It is the same 12Oz coffee why am I paying more for one ? — a take on cost vs value based pricing

Sinduja Ramanujam
5 min readMay 17, 2021

Prologue:

I walked into Costco one day wanting to buy a bag of coffee beans. If you have been to Costco you know there is a good selection that you can choose from and they also carry a few fancy bags of beans. I was particularly confused between 2 bags and thought I should treat myself (because why not) and ended by buying both. Fast forward to the time when I am almost done with both the bags, I was wondering why they did not taste that different? Mind you I am no coffee connoisseur but I definitely drink enough to taste a stronger one vs being the same. That’s when something very interesting jumped out from both the bags both were roasted in the same Starbucks roastery and just for comparison, I paid $6/pound for the bag with the starbucks brand and $3.50/pound for the Kirkland brand (Costco’s very own brand). That got me thinking about the difference.

Introducing Cost vs value pricing. Almost all of us associate a name brand with better quality, with better craftsmanship and better image overall. This is the psyche that many companies use to their advantage and add a premium to their brand.

The conceptual framework:

Though there are many ways to price your product and companies use many pricing strategies, two very interesting ones are Cost based pricing and value based pricing.

What is Cost based pricing:

Cost based pricing is the simple act of adding a mark-up to your production cost. For example: if your goods cost $50 to make you add $20 as the mark-up and sell it to consumers for $70. Here $50 is your production cost and $20 is your product markup. As you would have already guessed this is a very straightforward pricing strategy, you simply have to add a % markup and you are done.

You can handle setting the price in two ways :

  • Full cost pricing : This takes into account variable cost (this changes based on how many units you will produce, eg: raw materials to produce your goods) + fixed cost (This does not change based on # of goods produced, eg: your warehouse rent) + % markup.
  • Direct pricing: This takes into account only the variable cost + % markup. You would want to do this if you are in a highly competitive market and need an edge.

But beware, Cost based pricing however ignores the following :

  • Customers’ Willingness to pay: this helps you determine what your product is actually worth. But ignoring this you are essentially either leaving money on the table or are in a bubble thinking customers will pay more. Both of which are not good for your product in the long run.
  • Competitor’s pricing model: If you are not the first one in the market and there is already someone who has done the homework, it is always a good idea to take some learnings from there before you set your price.

What is Value based pricing:

This is a very interesting way of handling your pricing strategy. You will need in depth knowledge of your consumers and the segment of the consumers you are trying to target. In case of variable pricing it’s very important to determine your target consumers and the segment of the population that represent eg: first time parents, high earning individuals etc. this helps you gauge the amount they are willing to pay for your service. For example: if your product costs $50 to manufacture but the target population is willing to pay $200 for it , then you have a difference of $150 to play with and you can set your selling price anywhere from $50.01 to $199.99.

Things to think about and research on when thinking about value based pricing strategy:

  • Finding your right segment: you are probably considering value based products because you think your product has a higher value for someone in a certain segment than someone else. Baby diapers aren’t very useful if I don’t have a baby at home and so it is your responsibility to find that segment where you think your target audiences are.
  • Compare with other competitions in the market: If there is a similar product in the market that has used a similar pricing technique as yours then you want to consider if you should follow the competition or take a different route altogether. Again remember there are so many things that need to go into before making that decision but competitive analysis plays a huge part in that decision.
  • Know your differentiation value: This goes hand in hand with the competitive analysis, by doing the analysis you will see one pattern emerge, your differentiator compared to what’s in the market out there. Let’s take a different lens here and wear your problem solving hat, how does your differentiator solve the customer’s problem? If directly and very effectively then you probably have an amazing product that the market and customers have been waiting for, so look no further and take the pricing route you think suits you best.

The Nexus beyond:

There are so many other ways that you can price your products ranging from demand-based pricing to break-even pricing but what’s right for your business model and your product is for you to decide based on the factors mentioned above. Here are a few companies that have adopted the Cost based and Value based pricing and have been excelling at it.

Cost based : Costco, Everlane, Walmart, Mcdonalds, etc.

Value based: Starbucks, Louis Vuitton, Trader Joes, Apple, etc.

Know of others that I have missed or should have covered in here — leave your thoughts in the comments below.

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