Economic and Perceived Value Pricing
It is important for a firm to get its pricing strategy right because the potential impact on its net revenue is
enormous. Traditional pricing models advocate an economic approach that involves computing the firm’s
cost of goods sold (COGS) and a required profit margin that is added on top of the costs to determine the
price of the product.
Recently there has been an abundance of journal articles that advocate a perceived value approach,
whereby the value of the product to the consumer is quantified and then a profit margin is added on top of
this quantified value to determine the price of the product. For example, if the cost to make a gallon of a
radically new biocide product is $5 and the required profit margin is 100% of cost, then, using the
economic approach, the suggested price per gallon would be $10.
On the other hand, if consumers perceive that the biocide is valued at $100 because of cost savings to
the consumers, and a margin, say $10, is added on top of it, this perceived value approach would
suggest pricing the biocide at $110. Five-dollar cups of coffee or three-dollar bottles of water are prime
examples of this perceived value approach. The assumption with the perceived value approach is that the
consumers are not likely to know the cost structure of the product.
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1.) Decision on whether prices should reflect the cost of making the product, as suggested
by the economic value approach, or whether prices should reflect the perceived value
of the product
Pricing is a critical strategy that influences the demand for a company’s products or
services and hence affects its profitability at the end of each financial year. Price plays a very
important role in influencing the buying decisions of customers. Competition, costs and price
sensitivity are some of the known parameters that influence the pricing strategy of a company.
Economic value approach is one the methods that companies use to set prices for their products
and /or services (Vesanen, 2007). This method uses accounting data which enables a company
to set prices that will enable it to achieve a certain mark up on costs which in turn assist in
realizing a desired return on investment. The main advantage of this price setting method is that
it is easy to calculate since accounting data is readily available. It is easy to forecast into the
future and to budget. It however ignores certain aspects of demand as it does not take into
account consumer willingness to pay the price and price elasticity of demand. It also ignores
industry forces such as the competition. Perceived value pricing quantifies data on perceived
customer value of a product in setting prices for a product (Smith, 2011). This method is
concerned with creating additional customer value to increase customers’ willingness to pay
more in spite of competitor prices. This approach is driven by a deep understanding of
customers’ needs, customers’ willingness to pay, price elasticity and customers’ perception of
value. The main weakness of perceived value pricing is that data on customer preferences,
willingness to pay and price elasticity are not readily available and tends to be subjective. This
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approach also tends to set ridiculously high prices that encourage entry into the industry by new
players. It is apparent that none of the two pricing strategies is without weaknesses. The best
pricing strategy is one that takes into account costs of goods sold, competitors pricing and price
sensitivity parameters (Pancras, 2010).
2.) The advantages and risks of each approach, and implications they have when crafting
marketing strategy?
Economic value approach is very easy to use as it relies on readily available
accounting data on costs. The approach also aids in planning and is a good method in countering
competitors pricing strategies. This strategy can assist in achieving a cost leadership marketing
strategy. In the event that a company wants to offer its products at the lowest price possible, this
strategy will assist in achieving this goal. This strategy can however ignite unsustainable price
wars that may be detrimental to the company. It should therefore take into consideration
competitor pricing strategies before setting prices. This strategy is most ideal in fast moving
consumer goods targeting the mass market (Avlonitis &Indounas, 2007). Perceive value pricing
is a subjective pricing method since it is difficult to quantify perceived customer value. Getting
data from all actual and prospective customers of a product or service is difficult. However the
method is ideal for differentiation marketing strategy. This strategy is whereby a company
intends to differentiate itself and the products it serves in a given market segment. This strategy
is ideal for unique and specialized products and services targeting distinct market segments. It
can be used in high end markets offering unique products such as high end wines and super
luxurious cars (Garbarino & Lee, 2003).
3.) How the approach differs if you are marketing a service rather than a product
Unlike products which are tangible, services are intangible. It is therefore difficult to
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calculate costs of goods sold in a service to enable a cost accountant set a mark up. Perceived
value pricing is most ideal for services since the quality of a service is mainly perceived but
cannot be measured(Vesanen, 2007). Economic value approach even though easy to use may
not be ideal because of challenges in getting data on costs. Even when the costs can be found,
the value that clients attach to a service will definitely determine whether they will buy a
service or not. For example in a hotel, the aesthetics, ambience, friendliness of waiters,
speed at which service is offered and manner in which complaints are addressed will
influence the prices set for the various services (Calantone & Di Benedetto, 2007). Perceived
value pricing even though ideal for service should not ignore competitor pricing strategies
since competitive pricing can bring down a company. The other reason why perceived value
pricing is ideal for services is because this method is concerned with creating additional
customer value to increase customers’ willingness to pay. This approach is also driven by a
deep understanding of customers’ needs, customers’ willingness to pay, price elasticity and
customers’ perception of value (Anuwichanont, 2011).
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References
Anuwichanont, J., PhD. (2011). The impact of price perception on customer loyalty in the airline
context. Journal of Business & Economics Research, 9(9), 37-49.
