How you price your products shapes how customers perceive your value, how fast your business can grow and more. Two of the most widely used pricing strategies are cost-based and value-based models: one starts with your inputs, and the other starts with your impact.

Below, we'll explain how cost-based pricing and value-based pricing work, when to use each and how to combine them without compromising your margins or market position.

What's in this article?

• What's the difference between cost-based and value-based pricing?
  
• How to calculate cost-based pricing
  
• How does value-based pricing work?
  
• Can you combine cost-based and value-based pricing?
  
• Challenges with cost-based and value-based pricing
  

What's the difference between cost-based and value-based pricing?

Cost-based pricing starts with what it costs for your business to operate, while value-based pricing starts with what your product is worth to the customer. The difference can be substantial: if it costs you £10 to deliver a software product and you add a 50% margin, your cost-based price would be £15. But if that product helps a customer avoid £1,000 per month in downtime, they might gladly pay £100, £200 or more because your price reflects their gain, not your expense.

Each strategy reflects different philosophies about what drives pricing power. Here's how to calculate each type of price and determine which method is right for your business:

Cost-based pricing

Cost-based pricing is business-centric. You begin with what it costs to produce or deliver your product, then add a markup to cover overhead and generate profit.

The pricing process is mostly internal. You sum your fixed and variable costs per unit, add a fixed margin (e.g. 50%) and set the resulting number as your selling price. There's no need to consider competitor prices or customer expectations, though many businesses layer those in as a sanity check.

Cost-based pricing is useful when:

• You sell commoditised products with little differentiation
  
• Costs are predictable and margins need to stay tight
  
• You have limited access to customer insights or pricing data
  

Value-based pricing

Value-based pricing is customer-centric. You determine how much value the product creates for the customer – measured in time saved, revenue earned, convenience gained or risk avoided – and price accordingly.

Value-based pricing requires external research. You need to understand how customers use your product and what outcomes they care about, estimate how much financial or emotional value those outcomes represent and choose a price that lets the customer capture some of that value while you capture the rest. This exercise often results in tiered or segmented pricing, in which you charge different prices to different customer segments based on perceived value.

Value-based pricing works best when:

• Your product delivers relevant outcomes
  
• Customers vary in how much value they receive (and are willing to pay for)
  
• Customers recognise your product differentiation and would pay to access it
  
• Switching costs are high or alternatives are weaker in your market
  

It's especially common in software-as-a-service (SaaS), healthcare, financial services, education and any category in which the product can substantially affect costs, revenue, time or peace of mind.

Cost-based and value-based pricing can work. But they solve different problems, and which one you choose can shape how you think about business growth, market positioning and product design.

How to calculate cost-based pricing

Cost-based pricing is one of the most common pricing methods, especially in retail, manufacturing and services with predictable cost structures.

Here's how to calculate prices using this method:

Start by calculating your total cost per unit

This includes:

• Variable costs: Anything that scales with production, including materials, direct labour, packaging and shipping.
  
• A share of fixed costs: Rent, salaries, equipment and software subscriptions, allocated across the number of units you expect to sell.
  

For example, if it takes £4 in materials and £1.50 in labour and you allocate £0.50 of fixed overhead per unit, your total cost is £6 per unit.

Choose your markup

Markup is the amount you add to your cost to provide profit, and it's often expressed as a percentage of cost. The right markup percentage depends on your industry, your pricing power and what your customers expect. Some businesses use a standard margin across all products, while others vary margins by category, season or channel.

Calculate your price

Formula: Selling Price = Cost + (Cost × Markup)

For example, a product that costs £6 to make and is sold at a 50% markup would be calculated as:

• £6 + (£6 × 0.50) = £9 price
  

You now have a price that covers costs and delivers a target profit per unit.

Pressure-test the price against the market

The biggest risk with pure cost-based pricing is that it ignores demand and competition:

• Are customers willing to pay this price?
  
• Are competitors charging substantially more or less for a similar product?
  
• Does your price reflect the perceived quality or value of your offer?
  

If you're underpricing relative to the market, you might be leaving money on the table. If you're overpricing and don't have clear differentiation, you might be pricing yourself out of the sale. The smartest use of cost-based pricing is as a starting point. Then you can adjust it based on customer insights, competitor benchmarks and market dynamics.

How does value-based pricing work?

Value-based pricing focuses on what the product is worth to the customer. That affects how you price, segment and market your products.

Here's what the process looks like:

Identify the value you're delivering

Understand what measurable impact your product has on customers:

• For a B2B product: How much time does it save? What kind of errors does it prevent? How much revenue does it help generate or retain?
  
• For a B2C product: What emotion or experience does it provide? What habit or need does it replace? What would someone otherwise spend to get a similar benefit?
  

Quantify that value

Once you understand the outcomes your product delivers, assign a pound value – or at least a range of values.

That value can come from:

• Internal benchmarking (e.g. our software reduces churn by 4%, which is worth £X in saved revenue)
  
• External comparisons (e.g. a consultant would charge £Y to deliver the same insight)
  
• Customer feedback (e.g. "this replaced three other services we were paying for")
  

Understanding the upper limit of what the product is worth gives you a maximum price to work down from and reveals pricing power you won't see from cost-based pricing alone.

