Value-based pricing aims for prices to reflect the value customers associate with a product or service offering. Simple enough to state, but what does this mean?
In the mind of a customer, the total value of an offering is the difference between the perceived benefits a customer gains in acquiring the offering and the perceived price they pay to acquire the offering.
Mathematically, we define value as
where V is for value, B is for benefits, and P is for price.
This simple equation states, from the customer’s perspective, value is the benefits gained less the price extracted.
According to this definition, if an offering delivers more benefits, customers gain more value in transacting. If it delivers less benefits, customers attain less value in transacting. In contrast, if the offering’s price goes down, customers gain value in transacting. If price goes up, customers achieve less value in transacting. That overcomes the rationality hurdle.
We use this specific definition of value because it (1) reflects the customer’s perspective to the issue of “what is a good value” and (2) it distinguishes the concept of value from benefits and price. For defining value-based pricing, this is the most relevant definition of value.
In relation to economic terms, this equation defines the total value to be the same as consumer surplus. Benefits reflects the potential industry demand function, or the potential willingness of customers to pay. And price is price.