Customer-Driven Pricing

What Is Customer-Driven Pricing?

One important decision companies face is setting prices. The three major pricing strategies are cost-based pricing, competition-based pricing, and customer driver or customer value-based pricing. Customer-driven pricing is the practice of setting prices according to customers' perceived value of a company's goods or services.

The assumption basis for this model is that a customer is willing to pay a certain price when the value delivered exceeds that cost. Customer-driven pricing can work when a product or service is customizable as opposed to commoditized (e.g., corn) as there will be many options if there are many competitors offering similar products or services.

The pricing strategy can also be applied in different geographical markets, where supply and demand forces are biased toward the seller and the customer may be willing to pay more than a customer elsewhere. Customer-driven pricing is contrasted with competition based pricing - setting prices based on competitors' prices and strategies — and cost-based pricing, in which a company concentrates on reaching a margin target with little regard to analyzing customers' perceived value.

How Customer-Driven Pricing Works

To optimize pricing, companies need to consider how to best segment the market so that prices reflect the differences in value discerned by different types of consumers. To do this, companies must undertake a comprehensive understanding of how a customer values a product or service.

If it is a business, is this product or service integral to its operations, something that is absolutely necessary to keep the business running smoothly? Does it provide additional or differentiated benefits to an ordinary consumer? If so, the company may be able to set prices at premiums to increase aggregate sales.

If the company's offering is available to customers from several competitors in a given market and lacks meaningful differentiation, then customer-driven pricing is unlikely to succeed as a strategy to enhance revenues. Where competition may be thinner, even if its product or service does not distinguish itself, a company may be able to engage in customer-driven pricing because supply could be constrained relative to demand.

The customer-driven pricing strategy works well for products that appeal to consumers' emotional needs and in niche markets.

Customer-Driven Pricing in the Age of E-Commerce

In previous eras when information was not as free-flowing as today, companies had more latitude to vary its prices of goods and services among different customer groups. Product and service attributes, as well as prices, were not as transparent as they are today. This presents challenges to companies to set customer-driven prices because information advantages have been eroded.

It is still possible, though, for companies that stay current on the needs of long-standing customers to retain pricing power when they provide product or service value that exceeds the cost to the customers.