Value-based pricing: how to quantify customer value with interviews and data

Value-based pricing sets your price from what the product is worth to the customer, instead of from your costs or from a competitor's price. In practice, you estimate the money a customer gains or saves compared with their next-best option, then charge a share of that difference so that switching is clearly worth it for them. The estimate comes from interviews and the customer's own numbers, and it usually differs a lot between segments.

How value-based pricing differs from the alternatives

Wikipedia's summary contrasts it with cost-based pricing, which adds a margin to what the product costs to make. Cost-based pricing is easy to calculate and makes sure you cover costs, but it ignores what the customer would pay. Competitor-based pricing copies the market's price level, which tells you nothing about whether your product is worth more or less than theirs.

Value-based pricing is harder. The same summary lists the main obstacles: understanding what customers value, communicating and quantifying that value, and the time and resources needed to gather the customer data. In business markets, James Anderson and James Narus argued in Harvard Business Review that suppliers should build "customer value models" from field value assessments, which means gathering data about customers firsthand wherever possible. That is the core of the work: getting real numbers from real customers.

A worked example: freight invoice auditing for food distributors

Suppose you sell software that checks freight carrier invoices against contracted rates and flags overcharges for mid-size food distributors. Every number below is hypothetical. The point is the method and the arithmetic.

Step 1: Name the next-best alternative. In interviews, you learn that many distributors either check freight bills by hand or use an audit firm that is paid a share of what it recovers. For this example, assume the audit firm takes 30% of recoveries and does not reduce the distributor's own checking time.

Step 2: Estimate the value your product creates, using the customer's numbers.

One distributor tells you it spends about $4,000,000 a year on freight. From a sample of its invoices, you estimate that about 1.5% of that is billed incorrectly: $4,000,000 x 1.5% = $60,000 a year. If your software catches 70% of those errors, it recovers $60,000 x 70% = $42,000.

The accounts payable team spends about 10 hours a week checking freight bills. With the software, that drops to 3 hours, saving 7 hours x 50 weeks = 350 hours a year. At a loaded cost of $30 an hour, that is 350 x $30 = $10,500. (Check real wages for the role in the Bureau of Labor Statistics wage tables, then ask the customer what they actually pay.)

Total value to this customer: $42,000 + $10,500 = $52,500 a year.

Step 3: Compare with the alternative. With the audit firm, the distributor would recover the same $42,000 but pay $42,000 x 30% = $12,600, keeping $29,400. It saves no time. With your software, it gets $52,500 of value before paying you.

Step 4: Find the ceiling and set a price below it. The customer is indifferent when your price leaves them with the same $29,400 they would keep with the audit firm: $52,500 - $29,400 = $23,100 a year. That is the ceiling for this customer, not the target. Switching takes effort and your estimate might be wrong, so price well below it. At $15,000 a year, the customer keeps $52,500 - $15,000 = $37,500, which is $8,100 more than with the audit firm.

Step 5: Check other segments. A distributor with $1,000,000 in freight spend has a quarter of the recovery value, about $10,500 at the same error and catch rates. A single price of $15,000 would be too high for them. That points toward pricing by freight spend band, or tiered plans built around company size.

Where the numbers come from

Each input in the example is something you can research:

• The baseline. Ask how the work is done today, how long it takes and what it costs. Ask for records where possible: a sample of invoices, a time estimate from the person who does the work, or last year's audit firm statements.
• The size of the problem. Freight spend, error rates and time spent vary by customer. Collect them from several customers, not one enthusiastic one.
• Your effect. The 70% catch rate is the weakest number in the example. Measure it on a pilot using the customer's own invoices before you quote it to anyone.
• The alternative. Ask what they use now and what it costs, or what they looked at and rejected. How to interview customers who chose another product helps here.
• Who owns the money. Recovered overcharges might go to the finance budget while time savings go to operations. Ask who would approve the purchase and which of the two they care about. How to interview B2B buyers, users and champions covers the different roles.

Good questions for a value interview:

• "Walk me through the last month of checking freight bills. Who did what, and how long did it take?"
• "When did you last find an overcharge? How much was it, and how did you find it?"
• "What do you pay today for audits or for this work, and how is that calculated?"
• "If this saved you 7 hours a week, what would that time go to?"
• "Who would need to agree before you paid for something like this?"

Keep separate what people told you, what you saw in their records, and what you assumed. A value estimate built mostly on assumptions is a hypothesis to test with a pilot and real quotes. How to research willingness to pay covers that step.

Using the value estimate in sales

The same model helps you sell. Show a prospect the calculation with their own inputs and let them change the numbers they disagree with. Anderson and Narus argue that suppliers can also use value models to show customers the results they delivered over time. If you promise $42,000 in recoveries, report what was actually recovered.

Your next step

Write your customer's next-best alternative and three numbers you would need to estimate the value you create. Then schedule five interviews to fill in those numbers, and ask each person for a record that backs them up.

If you do not know people in the market, Instant Expert can find people who match a description you write, such as "accounts payable managers at food distributors." You review who it finds, it sends your invitations, and you pay only for calls that get booked. The directory pages for finance professionals in food distribution and operations professionals in food distribution are one place to start.