Author: Mr Lam Kwai Soon, COO and Tax Managing Director, Cheng & Co. Group
Inflation is surging. Everybody feels it. Cost of raw materials and labor increases. Raise your price and your customer may just stop buying. Keep your price as it is, and your business will suffer shrinking profitability. What then?
This is quite an ordeal. Is there a way out?
It’s common to price your product by adding a markup to your cost. If the cost goes up but the final price remains, your margin will just fade away. Raise your price, and your customers may stop buying from you. Which ones do though? If they don’t want to pay, it means either they can’t afford it or they aren’t getting what they want from you.
Logically speaking, there is no sense in continuing business with them. On the other side of the coin are customers who stay, and they do so because your products or services give them what they want, and they can afford it. Would it not be better to focus your effort on these sorts of customers?
This is the basis of value-based pricing. Under value-based pricing, your price depends on the amount that your customers are willing to pay for the value they get from using your product or services.
From Value to Price
We understand that values vary between people and across time. Therefore, you’d need to estimate roughly how much your target market values your product.
You could possibly derive that amount by surveying your target market. However, given that value can change over time, you’d need to re-assess it periodically in order to stay updated.
For example, if a customer saves RM1000 by using your product, then that could be the value of your product. If the cost of your product is RM100, then you may consider setting your price anywhere between RM100 and RM1000.
Of course, so far we’ve only used simple examples for illustration. You’d have to assess more than one customer in order to derive a more accurate value-based pricing e figure for a value.
Value-based pricing vs. Cost-Plus Pricing
Many pricing strategies exist but cost-plus pricing would be the most direct comparison because it’s the most commonly-used form of pricing. Cost-plus pricing essentially involves adding a fixed markup to the cost of your product.
For example, if the cost of your product is RM100, and your markup is 20% of your cost, then the final price of your product would be RM120.
As you can see, rather than be bound by a fixed markup, value-based pricing leaves you more room to increase the price.
Benefits of Your Products
This is where intensive marketing effort is needed. The idea is that your price is based on the value of their benefits. Therefore, your product must actually benefit your customers in the way that they expect. The great thing about value-based pricing is that it shifts the focus of your relationship with your customers from the RM spent to the benefits that they will receive.
Breaking the News to Your Customers
The most important thing to bear in mind is that, no matter how well you word this, there will be customers who won’t accept it, and just leave. However, for the ones that remain, you have a chance to turn this revenue model into a sustainable one.
You may do so by delivering quality products, and, just as crucial, communicating with your customers with plain honesty. Simple, factual statements help to foster good relations with your customers as you show them that you have nothing to hide.
It’s 2023, and prices are not going down. Why should your margin have to suffer? Pricing your products and services by value could very well improve your revenue model. If you’re unsure of how to proceed with value-based pricing, do feel free to reach our experts for further consultation.
Steps to Value-based Pricing
Many guides are available online on the steps to be taken in order to adopt a value-based pricing strategy. However, it’s time-consuming to search for and review all materials. Therefore, we’ve done some reading for you, and we’re outlining the process in the following steps:
1. Understanding the Situation Completely (360)
Every sort of planning requires a genuine, deep understanding of what is happening, and what will happen. The point of this step is to identify the gap between your customers’ expectations and the value that your products and your competitors’ products offer.
The essence of value-based pricing is that customers pay for your offerings based on how much they are valued, and that the values that you offer must be more than what your competitors are offering. Once the gap is identified, you could address the questions of the following:
Therefore, your question would center on value. This entails that you research the following:
At the end of this exercise, you should have established the following at hand:
2. Confirm Your Value and Pricing Strategy
Now that you know what value to offer, and at what price to set for such a value, it’s time to put those into an actionable plan.
Your plan should outline the following:
Right now, you’re probably asking how you could set the best price, for too high pushes buyers away, and too low pushes your bottom line to below zero.
3. Communicate Decision and Strategy
Once your strategy is finalized, it’s time to communicate it to all the parties involved. The first group of people to be educated is your own people because they are the frontliners who will have to directly relay the message to your customers, and answer all questions put forth. This can be done via emails and a series of repetitive, brief internal training sessions.
Unlike your customers, your staff members work for you, and, therefore, not only you educate them, but you may also solicit their help in getting down all likely questions and objections that your customers will respond with. This could be done through brainstorming sessions, and then compiling all questions and answers into one FAQ.
The point of the FAQ is mainly to help you and your employees to communicate effectively on the value that you provide, and that how it justifies the new prices. From then on, you’ll need to create emails, social media postings, blogposts, and any other media that you deem relevant to announce the price increase as well as the purpose of that increase.
Once your messages and staff members are ready, you may proceed with informing your customers of the price increase. Remember to be frank and honest with them, meaning that it is best to avoid euphemisms or sugar-coating words such as price adjustments.
This blog post is an excerpt from The Connection E-Magazine: SMEs Sustainability in Malaysia 2023.