Pricing case - how to go deep into the case and what the difference is between value and competition based approach

Question

Hi everyone,

I am struggling with pricing cases. I know that there are 3 main approaches to pricing cases: cost-based, competition-based and value-based. How I generally approach these cases is I ask for the firm's general objective (generally to make profits from that product, the sooner the better) and then I go through the three main pricing strategies and see if / where they intersect. Cost-based pricing seems relatively straightforward, but I do struggle with understanding the distinction between competition-based pricing and value-based pricing.

If for example we find that the value-added of our product vs. the next best alternative is 100 euros, we might decide to price it 50 euros higher (because of the stickiness of the demand / switching costs). But is that a competition-based or a value-based approach? I would argue it is a value-based approach (eventhough it obliged us to look at what the competition offers). But in that case, what is the competition-based pricing strategy? What concrete calculations does it entail?

Finally, cost-based pricing kicks in: our price (competition price + 50 euros) is only sustainable if it's higher than the contribution margin (as this would allow us to recover fixed costs and then to make profits).

Another problem I face is I am rather limited when answering these pricing cases. I don't really know what to look and ask for apart from computing the added value and contribution margin...

I thank you in advance for your help!

Answer 1

Hi,

It depends on the case. Sometimes you need to take into account all the 3 types of pricing and define the right strategy.

1. Cost-based pricing - you actually check what are the costs and apply the industry / target markup. You need to take into account R&D and capital costs if the case (interviewer) specifically states that. Also, the availability of patent is important, since the whole point of it is to protect your price and achieve ROI on the whole R&D pipeline (think of a pipeline of drugs where 8/10 were not launched / approved)

2. Competitors - basically it's simply benchmarking against competitors with a similar product. Make sure you take into account the segment (i.e. in premium higher price may be the proxy for quality). Since the value proposition of the competitors may be different, competitor pricing is just one of the metrics that you should take into account

3. Value-based pricing can be done in 2 ways:

For existing products, you identify what it the economic value and perceived value for the customer. Also, you compare the value proposition and features of your product vs. the VP of your competitors. If you have a significant difference in value prop - you have to define how much value you propose to the customer in $ terms. (e.g. your product may have additional customer support, better packaging, additional features and thus should be priced hire. Or it should be priced the same and you will win the market share due to these differences)
For the new products, you can calculate the closest alternatives and think how much additional value we provide by replacing them. Think of the discount airlines compared to trains or buses

4. Pricing strategy - here you define how you will price the product taking into account 1,2,3 and your company strategy. Maybe you decide to have a zero margin if you can cross-sell other services. Or maybe you would like to subsidize to win the competition. Also, think of price differentiation and having different pricing tiers (e.g. basic, premium or even freemium) and how it helps to drive price perception and fulfill strategic goals

Good luck!

Answer 2

Hi,

to complete other answer, I would say in a nutshell :

- value based is calculated on the value you create for the clients compared to other solutions. (e.g if you provide an emergency reperal to offshore oil production, you can basically compare the value of your service to the cost of production being shutdown...)

- competition based is calculated based on the pricing of competitors, the differenciation factor and the purchasing criteria to make sure your product will find customers

Best

Benjamin

Answer 3

Thank you Vlad! I understand what you mean, but really don't see what information / data precisely I should ask for when using the competition-based approach. More specifically, what calculations should I make (i.e. what business indicator should I compute). Thanks a lot for your help!