How Value-Based Pricing Can Harm Your Business

Value-based pricing has become something of a holy grail in the world of service businesses. The theory is seductive: Instead of charging by the hour or offering rigid packages, you price your services based on the value they deliver to the client. If your support helps someone generate $100k in revenue, why shouldn’t you charge $10k instead of $2k?

This approach can lead to higher margins and more premium clients, but it comes with downsides. When it doesn’t work, it can quietly eat away at your profitability, create client resentment and hold up your growth.

Related: The Price Is Right: How to Price Your Product for Long-Term Success

Why everyone’s talking about value-based pricing

Value-based pricing has gotten a lot of attention in the last few years. In short, value-based pricing is the idea that you can charge for your services based on the value it adds to the business purchasing them, rather than based on the cost of delivery for you as the service provider.

There are real reasons why this makes sense. Research shows that higher prices can increase the perceived value of your services. By undercutting your price, you may actually be devaluing your services — so there is good reason to keep your prices above rock bottom. Lower prices can attract clients looking for the cheapest option on the market, which are often the most difficult to service.

There is also compelling evidence that women tend to underprice their services in order to try to secure business, which can be exacerbated in industries historically dominated by men. The value-based pricing movement has helped to empower women to price their services closer to market or even above market standard.

If pricing is too high, customers can feel resentful after they’ve made the purchasing decision. Too often, a business owner purchases out of emotion, pays too much and later realizes they overpaid. That immediately strains the client relationship with the service provider and sometimes even results in a more difficult journey between the two parties.

Value-based pricing can work, especially when the value you provide is clear, measurable and ideally tied to revenue, like a sales consultant who increases close rates or an ad strategist who drops cost-per-lead. However, there are downsides to both the business and the market for service delivery to small businesses, especially.

Related: Did You Price Your Product Right? How to Know.

When value-based pricing doesn’t work

On the other hand, value-based pricing has often gotten out of hand. Entrepreneurs are being encouraged to continue to increase their pricing based on the maximum potential impact their services could have. More than 50% of businesses fail in their first year, and overpricing the market standard or the amount you can reasonably expect to be paid if you’re early in your business evolution can put you on a difficult path as a business owner.

It’s increasingly common to meet founders who are struggling to sell and yet are priced above market. Just because services can provide value doesn’t mean you are in a position to charge those premium prices from early on. If you aren’t selling, your pricing might just be too high, too soon in your business’s growth.

Value-based also compromises the purchasers in a way that has become detrimental to the small business market at large. As service providers continue to raise their prices much faster than their costs increase, the potential customers of these businesses are put in a difficult position.

For example, if, as a brand-new founder, you are being asked to pay $10k for a website when it only costs the provider $1k, that creates a predatory pricing situation for the customer.

It’s time for this race to the bottom to stop to protect both the customers and the service providers.

Related: 6 Strategies for Avoiding the ‘Race to the Bottom’ Price War You Don’t Want to Win

What to do instead

There are quite a few other options to integrate value-based principles while keeping things fair.

Milestone-based pricing or incentive pricing is a way for service providers to share in the benefits that their services provide, without locking customers into a high price upfront. For example, an ads specialist can charge a base price plus a per-lead or per-signing fee. This incentivizes the specialist to do their best work while enabling them to share the upside and protecting the customer from potential downside.

Modular pricing is another option for right-sizing pricing. Offering an à la carte pricing menu allows clients to choose the services they truly need, instead of being locked into choosing from one or two fixed packages.

Regardless of your pricing strategy, consider where you are in the market and where that puts your margin. If you are priced in line with your market, and your margin is in a reasonable range for your industry, you are likely fairly priced. If you’re significantly above market, making above-average margin, or if you aren’t selling as much as you want to, try one of the strategies above and observe how it impacts your sales.

It’s time that we find a middle ground where service providers are paid fairly for their time, and customers are paying a fair markup on the cost.

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