Cost-based pricing and value-based pricing are two different ways a product manager can decide on the price of a product.
A cost-based price is the cost of producing a unit of the product plus a certain margin. For one example of applying cost-based pricing, see Adam Bullied's blog entry on the pricing new products.
A value-based price reflects the value of the product to the customer. The way I suggest pricing a product based on value is to use negative pricing.
Dr. Anderson points out that price and volume have mutual feedback effects:
Since your unit cost is changing with volume, your price will determine how much you sell. This will then impact volume which then impacts unit cost.As a result:
So what’s wrong with cost plus pricing? Simple - cost plus pricing will cause you to over-price your product when there is a weak market and will cause you to under-price your product when there is a strong market.Let me try to reconcile some of the conflict between the two approaches.
The goal that both approaches have in common is to maximize profit. Maximizing profit means finding the ideal balance of margin and volume.
With cost-based pricing, your product manager tries to find the right margin but can also take the impact on volume into account. The hazard is that all the variables are dependent, and maintaining positive margin may result in such small volume that the product isn't profitable.
With value-based pricing, your product manager uses knowledge of the competition and the urgency of the problems being solved to determine the price of the product. A product that addresses urgent problems that the competition doesn't address merits a high price. The hazard is that the value-based price of the product may not cover the costs.
It's fairly straightforward to conclude that there has to be some convergence of the two approaches. Whether it's you, your product manager, or another person in your company, someone has to project the costs and compare them to the value of the product to the customer. This analysis is part of determining whether the product is worth developing in the first place.
Either way, pricing is often an iterative process. Initial research into the market and your projected costs will almost certainly be incomplete or off target. By "testing" prices in the market, your product manager will gain further insight into what the product's true value is to the customer.