of not solving this problem in dollars?
- What is the economic benefit to the customer if they solve this problem?
- How do we help the customer grow their business and be more profitable?
- How do we help make their business more valuable?
- Can price-sensitivity be affected by payment terms?
Looking beyond the client, consider:
- What do companies in this industry usually spend on marketing or what you do?
- What is reasonable that they can spend?
- Marketing as a percentage of company turnover … what budget is this coming out of?
These questions help determine the price-sensitivity of the buyer which influences what price you can ask.
You then consider all these factors to arrive at an upper and lower bound for a price. Finally, you decide on a specific price within that range.
Baker’s book includes a full list of price-sensitivity diagnosis questions and I strongly recommend picking it up if you’re interested in value-based pricing.
This approach to setting value-based prices is research-based and requires a fair bit of analysis. The benefit is that it helps you create a framework for pricing that can be applied across buyer industries and for many different clients.
Value-Based Pricing Is a State of Mind
As I’ve stated many times, consistently successful value-based pricing is a state of mind, not a method, and is based on the buyer’s way of seeing the world. To be good at pricing and charging for value, you must know what “value” is and means to your buyer. Naturally, that always starts with understanding the buyer.
Method 2: Using the Buyer’s Second Best Option to Determine Your Own Worth
While research- and insight-driven pricing is effective and helps build a value-driven culture in an agency, there are cases when you don’t want to make such an investment of your own time.
For those situations, “second best option.” is a good alternative approach. This can also be a practical way to try out value-based pricing for a pilot project. Pricing expert Mark Stiving describes this method in his book Impact Pricing.
1. Identify Second-Best Options
Start by identifying your buyer’s second-best option to your product or service. Remember that such options include not doing anything at all. The buyer can indeed make the informed choice not to buy, from anyone.
Options also include things that are different from yours but offer a kind of value you cannot provide. These include things that may seem irrelevant at a glance, which includes out of kindness cheaply hiring the buyer’s cousin’s son who’s in dire need of work experience. There might also be products that can do some of what you’re providing but which exist in different categories.
Failing to understand what customers consider to be alternatives is common, even among those who work in marketing. I was reminded of that some years ago. We went to the movies and as we were waiting for the feature to start the commercials rolled. One of the longest ads included a commercial for a bowling and games venue which marketed itself as a “perfect Friday night.”
My conclusion was that the ads selling department at the movie chain was entrenched in thinking of themselves as being in the “movie business.” This bias stopped them from realizing that they were running commercials for a direct competitor right in front of their best-paying customers!
2. List Your Advantages and Disadvantages as Viewed By the Buyer
Consider the second-best options you’ve identified, then list the things they have that are superior or inferior to your offering. This needs to be done from the perspective of the buyer. A bit of method acting might help you get in the right frame of mind:
- If I were Buyer X what would my first priority be?
- What would I worry about?
- What would my manager expect of me?
- Which are the things I would have to do to look good to my superiors?
- What does my company want to achieve?
An easy way to compile this information is to bring out the trusty old spreadsheet. Make columns for the various alternatives and then rate each of them on a number of aspects or features. Simply list one feature per row and then rate how each alternative ranks for each feature in percent. Add new rows as needed.
I’ve attached a sample sheet at the end of this article, which you can use as a starting point.
The mistake many makes when performing this analysis is to undervalue what their competitors are doing and overvalue their own distinct features. For this to work, be critical and consider what your ideal buyer values. Value-based pricing is not about what you, the seller, think is important.
3. Put a Value in Dollars and Cents on Each Feature
The next step is to estimate the monetary value of each advantage or disadvantage for your buyer. This is where gut feeling and your knowledge of the buyer and their industry comes into play. Use the insights you have about their situation and what they consider important to arrive at a number. If in doubt, go lower than your initial estimate.
If coming up with numbers is hard, try using a fixed scale of 500; 1000; 2,000; 5,000; 10,000; 20,000; 50,000; 100,000 and so on. If in doubt, round up.
4. Finally Calculate Your Value-Based Price Using Our Spreadsheet With Ready Formulas
The formula for setting your value-based prices is simple:
(your calculated price) = + (value of your advantages) - (value of your disadvantages)
To make it easier, I’ve prepared a spreadsheet. Make a copy of the spreadsheet template below, replace “Buyer X” with your buyer’s name, then input the the data you have to get the number calculated for you.
Note that there’s no true formula for a value-based price. You can’t calculate yourself into the mind of the buyer. These formulas should be seen as a way to think about value-based prices in a structured way.
The price will pop out in the yellow cell at the bottom of the sheet.
I want to stress that this number isn’t a final, magical value-based price. It’s an estimate of what a price could be based on the reasoning I’ve written about above.
If it’s vastly different from the price of the second-best options you’ve considered, you should consider why.
Remember that the buyer needs to understand why your price is higher than those of their alternative options and not view that as a problem. Doing that requires you and the buyer arriving at a conceptual agreement. You will also need to have sound arguments and a good case. Also consciously making decisions regarding how you communicate, dress and act while remaining genuinely you helps – value is about buyer perceptions.
Erring on the Side of Caution
Depending on the accuracy of your calculations, it can be a good idea to divide whatever number you arrive at with a value between 5 and 10. Value-based pricing isn’t an exact science and that needs to be taken into account. Even after dividing, your value-based price will probably still be multiples of what an hour-based price would be.
Dividing your number in such a way could in some cases result in the value-based price being less than the estimated price if you’d billed per hour. In that case and if you really need the work, go with the higher price. Chances are your competitors are calculating their prices based on hours and you’ll underbid if you charge the lower price.
When comparing the cost to price, you’ll want to aim for a factor or at least 3. That is, your value-based price is at least 3 times your own costs for doing the work. Your costs include your own or your team’s salaries (monthly salary divided by effective working time) and costs such as accountant and rent.
Some Things Just Ain’t Worth It
Once you start considering the value of what you’re selling you’ll realize that some projects just aren’t worth undertaking. Your internal cost for providing the work doesn’t exceed the value generated. In those cases, it’s best to discuss with the client the idea of transforming the project into something with a better cost-benefit ratio. Such a project with more leverage would also benefit the client more. They’ll most likely appreciate your proactivity and value your honest counsel.
Projects that cannot be made to deliver more value might just not be a good fit. It’s probably best to just leave those to agencies that are willing to perform commoditized work for a low hourly rate.
How to Present Value-Based Prices
Once you have a price ready and feel confident about it, the next step is presenting it in a way that puts it in the right context. Whether something seems expensive or not depends to a massive degree on context.
To find out more, read the fourth and final part:
Conclusion: Setting Value-Based Prices Isn’t Necessarily Hard But Requires Asking the Right Questions
If you’ve been hesitant to try presenting value-based prices in a proposal, take one of the methods above for a spin. Chances are you will be pleasantly surprised at how natural this seems once you get the hang of it.