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How To Create an Effective Value-based Pricing Strategy

How To Create an Effective Value-based Pricing Strategy

Value-based pricing is a smart way to charge more for your services — but most agencies are doing it wrong. They arbitrarily quantify the value they expect customers to get from their services and end up shortchanging their business or pricing their services out of the market.

So, how do you do value-based pricing right? To create an effective value-based strategy, you need data drawn from four things: production costs, markup, willingness to sell, and willingness to pay. This article will show you exactly how to get the information required and piece everything together for an effective value-based pricing strategy.

1. Calculate your cost of production

It’s important that you charge enough to cover the costs of the resources needed to provide the service to your client. If your price doesn’t account for your service production costs, you’ll be out of business in no time.

The mistake many businesses make when calculating their cost of production is that they only pay attention to fixed costs like their salaries and forget about variable costs like one-time production expenses. If you want accurate data, you need to be as granular as possible — add up the costs of everything that goes into producing a specific deliverable for your client.

For example, let’s say a content agency is trying to figure out how much they spend to produce one blog post. They’ll need to account for their writer’s hourly fee over the period spent on the draft. They’ll also need to build in the editor’s fee, the cost of tools and software, the time spent interviewing subject matter experts, and even the one-time fee they paid to access Harvard Business Review.

2. Set your markup

Markup is the amount added to the cost of a service or product to get its cost-plus price. And it is usually calculated as a percentage of the cost of production.

To determine your markup, subtract your cost of production from your ongoing business operating expenses like taxes, salaries, loans, and admin software subscription fees like your monthly client collaboration portal payment.

For example, let’s say a business delivers five blog posts per month, the cost of producing them is $750 (that is $150 per article), and its monthly operating cost is $1,250. In that case, the markup will be: (1,250 – 750)/750 × 100 = 66.7%.

After adding your markup, the price you arrive at should be enough to cover your overall business expenses over a specific period, like a month or a year. If we build in a 66.7% markup to the $150 cost of producing a blog post, we find out that the content agency needs to charge $250 per article to break even.

3. Set your Willingness to Sell (WTS)

Willingness to Sell (WTS) is the lowest amount you can accept in exchange for your services. Anything lower, and it wouldn’t be worth pursuing a sale because you’ll incur a loss.

At the most basic level, your Willingness to Sell is your cost-plus pricing. Add your markup to your cost of production to know the lowest price you can fix to cover your business expenses. Based on our previous example, the Willingness to Sell is $150 × 166.7% = $250.

4. Find out Willingness to Pay (WTP)

On the flip side, Willingness to Pay is the highest amount your client is willing to pay for a product or service. As a business, the last thing you want is to price your services so high that nobody can afford them, no matter their value.

You can determine Willingness to Pay in three simple ways.

Administer pricing surveys

Pricing surveys help you gather quantitative feedback about how much customers are willing to pay for value. You can conduct these surveys on social media or in closed online communities or create a form and share it with your potential customers via email.

Your pricing survey question should be close ended to prevent irrelevant responses and make it easy for respondents to choose their answers. Also, describe the benefit of your productized service so respondents have enough context to choose a realistic answer. For example, you can ask:

How much will you pay for a community that provides access to C-level executives as mentors?

  1. $1,000–$1,500
  2. $1,500–$2,000
  3. $2,000 and above

Organize focus groups

A focus group is an interview or conversation with some members of your target audience to help you gather qualitative information. The insights from focus groups provide more context for qualitative responses gathered during the survey. For example, let’s say most of the respondents chose option B in your pricing survey. During the focus group discussions, you can find out why your target market is not willing to pay more than that amount of money for your productized services.

You can organize focus groups physically or virtually. The most important thing is that the participants must represent different segments of your target audience so their responses truly reflect what your audience wants.

Conduct competitor research

Competitor research helps you discover competitor pricing trends, which gives you a better idea of the highest amounts they charge for their services.

Most productized services businesses publish this information on their websites, so it shouldn’t be hard to find. Make sure you look at the prices and packages for the enterprise businesses, fast-growing businesses, and early-stage businesses in your industry, so the data is representative.

Implement your value-based strategy gradually

Once you’ve got your WTS figure and WTP figure, the right value-based pricing should be somewhere in between. Value is qualitative, and we can’t tell you exactly how much you should charge. The precise figure you quote depends on your business goals, but at least you know what amount is too high and what the least amount you can charge for the value of your product is.

Don’t switch to value-based pricing overnight, especially if you’ve already gathered some brand awareness in the market. If you want to switch to value-based pricing, start with your new clients and gradually introduce higher prices to your legacy customers.

To learn more about the value-based pricing model, check out this post where we broke down all there’s to know about it!