The Role of Value Pricing

The value at the heart of pricing strategy is not use value, but is what economists call exchange value or
economicvalue. Economic value depends on the alternatives customers have available to satisfy the
same need. Only the part ofeconomic value associated with differentiation, which we call differentiation
value, can be potentially be captured in theprice. Differentiation value come in two forms: monetary
and psychological, both of which may be instrumental in shapinga customer's choice but require very
different approaches to estimate them.

Monetary value represents the total cost savings or income enhancements that a customer accrues as a
result of purchasing a product. Psychological value refers to the many ways that a product creates
innate satisfaction for the customer. A Rolex watch may not create any tangible monetary benefits for
most customers, but a certain segment of watch wearers derives deep psychological benefit from the
prestige and beauty associated with ownership to which they will ascribe some economic worth. As the
Rolex example illustrates, consumer products often create more psychological than monetary value
because they focus on creating satisfaction and pleasure.

VALUE-BASED MARKET SEGMENTATION

Market segmentation is one of the most important tasks in marketing. Identifying and describing market
subgroups in a way that guides marketing and sales decision-making makes the marketing and pricing
process much more efficient and effective. To conduct a value-based segmentation, this is the
recommended process:

Step 1: Determine Basic Segmentation Criteria

Choosing appropriate segmentation criteria starts with a descriptive profile of the total market to
identify obvious segments and differences among them. In consumer markets, basic demographics of
age, gender, and income provide obvious discriminators. Outputs include buying patterns, customer
descriptions, a preliminary set of current customer needs, and a provisional list of unmet customer
needs. Though the eventual pricing strategy will rely on value-based segmentation, communications and
sales strategies are likely to be heavily dependent on those obvious customer characteristics on which
media choices and sales territory assignments are based.

Step 2: Identify Discriminating Value Drivers

Having preliminary segmentations in hand, you identify those value drivers the purchase motivators-
that vary the most among segments but which have more or less homogenous levels within segments.
This allows you to zero in on what's most important to each customer segment. The outputs of this step
include a number of useful building blocks for value-based market segmentation, including a list of value
drivers ranked by their ability to discriminate among customers, an explanation of why each driver adds
value, and whether customers in each segment recognize that value. The list should also include the
value the customer will receive if your product or service offering satisfies unmet needs.

Step 3: Determine Your Operational Constraints and Advantages

Experience, capital spending plans, personnel capabilities, and overall company strategy are among the
inputs to this step. The competitive strengths and weaknesses on key drivers must also be examined
closely. After this, the lists of customer needs served and unserved, the seller's advantages and resource
limitations, and competitors' abilities can be cross-referenced and compared.

Step 4: Create Primary and Secondary Segments

In theory, your primary segmentation is based on the most important criterion differentiating your
customers. Your secondary segmentation divides primary segments into distinct subgroups according to
your second most important criterion. Your primary segmentation should account for your company's
capabilities and constraints as well as customer needs. A primary value segmentation that recognizes
such a "strategic overlap" discriminates on what is likely to be the most important differentiator among
customers: the needs that have the most impact on the seller's operational constraints and whether
those needs can be satisfied profitably, if at all. Your secondary segmentation, therefore, will use the
value driver that varies the most among the sub-segments within each primary segment.

Example, two primary segments emerge: buyers needing precise timing and those who are willing to
relinquish timing control for a break on price. Within the "customer-controlled scheduling" primary
segment, three secondary segments have different needs for special service: A "brand focus" segment
requires custom services and tailored solutions.

"Consistency" segment customers, more value-driven and concerned with their own margins, insist on
getting high quality print every time but expect standard services such as proofing, binding, and
trimming.

A "unique equipment" segment has special needs such as odd trim sizes, small print orders, and
customer tailored binding, yet still wants control of the print scheduling process See Fig. 1in page 6 for
illustration.

Step 5: Create Detailed Segment Descriptions

Value-based segmentation variables can look fine to the price strategist, but segments should be
described in everyday business terms so that salespeople and marketing communications planners know
what kinds of customers each segment represents.

Step 6: Develop Segment Metrics and Fences

Metrics are the basis for tracking the value customers receive and how they pay for it. For example, car
rental companies once used a distance- based value metric and charged customers for the mileage
traveled, in addition to the time used. Fences are those policies, rules, programs, and structures that
customers must follow to qualify for price discounts or rewards. For example, minimum volume
requirements, time-based membership requirements, bundled purchase requirements. Choose metrics
and fences that establish and enforce premium prices for high value segments, and allow feature
repackaging and unbundling to appeal to low-value and low-cost-to-serve segments. Identifying value-
based segments, the metrics of pricing offerings, and the fences that maintain a price structure allow a
marketer to expand its profit margins by aligning its prices, service bundles, and capacity utilization with
the different value levels demanded by different customers.

Key Points:

 Pricing strategy focuses on exchange value, not use value. This value depends on customers'
alternatives and the differentiation your product offers.
 Differentiation value comes in two forms:
o Monetary: Cost savings or income enhancements from the product.
o Psychological: Satisfaction and pleasure gained from owning or using the product.
 Value-based market segmentation helps target marketing and pricing effectively. Here's the
recommended process:

1. Determine Basic Segmentation Criteria: Identify obvious market subgroups based on

demographics (age, gender, income).

2. Identify Discriminating Value Drivers: Determine the purchase motivators that differ
most among segments.

 Cost savings: Some segments might prioritize substantial cost reduction, while
others might be more willing to pay a premium for added features or
convenience.
 Status and prestige: Some segments might be motivated by owning brands or
products associated with social status or exclusivity.
 Lifestyle and experience: Segments seeking specific experiences or integration
with their desired lifestyle might value features or services differently.