Set a price that reflects the value

A value-based price sits somewhere between your cost floor and the customer's value ceiling. You want them to feel as though they're getting a return on the price they pay, whether that's return on investment (ROI) in pounds or a worthwhile upgrade in experience, convenience or results.

In practice, this often means:

• Tiered pricing, in which basic, pro and enterprise plans offer increasing value
  
• Segment-specific offers, in which non-profits, start-ups or large teams get custom pricing based on context and willingness to pay
  
• Usage-based models, in which billing is tied to activity, volume or results achieved
  

These pricing structures make it easier to match what you charge with the value a given customer gets.

Communicate the value

Value-based pricing works only if your customers see the value. You need to frame the price in terms of what they gain.

For example:

• If your platform saves a team 80 hours per month, show how that translates into savings or freed-up headcount.
  
• If your security tool prevents an incident that would cost £100,000, that context matters more than a feature checklist.
  
• If your brand earns customer loyalty in a crowded space, make sure your price signals that quality and differentiation.
  

A product that's £200 per month can feel like a steal or a splurge depending on how clearly the stakes and payoff are articulated.

Value-based pricing can be difficult to implement for multiple reasons:

• It requires real research: customer interviews, usage data, competitor benchmarks and some ability to translate outcomes into pounds.
  
• Value is subjective. One business might see a key workflow solution, while another sees a nice-to-have reporting tool. Their willingness to pay will be different.
  
• What a customer is willing to pay can shift with economic conditions, competitive alternatives or internal priorities, and that is likely to change over time.
  
• If your team isn't aligned on value (if sales leads with discounts or product leads with features), it's hard to make the pricing stick.
  

But when it works, value-based pricing creates room for better margins, stronger product-market fit and pricing that increases as your impact grows.

Can you combine cost-based and value-based pricing?

Many businesses combine cost-based and value-based pricing, whether they realise it or not. Blending the models often leads to more grounded decisions that drive higher profits.

A hybrid model works best when:

• You're selling a mix of commoditised and differentiated products
  
• You have diverse customer segments with different needs and budgets
  
• Your product delivers high value to some users but not all
  
• You want to simplify internal pricing decisions without leaving revenue on the table
  

In these cases, cost-based pricing gives you stability, while value-based pricing helps you stretch your margins where the market allows.

‍Here's how a hybrid method works in practice:

Use cost-based pricing to define your floor

Start by figuring out the minimum viable price. What do you need to charge to cover your costs and hit a sustainable profit margin? That baseline ensures you're not pricing below what it takes to stay in business, especially if your margins are tight or variable.

Use value-based pricing to define your ceiling

What's the highest price the market could support, based on the real value your product delivers? If customers are getting £1,000 of benefit from something that costs you £50 to deliver, your markup doesn't have to stop at times two. You have room to capture more of that upside – as long as the customer still comes out ahead.

Choose a price that reflects both

Once you've defined the range between your cost floor and value ceiling, you'll need to choose a price between those numbers. Based on your business strategy, market dynamics and customer segmentation, you might:

• Set different prices for different tiers, matched to the value delivered
  
• Charge cost-based prices for some product lines (such as basic add-ons) and value-based prices for others (such as core or premium offerings)
  
• Start with a cost-based price, and increase it as you build more value into the product or gain pricing power
  

Combining these models means grounding your pricing in business reality while still matching it to the value your customers see.

Challenges with cost-based and value-based pricing

Cost-based and value-based pricing have trade-offs – some structural, some behavioural. Knowing where each model tends to break down can help you avoid missteps. Here's what to watch for with each one:

Cost-based pricing

• Ignores customer willingness to pay: You can set a price that covers your costs and meets your margin target and still miss the market entirely. If customers aren't willing to pay that price, it doesn't matter how sound your maths is.
  
• Misses out on upside: If customers would have happily paid more, cost-plus pricing won't capture it. It locks you into a markup rather than asking what the product is worth.
  
• Overlooks competition: Cost-based formulas rarely account for what else is out there. You might end up charging more than a better alternative or less than a weaker one simply because your costs differ.
  
• Creates pricing inertia: When you rely on a fixed markup, you stop asking whether the price still fits the market. That makes it easy to fall behind or overcomplicate the situation as costs shift.
  
• Can reduce cost discipline: When you know you'll always add a margin on top of your costs, there's less urgency to improve efficiency. That mindset can creep in and compound over time.
  

Value-based pricing

• Is resource-intensive: True value-based pricing requires deep market research to understand how people use your product.
  
• Relies on subjective value judgments: Different customers perceive value in different ways. That variability makes it difficult to land on one clear price, especially if you're serving more than one segment.
  
• Is subject to shifts over time: What your product is worth to customers isn't static. Economic conditions, new competitors and changing customer priorities can all change willingness to pay.
  
• Can risk alienating customers: If you misread what customers value or how much, they could ignore your price, churn or downgrade. The consequences of bad value pricing are often worse than a miscalculated cost-based pricing model.
  
• Requires careful internal alignment: Sales teams need to know how to sell the value. Product teams need to know how pricing ties to outcomes. Finance needs to model for ranges, not fixed markups. It's a mindset shift across the entire business.
  

Many businesses benefit from building fluency in cost-based and value-based pricing: knowing when to lead with one and how to course-correct when it stops working. Pricing needs regular tuning and a strategy that evolves with your business.