Value-based pricing does not assume that one can price fully to value. How much differentiation value one can actually capture, even once it is quantified and communicated to buyers, depends on other factors. Before one can set a viable market price, one must firm understand and manage those factors.
For example, how certain is the buyer that the savings will actually be realized? This is always a big one for new pharmaceuticals, since drugs perform better in controlled trials than when real world patients take them less consistently and real world doctors prescribe them for less than ideal candidates. When the pharma company is willing to price a new product much below its potential value at the time of launch but the payer is unwilling to take the risk, pharma companies are increasing offering guarantees. In return for paying a higher price that more closely reflects the value, the payer gets a refund—or even more in the case of a recent osteoporosis drug—if the treatment fails.
There are also purely psychological factors that determine the amount of differentiation value that can be captured. One of those is the importance of the end-benefit associated with the purchase. You might happily pull out your coupon to offset part of the cost of a regular dinner with your husband or wife. But would you use a coupon for a discount if the differ were to celebrate your first wedding anniversary? Would you send a gift to a client, say an excellent bottle of wine, from a discount wine merchant or from one with a name that everyone knows charges full price? For some reason, paying fully for the differentiation value seems right when then end-benefit (use value) of something is very high.
Exhibit 6-4 on pages 132-33 of the Strategy and Tactics of Pricing, 5th edition describes eight such factors that influence the amount of differentiation value that is can be captured in the price.
- Size of expenditure: Buyers are more (or less) price sensitive when expenditures are relatively large (or small).
- Shared costs: Buyers are less price sensitive when some or all the purchase price is paid by others.
- Switching costs: Buyers are less sensitive to the price of a product the greater the added cost (both monetary and non-monetary) of switching from their current supplier (if any)?
- Perceived risk: Buyers are less price sensitive when it is difficult to compare suppliers and the cost of not getting the expected benefits of a purchase are high.
- Importance of end-benefit: Buyers are less price sensitive when the product is a small part of the cost of a benefit with high economic or psychological importance.
- Price-quality perceptions: Buyers are less sensitive to a product’s price to the extent that price is a proxy for the likely quality of the purchase.
- Perceived fairness: Buyers are more sensitive to a product’s price when it is outside the range that they perceive as “fair or reasonable”.
- Price framing: Buyers are more sensitive when they perceive the price as a “loss” rather than as a forgone “gain”. They are more price sensitive when the price is paid separately than when it is part of a bundle.
Those factors that suppress a buyer’s wiliness to pay must either be reflected in the share of differentiation value that you attempt to charge for, or must be managed through communication that changes buyers’ perception of them.
LeveragePoint uses these pricing sensitivity factors in its new Price Setting Tool. The value model (based on Economic Value Estimation™) that establishes the reference price of the next best competitive alternative and the differentiated value is imported into a pricing tool that walks the price setter through the pricing sensitivity analysis and factors in cost considerations.
