Customer-based pricing is a strategy in which businesses set prices based on the product or service’s perceived value to the customer, rather than based on how much it costs to produce the product or how much competitors charge. Customer-based pricing focuses on how much a customer is willing to pay, which can vary depending on their needs, preferences, and the benefits they see in the product.

The goal for businesses that use customer-based pricing is to create a sense of fairness and to maximise revenue by aligning their pricing with the customer’s expectations and perceived value. This strategy often involves market research, customer feedback, and an analysis of buying behaviors to determine optimal pricing points that resonate with the target audience.

Below, we’ll explain how customer-based pricing works, how to create a customer-based pricing strategy, and the benefits and challenges of using this strategy.

What’s in this article?

• Types of businesses that use customer-based pricing
  
• How to create a customer-based pricing strategy
  
• Benefits of using customer-based pricing
  
• Challenges and best practices with customer-based pricing
  

Types of businesses that use customer-based pricing

Customer-based pricing is popular in many industries, especially those in which customer value perception can be distinctly identified. Here are some industries and business types that frequently use this model.

Industries using customer-based pricing

• Software and technology: Businesses with software-as-a-service (SaaS) or technology products often use customer-based pricing. They can scale their offerings easily and differentiate pricing based on features such as premium support or additional functionalities that different segments value.

• Pharmaceuticals: Companies in the pharmaceutical sector often set prices based on the value their drugs or treatments provide, such as accessing life-saving capabilities or avoiding the cost of alternative treatments.

• Luxury goods: Brands in the luxury sector – such as high-end fashion, watches, and cars – typically price their products based on the perceived prestige and status they confer to the buyer rather than on cost alone.

• Consulting services: Consulting firms often use customer-based pricing to set their fees at the perceived value they bring to a business, such as expertise or potential revenue increase.

• Hospitality and travel: Airlines and hotels often use customer-based pricing to adjust rates based on demand, customer loyalty, and perceived value of the experience at different times or seasons.

Common traits of businesses that use customer-based pricing

• High differentiation: Businesses with highly differentiated products or services that are unique or have few direct competitors are more likely to succeed with customer-based pricing.

• Flexible offerings: Companies that can customise their products or services to meet specific customer needs or preferences can use customer-based pricing more effectively.

• Strong brand identity: Businesses with a solid brand identity or those that evoke compelling emotional connections often use customer-based pricing, as customers might perceive their products as more valuable.

• Market leadership: Market leaders or innovators in an industry adopt customer-based pricing to capitalise on their unique position and offerings before competitors catch up.

• Customer insight capabilities: Businesses with advanced analytics, customer research capabilities, or strong direct customer relationships are better positioned to use customer-based pricing.

How to create a customer-based pricing strategy

To create a customer-based pricing strategy that works for your business, you need to understand your customers – what they value, what they’re willing to pay, and how they make buying decisions.

• Conduct customer research: Look at surveys, interviews, and purchase histories to assess what matters to your customers. Find out their needs, desires, and pain points; how they use your product; what problems they’re trying to solve; and what aspects they value the most.

• Identify key segments: Break down your market into distinct groups or segments based on factors such as demographics, buying habits, or what they value most. Some customers might prioritise premium features and exclusive access, while others just want a product that works at the best price.

• Figure out what they’ll pay: Determine what each segment is willing to pay. Methods such as Van Westendorp’s Price Sensitivity Model, conjoint analysis, or just straightforward pricing surveys can help you with this. Map out how sensitive each segment is to price changes and what price feels “right” for the value they’re getting.

• Customise your value propositions: Once you know your segments, match them with value propositions that speak directly to what they care about. For example, you could have a basic, essentials-only version for price-sensitive customers and a premium version with additional features for those willing to pay more. Make sure each price point feels justified and fair to the customer.

• Set your prices: Use what you’ve learned to set prices that reflect what different groups think your product is worth. While cost-plus pricing generally has retail companies aiming for profit margins between 30% and 50%, this strategy is more about assessing how much value customers see in your products or services. You can use more than one pricing model, so experiment with tiered pricing, subscription plans, or dynamic pricing that changes based on demand or customer behaviour.

• Test, learn, and refine: Launch your pricing and pay close attention to customer reactions. Are customers going for the price points you’ve set? Are there unexpected drop-offs? Use A/B tests or trial runs to see what sticks and where you might need to tweak things. Be ready to adjust quickly based on real-world feedback.

• Communicate: Communicate the value behind your pricing and why each price point makes sense. Make sure your sales and marketing teams are able to communicate this information effectively. If customers understand what they’re getting and why it’s worth it, they’re more likely to buy in.

• Stay flexible and adapt: Keep a close eye on market shifts, competitor moves, and changes in customer sentiment. Be prepared to revisit and adjust your strategy as needed to support customer expectations and market conditions.

Benefits of using customer-based pricing

Implementing a customer-based pricing strategy can help businesses maximise revenue without compromising on customer experience. Here are some benefits of this strategy.

