Cost-based pricing sets a price by adding a margin to what the product costs to make. Value-based pricing sets a price from the value the product creates for a specific customer compared with the next best alternative. Research on industrial and B2B firms links value-based pricing to better performance, yet most companies still price mainly on cost or on competitors' prices. The two approaches can also work together: many industrial firms use a cost-plus formula as the mechanics while setting the margin according to customer value.
Cost-based pricing, competition-based pricing and value-based pricing
Pricing research usually describes three approaches, depending on which information drives the price (Ingenbleek, Frambach & Verhallen, 2013).
- Cost-based (cost-plus) pricing. Start with unit cost, add a target margin. Simple, defensible internally and easy to apply across thousands of part numbers. It ignores what the customer would be willing to pay.
- Competition-based pricing. Set price relative to competitors' prices. Useful when products are hard to tell apart. It hands your pricing decisions to whoever prices lowest.
- Value-based pricing. Estimate the economic value your offering creates for a customer segment against the next best alternative, then set a price that shares that value. It needs customer knowledge and proof, which is why it is harder to do.
What the research says about each
Value-based pricing is linked to better performance
Liozu and Hinterhuber (2013) surveyed 1,812 professionals involved in pricing. They found a positive relationship between value-based pricing and firm performance, and no such relationship for competition-based pricing. The three pricing orientations also shaped firms' pricing capabilities differently, and those capabilities were in turn linked to performance.
For new products, a survey of 144 production and service companies found that value-informed pricing had an unambiguous positive effect on both relative price level and market performance (Ingenbleek et al., 2013). The same study adds two cautions. Value-informed pricing alone was often not enough, and the effects of cost-informed and competition-informed pricing depended on the objective, the product's advantage, relative costs and competitive intensity. Poor pricing practices could also cancel out the benefit of having a better product.
Yet most companies still price on cost
Hinterhuber (2008) reports that more than 80 percent of companies still set prices mainly on costs or competitors' prices. In a survey of 81 executives across B2B and B2C industries in Germany, Austria, China and the USA, he identified five obstacles:
- Deficits in value assessment
- Deficits in value communication
- Lack of effective market segmentation
- Deficits in sales force management
- Lack of support from senior management
In industrial relationships, Töytäri, Rajala and Alejandro (2015) found that sellers overcome barriers to value-based pricing by understanding and influencing how customers want to perceive value, influencing the value customers perceive and improving their bargaining position.
Cost-plus and value-based are not always opposites
This is the finding most guides leave out. Guerreiro and Amaral (2018) studied an industrial company and argued that using a cost-plus-margin formula does not necessarily mean pricing on cost. In B2B settings, companies often keep the simple cost-plus mechanics while setting the margin based on value. They also note that earlier studies may have misclassified such firms as cost-based simply because their formula contained a cost term.
For many manufacturers, that is the practical route. You don't need to throw out your quoting system. You need to decide margins with customer value in mind instead of a fixed markup for everything.
Value-based vs cost-based pricing at a glance
- Starting point. Cost-based starts from your cost. Value-based starts from the customer's alternative and the value you add to it.
- Information needed. Cost-based needs accurate costing. Value-based needs costing plus customer research, segmentation and proof of value.
- Main risk. Cost-based can leave money on the table when your product is worth more, and can price you out when it is worth less. Value-based can fail if the value claim is not documented or the sales team cannot defend it.
- Who owns it. Cost-based often sits with finance or estimating. Value-based needs marketing, sales and senior management working together.
- Best fit. Cost-based suits commodity items and high-volume catalogues. Value-based suits engineered products, solutions and services where the outcome varies by customer.
How to move from cost-plus to value-based pricing
You don't have to switch everything at once. These steps follow the obstacles and capabilities the research identifies.
- Pick one segment and one product line. Hinterhuber (2008) lists weak segmentation as an obstacle. Value differs by segment, so start where you understand the customer best.
- Define the next best alternative. What will the customer do if they don't buy from you: a competitor, a repair, an in-house fix or nothing?
- Quantify the difference in the customer's terms. Downtime avoided, scrap reduced, energy saved, labour hours, compliance risk. Our value proposition worksheet covers this step, and documented case studies and references supply the proof.
- Learn value through dialogue. Raja and colleagues (2020) studied two global industrial leaders, interviewing 66 people inside the firms and 12 customers and suppliers. They found that value is discovered through dialogue with customers over time, and that this learning is the base for value-based pricing and selling.
- Keep your cost-plus formula, but set margins by value. Following Guerreiro and Amaral (2018), your quoting tool can still show cost and margin. The margin is the decision that changes.
- Train and equip sales to defend the price. Remember that several people in the buying center will judge the price, each from their own angle. Value-based selling capability was linked to better sales performance in a study of 186 B2B sales leaders, and it mattered more when customer needs were complex and competition was intense (Liu, Zhao & Wang, 2023).
- Get a senior sponsor. Lack of senior management support is one of Hinterhuber's five obstacles. Pricing changes touch margins, sales compensation and customer relationships, so someone at the top has to own them.
