Perceived Value Pricing or Cost Plus Pricing?

Pricing is always a challenge for businesses. In the ideal world (from a business perspective), prices are set high relative to costs and combines make a bunch of money. In the ideal world (from a buyer perspective) products and services would be priced slightly above cost, just enough to the keep the supplier in business and innovative, but not so much that the buyer’s capital was going to fund excessive seller’s profit.

These two perspectives roughly correspond to perceived value (charge as much as you can because your product has a high perceived value to the buyer) and “cost plus” pricing where products are priced at some level above costs, usually a small percentage above cost. At the extreme of this is commodity pricing, which basically says corn is corn and the buyer wants the lowest price.

One extreme of perceived value pricing was in the news recently.  Apple paid $3 billion to buy Beats by Dr. Dre headphones.  These high end headphones, which retail for up to $450 dollars, cost only about $14 to make, a markup of 3,200%! . This, of course, is a dream margin for any business.

How can Beats get away with 3,200% margins? They have a very high perceived value to the buyer. Aligned with youth culture, the iconic Dr. Dre and music, these headphones brand the wearer as a hip, youthful music lover. It doesn’t matter that the headphones have only receive mediocre reviews; they are cool and the thing to have.

We see these margins on everything from Air Jordan sneakers, Apple computers and nearly all perfumes. Perceived value can be very profitable.

Few businesses can make products that buyers are so caught up in perceived value that they have near limitless pricing power. Try to charge and arm and a leg for notebook paper and pencils and you’re destined to failure.

Here are a few local business types in Kona that have very strong pricing power due to perceived value:

  • Specialty Agriculture
  • Urgent Care providers
  • Tow Trucks
  • Bail Bondsmen
  • Pest Control Companies
  • Star Gazing Tours
  • Helicopter Tours
  • Wedding Providers
  • Medical Specialists

All of these have scarcity—we’re on a geographically isolated island—and a high emotional value to the problems they solve. The price of beauty, health, weddings, freedom and access to remote areas give these business a strong case to price according to perceived value instead of cost plus a small markup.

Businesses that can develop ways to create a niche of high perceived value products that are in demand, will have good pricing power. The closer you come to the commodity level, the lower your per unit profits, and the higher need you’ll have to sell a large volume.

At Kona Impact, we work with businesses in Kona, Hawaii every day and often talk about product pricing with them.

perceived value