An alternative to cost-plus pricing

In my last post, I began a discussion of the shortcomings of a cost-plus pricing system. I also gave a real life example of a Brand Ladder, which we used to rightsize the prices of private label items. In reality, the Brand Ladder is the practical application of a well-trodden, ubiquitous concept within the world of strategic pricing, which is the notion of Value Based Pricing.

My own simplified, colloquial definition of Value Based Pricing is: Understand your customers' needs and how much they value your product, meet those needs and charge accordingly. Sounds easy enough, right?

Let's pretend that we are thinking of opening a hamburger stand/restaurant. There are two locations where we can set up shop.

1. We'll call the first location Cortland, in honor of a former stretch of industrial manufacturers right here in beautiful Chicago, IL. This area is recently defunct, but we will assume that it is still a manufacturing area.
2. The second location we're scouting is called North Face. It sits in the Lincoln Park neighborhood in Chicago, which is yuppie nirvana.

Off the top of your head, who do you think would buy burgers at each location?

1. Cortland - Blue collar types on a short lunch break in search of a quick, cheap meal that will fill them up for the rest of the workday.
2. North Face - Whitecollar millennials getting out of the office that want to eat at a fresh, locally sourced, quirky (i.e. non-chain) option.

Ok, now we're starting to paint a picture! I think the burgers would look something like this:

A burger that takes pride in its craft.

 VS.

In Chicago, a burger is technically a salad anyway.

What would you charge for a burger in each place?

1. Cortland needs to be quick, "good enough" in terms of quality, and provide great value. After looking at similar options to see where they're priced, $7.99 for a cheeseburger, fries, and fountain drink is fair. In and out in 20 minutes or your next burger is free. This is a high volume shop that needs a simple menu for quick customer turns.
2. North Face is has a hand-pressed patty made of a special in-house blended beef. The bun is brioche, because that is a fun word to say. Cheese is organic, usually Havarti. Avocados are extra because we harvest them from the tree we planted on the rooftop. Asparagus instead of fries because of course they have asparagus instead of fries at this place. Drinks are extra. I looked around the neighborhood and somewhere in the $12-$14 (+ drink!) range seems right.

So what is the point of this goofy example? Well, first, you should write about what you know, and I know about eating burgers. Second, I wanted to illustrate the notion of pricing to value. Think of the above example in the following way:

As value goes up, the price charged can/should go up. If you are offering a premium burger at North Face, then you should charge more than Cortland. Similarly, if you're Cortland and are offering a good but not great burger, you can't get away with charging a premium price. Either way, you have to know what your customer values before you can slap a price on it.

(Also, I'd be doing a disservice to my readers if I didn't pause for a moment and point out that this strategy is commonly called Good-Better-Best, or GBB. You have an entry level price for your Good item, a higher price for your Better item, and a premium price for your Best item. You hear this term and acronym getting thrown around all over the pricing world.)

You may be thinking to yourself, uhhhhh, hey Dan, this is a pretty simple concept. I agree. It's straightforward when you understand what your customers value. When you don't you get real-world examples like this:

Pretty obvious that the Steel item is way underpriced.

Why am I belaboring this topic that is found in virtually every pricing strategy book, conference, or course? Because the tricky part is how you actually find what your customers value. I feel that there is a gap in HOW you implement a value-based pricing system. That's actually one of the big reasons I started this blog.

This post has been fairly high level. Over time I'll get into the nitty-gritty of how to actually do some of this stuff. I'll touch on elasticity, competitor data, hypothesis testing, other sources of great pricing information, and all sorts of fun stuff. Drop any specific topics you want me to write about in the comments. Thanks for reading!