3. Operational Constraints and Advantages: Consider your company's strengths,

weaknesses, and capabilities.

Strengths:

 Internal Research:
o Analyze your current pricing strategy: Look for historical data on how price
changes have impacted sales, customer segmentation, and profit margins.
 o Review customer feedback: Analyze customer reviews, surveys, and support
tickets to understand their perception of your price and value proposition.
 Competitive Analysis:
o Research your competitors' pricing strategies
o Identify your competitive advantages

Weaknesses:

 Internal Research:

Analyze any historical struggles with pricing: Identify instances where price changes
backfired or failed to achieve desired goals.

Assess your lack of data or clear metrics: Do you have enough data to support value-
based pricing decisions? Are your current metrics measuring customer value effectively?

Evaluate your sales and marketing alignment: Are your sales team and marketing team
communicating the value proposition effectively to customers?

Identify operational constraints: Are there any limitations in your production or delivery
process that hinder flexibility in pricing or bundling options?

 Customer Feedback:

Look for complaints about price or perceived value: Do customers feel they are getting
enough value for the price they pay?

Analyze any concerns about pricing complexity or lack of transparency: Is your pricing
structure easy for customers to understand?

Capabilities:

 Internal Resources:

Assess your data analytics capabilities: Can you analyze customer data to understand
their value drivers and segment your market effectively?

Evaluate your pricing flexibility: Can you adjust your pricing for different channels,
customer segments, or purchase quantities?

Analyze your ability to develop value-based pricing models: Do you have the expertise
to calculate the actual value your products or services deliver to customers?

Assess your sales and marketing agility: Can your team adapt their communication and
selling approach to different value segments?

 External Resources:

Consider seeking pricing consultants or experts: They can provide guidance and tools to
develop and implement value-based pricing strategies.
 Utilize industry research and reports: Gain insights into current pricing trends and best
practices in your industry.

4. Create Primary and Secondary Segments: Primary based on the most important
differentiator, secondary based on the next most important.

5. Create Detailed Segment Descriptions: Make descriptions clear for sales and marketing
teams.

Creating detailed segment descriptions is crucial for making value-based pricing

actionable. While technical terms and segmentation variables might work for pricing
gurus, salespeople and marketing teams need a clearer picture of who these segments
represent in everyday business terms. Here's how to bridge that gap:

1. Start with the Basics:

Segment Name: Give each segment a descriptive and memorable name that captures
their essence. Think "Budget-Conscious Bakers" or "Tech-Savvy Trendsetters."

Demographics: Briefly outline the segment's typical age range, income level, and any
relevant geographic or lifestyle characteristics. Think of them as broad brushstrokes.

2. Paint the Value Picture:

Motivations and Needs: What drives this segment? What problems are they trying to
solve or what desires are they trying to fulfill with your product or service? Think
beyond just features and delve into their emotional and functional needs.

Value Perception: How does this segment perceive the value you offer? Do they
prioritize cost savings, convenience, status, or something else entirely? Understanding
their "currency" is key.

3. Add a Dash of Personality:

Quotes and Anecdotes: Include fictional or real customer quotes that exemplify the
segment's mindset and priorities. This adds a human touch and makes the descriptions
relatable.

Behavioral Traits: Describe how this segment typically interacts with your brand. Are
they research-heavy comparison shoppers or impulse buyers? Do they prefer online
interactions or in-person consultations?

4. Bridge the Gap to Action:

 Marketing and Sales Strategies: Tailor your messaging and outreach to resonate with
each segment's specific needs and value preferences. Think targeted ad campaigns or
personalized sales pitches.

Pricing Nuances: Consider how pricing can reflect the different value perceptions of
each segment. Premium options might attract "Tech-Savvy Trendsetters," while value
bundles might appeal to "Budget-Conscious Bakers."

6. Segment Metrics and Fences: Develop ways to track customer value and maintain price
structures.

1. Define Segment Metrics:

Identify key indicators for each segment: Choose metrics that reflect the value drivers
they prioritize (e.g., cost savings for price-sensitive segments, ROI for business
customers).

Examples: Mileage in car rentals, revenue generated for marketing services, time saved
for productivity tools.

Consider internal metrics: Track operational costs associated with serving each segment
to optimize resource allocation.

2. Implement Fences:

Design policies to maintain price structure: Set minimum requirements or thresholds for
price discounts or premium services.

Examples: Minimum purchase quantities for bulk discounts, annual subscription

commitments for lower rates, usage limits for tiered pricing.

Balance exclusivity and accessibility: Ensure fences attract desired segments without
overly restricting access to valuable customers.

3. Use Metrics for Price Differentiation:

Analyze value received vs. price paid: Compare segment metrics to their corresponding
price levels to assess fairness and profitability.

Identify opportunities for price adjustments: Use data to justify premium pricing for
high-value segments and optimize offerings for cost-conscious segments.

Remember: Be transparent about value-based pricing and communicate the rationale

behind price differentiation to customers.
 4. Maintain Adaptability:

Regularly monitor and update metrics and fences: Adapt to changing customer needs,
market trends, and competitor strategies.

Collect customer feedback: Use surveys and reviews to understand their perception of
value and adjust your metrics accordingly.

Invest in data analytics: Leverage technology to automate tracking, analyze complex

data, and gain deeper insights into customer behavior.

Benefits of Value-Based Segmentation:

 Increased profit margins: Align prices, service bundles, and capacity with customer value
levels.
 More efficient marketing and pricing: Target different segments with relevant messages and
offers.
 Improved customer satisfaction: Deliver value that meets the needs and preferences of each
segment.