Value Pricing: Understanding Pricing and Value (Part 1)
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Pricing is one of the most important things that will affect your business whether you are selling goods or services.
Traditionally we price things based on their cost and we add some markup that we then call profit.
Pricing a product or service based on its actual or perceived value was not common sense.
After all, it makes much more sense to sell something that costs you $10 to produce for $15 dollars. But why not sell it for $100? isn't it worth as much?
Let's define value first and its role in pricing.
Value is simply the solution your product or service provides to the end customers. The pain it solves. Value can also be thought of in terms of cost. But should not be limited to cost alone.
Generally, professional firms' revenues are based on the number of people and the hours those people worked. Thus to increase revenue these firms had two levers on which they can act: increasing the number of hours worked or the number of people. Or both.
Usually, they tend to increase the number of hours worked because that perhaps is easier and allows the firm to maximize revenue without incurring additional charges that come with hiring new people, training them and retaining them.
However, this model is not always optimal for current employees because they tend to be overworked which ultimately damages their productivity henceforth the firms' revenue in the long term.
Perhaps the way we define value in business should be reconsidered.
But before we can do that, it is imperative to understand that the argument here is not that the traditional method of defining or even creating value is pointless or ineffectual; but rather, it could be better.
Future Proof Business Model
The business model of the future is a value-driven business model. It does not merely rely on the number of people, the billable hours and the efficiency as driving factors.
It relies on factors such as intellectual capital, effectiveness and price.
Let's take a deeper look at each of them in detail.
There are three types of capital that are required in the modern business model to create value.
Human Capital, Structural capital, and Social capital. They are all important but when it comes to creating a long-term value system the latter is perhaps the most important in the eyes of the customers.
Not only because it has a more human touch but also because in the eyes of consumers it creates trust.
Human capital can be exploited in two ways when the firm utilises more of what the employees know and when the employees know more than what is useful to the consumers.
In any case, human capital is owned by an individual, not the firm.
It is also crucial to mention that intellectual capital could also be negative because when such capital is directed toward negative ends it could have and certainly does have many negative consequences on society at large.
Effectiveness VS Efficiency
According to Jack Bergstrand, the founder of Brand Velocity productivity is a combination of effectiveness and efficiency.
In his own words efficiency is doing things right and effectiveness is doing the right things.
From this, we could easily extract that the goal of any professional work shouldn't be efficiency but rather effectiveness or a combination of both.
Don't get me wrong you can still be inefficient and be very effective but it is not always the case that efficiency translates into effectiveness.
For instance, knowledge firms have usually simplified the productivity metric as a ratio of benefit over cost. So to improve productivity cutting costs would be the lever to manipulate for most of them.
However, productivity cannot be that easily computed as it is not only a matter of cost and benefit. It goes beyond that. When we look at efficiency alone, we cannot base its usefulness merely on a matter of output.
For example, is a slower car less efficient than a faster one?
There is no definite answer to that question because factors such as comfort or safety would also come into play.
Therefore efficiency alone would not be a sufficient enough measure to measure value. For instance, some professional service providers measure their productivity based on efficiency.
They would simply consider the type of technologies being used to operate.
Even though it is very important to stay up to date with the latest technologies to perform faster and better, that alone is not what ultimately creates value.
It could even be the case that your competitors also use the same technologies.
Instead what they should be doing is measuring their value based on effectiveness, which is a much more appropriate measure of value, because that's where they'll be able to create a real competitive advantage.
What I meant is that they should narrowly define what value means to them and be able to create, communicate and capture that value.
In the end, true value should not only be delivered in an efficient way but also in a useful way.
Baker, R. J. (2011). 1. In Implementing value pricing: A radical business model for professional firms (p. 40). essay, Wiley.
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