• Untapped willingness to pay: By looking at how customer segments value different features or benefits, businesses can capture untapped willingness to pay that a flat pricing model would miss. This approach allows businesses to charge more where the perceived value is high, and to avoid leaving money on the table by underpricing products or services that are worth more to certain customers.

• Dynamic market positioning: When you know what each segment values most, you can position your products in the market with greater precision. This precision is a buffer against competitors: your pricing becomes more closely tied to customer value and harder to undercut without replicating that specific value alignment.

• Customer loyalty: Customer-based pricing sharpens your focus on distinct customer archetypes. This focus allows for more targeted marketing and product development efforts that resonate deeply with those segments. You can introduce upsell and cross-sell opportunities that feel logical and valuable to the customer rather than forced or opportunistic. By creating a customised experience for each customer segment, you can build loyalty and customer lifetime value (LTV).

• Targeted product development: With customer-based pricing, customer insights inform pricing strategies. These insights include what features customers value, what pain points they need addressed, and how much they’re willing to pay. Customers’ feedback can also directly inform product development, and allow companies to invest in the features or products that they know will yield the highest return based on customer demand.

• Balanced margins and volume: Unlike cost-plus or competitive pricing models that often create a zero-sum game between margins and sales volume, customer-based pricing can optimise both. With different pricing tiers for different customer segments, businesses can protect their margins with higher-cost, premium options while still driving volume through lower-priced, high-value base options.

• Agile pricing: In a rapidly changing market where customer preferences can shift quickly, customer-based pricing allows for more agile adjustments. Instead of sticking to rigid cost-based or competitor-based pricing models, businesses can pivot fluidly in response to real-time market feedback and customer sentiment.

Challenges and best practices with customer-based pricing

While customer-based pricing can deliver major advantages, it also comes with challenges. Below are some of the top difficulties associated with this type of pricing – and best practices to mitigate them while launching an effective strategy.

Challenges with customer-based pricing

• Gauging how different customers perceive value: Assessing value often requires sophisticated market research techniques and continuous data analysis to keep up with changing preferences and perceptions. Misreading these signals can lead to pricing that doesn’t fit with customer expectations, which can hurt sales and brand perception.

• Segmenting the market: If businesses segment too broadly, they risk losing the nuances of customer value perception. If they segment too narrowly, they can develop overly complicated strategies that are difficult to manage.

• Clearly communicating price differentiation: Businesses must clearly communicate why different prices exist for different customer groups or product versions. Without transparent communication, customers might feel they are being unfairly charged or manipulated, which can damage trust and brand reputation.

• Balancing maximum profit margins with customer satisfaction: Overestimating what a customer is willing to pay can lead to backlash, while underestimating can mean leaving revenue on the table.

• Collecting and analysing data continuously: Businesses must continuously collect and analyse data for effective customer-based pricing. Without strong analytics infrastructure and expertise, this can lead to data overload and make it hard to extract actionable insights.

• Adapting to market shifts: Companies must continuously adapt to shifts in market conditions, competitive actions, or evolving customer needs. Their customer-based pricing strategy must remain dynamic, which can be challenging without the right systems and processes in place.

Best practices for customer-based pricing

• Invest in deep customer research and insights: Use advanced techniques such as conjoint analysis, customer focus groups, and behavioural analytics to understand what customers say and also what drives their buying decisions. This will provide you with a solid foundation for pricing decisions that align with real customer value.

• Refine segmentation strategies to find the right balance: Use both demographic and psychographic data to create actionable segments that match with differentiated pricing models. Find a good balance – segments should be distinct enough to customise pricing but not so fragmented that segmentation becomes unsustainable.

• Use dynamic pricing models where appropriate: Businesses can use dynamic pricing models to respond to real-time demand, competitor pricing, and market changes. This can be especially helpful for businesses in fast-moving or highly competitive markets. However, be cautious about how these price changes are perceived, and prioritise transparency and fairness.

• Articulate your pricing rationale: Clearly communicate the value customers receive at different pricing tiers. Equip your marketing and sales teams to explain the pricing logic in a way that resonates with each segment. Doing so can help customers feel that the price they pay is justified.

• Employ pricing technology and analytics tools for analysis: Businesses can use technology and analytics tools to help manage and analyze data effectively. Pricing software can simulate different pricing scenarios, monitor competitor pricing, and automate data-driven adjustments to reduce the burden on teams – allowing for more strategic decision-making.

• Conduct limited pilots and tests of different pricing models: Pilot and test these models with a smaller customer segment or for a limited time before rolling them out across the board. This allows you to test assumptions, gather data, and make necessary adjustments without risking a broader customer backlash.

• Leverage data to adjust your strategy: Use customer feedback, sales data, and market trends to refine and adjust your pricing strategy. Regularly review what’s working and what’s not, and be ready to make iterative changes rather than overhaul the entire strategy.

• Build a cross-functional pricing team: Build a pricing team that involves marketing, sales, finance, product development, and customer support. This team can help ensure the pricing strategy is well-rounded and realistic, and that it’s implemented effectively across all customer touchpoints.