Illustrative example (hypothetical numbers, to show the logic only): A pump supplier's unit cost is $8,000 and its standard markup would give a price of $10,000. A competing pump sells for $10,500. For a food processor, the supplier's pump is documented to avoid about $6,000 a year in maintenance and downtime compared with the competitor. Value-based logic says the price ceiling sits near $10,500 plus some of that $6,000. The supplier might quote $12,500, still leaving the customer most of the first year's savings. The cost-plus formula would have priced it at $10,000.
Pricing for industrial services and solutions
Services and solutions are where value-based pricing fits best, because outcomes vary from customer to customer. In a survey of 129 transportation and 48 IT companies, pricing-competent industrial service firms took a holistic approach, paying attention to both company and market-related pricing objectives, methods, policies and information (Indounas, 2009). Research on smaller firms points the same way: in 127 SMEs, pricing capability, built through market-focused learning and innovativeness, had a positive effect on both the value customers saw in the price and on business performance (Ranjan & Nayak, 2022).
Frequently asked questions
What is the main difference between value-based and cost-based pricing?
Cost-based pricing starts from your cost and adds a margin. Value-based pricing starts from the value the customer gets compared with their next best alternative and sets a price that shares that value.
Is cost-plus pricing bad?
Not always. It is simple and works for commodity items. Research shows that a cost-plus formula can also be used with margins set by customer value (Guerreiro & Amaral, 2018). The risk is applying one markup to products that create very different value.
Why don't more companies use value-based pricing?
Hinterhuber (2008) found five main reasons: weak value assessment, weak value communication, poor segmentation, sales force management problems and lack of senior management support.
Does value-based pricing work in industrial markets?
Studies of industrial and B2B firms link it to better performance (Liozu & Hinterhuber, 2013). Liozu and Hinterhuber (2012) also interviewed 44 managers in 15 industrial firms and found sharp differences in how firms organize pricing depending on their pricing orientation.
How does branding affect price?
Research on B2B brand equity suggests a strong brand can support a price premium, though price and delivery usually weigh more. See our guide to B2B branding for industrial companies.
The bottom line
Pick the one product line where you know your customers' economics best and calculate the value you create against their next best option. If the price you charge is well below that number, you are pricing on cost and giving away margin. AXXEN helps industrial companies build the positioning and value story that makes a value-based price defensible. For the bigger picture, see our B2B marketing strategy playbook.
About the author
Mo Farrokhi, PhD, is the founder of AXXEN in Calgary, Alberta. His path runs from electrical engineering through an MBA and a PhD in marketing to industry roles, including VP Marketing & Product at a TSX-listed clean-tech company. AXXEN builds marketing systems for technology, manufacturing and industrial companies that have outgrown ad-hoc marketing.
Sources
- Guerreiro, R., & Amaral, J. V. (2018). Cost-based price and value-based price: Are they conflicting approaches? Journal of Business & Industrial Marketing, 33(3), 390–404. https://doi.org/10.1108/jbim-04-2016-0085
- Hinterhuber, A. (2008). Customer value-based pricing strategies: Why companies resist. Journal of Business Strategy, 29(4), 41–50. https://doi.org/10.1108/02756660810887079
- Indounas, K. (2009). Successful industrial service pricing. Journal of Business & Industrial Marketing, 24(2), 86–97. https://doi.org/10.1108/08858620910931703
- Ingenbleek, P. T. M., Frambach, R. T., & Verhallen, T. M. M. (2013). Best practices for new product pricing: Impact on market performance and price level under different conditions. Journal of Product Innovation Management, 30(3), 560–573. https://doi.org/10.1111/jpim.12008
- Liozu, S. M., & Hinterhuber, A. (2012). Industrial product pricing: A value-based approach. Journal of Business Strategy, 33(4), 28–39. https://doi.org/10.1108/02756661211242681
- Liozu, S. M., & Hinterhuber, A. (2013). Pricing orientation, pricing capabilities, and firm performance. Management Decision, 51(3), 594–614. https://doi.org/10.1108/00251741311309670
- Liu, Y., Zhao, X., & Wang, T. (2023). Value-based selling capability: Antecedents and implications for B2B sales performance. Journal of Business-to-Business Marketing, 30(4), 395–418. https://doi.org/10.1080/1051712x.2023.2272985
- Raja, J. Z., Frandsen, T., Kowalkowski, C., & Jarmatz, M. (2020). Learning to discover value: Value-based pricing and selling capabilities for services and solutions. Journal of Business Research, 114, 142–159. https://doi.org/10.1016/j.jbusres.2020.03.026
- Ranjan, P., & Nayak, J. K. (2022). Examining the antecedents and consequences of pricing capability: Evidence from SMEs. Journal of Business & Industrial Marketing, 38(1), 36–52. https://doi.org/10.1108/jbim-09-2021-0451
- Töytäri, P., Rajala, R., & Alejandro, T. B. (2015). Organizational and institutional barriers to value-based pricing in industrial relationships. Industrial Marketing Management, 47, 53–64. https://doi.org/10.1016/j.indmarman.2015.02.005
