Warren Buffett is right

Price is what you pay, value is what you get. 

Warren Buffett

Warren Buffett puts it very simply, but often those setting the price overlook this very obvious fact.

But what is value? 

Innovim Group - Exchange Value Price

Innovim Group - Exchange Value Price

In economics, there are two types of value – exchange value and use value.  Use value is the utility a consumer gains from a product.  But when setting a price, the market must be taken into account and therefore it is the exchange value that we look at and which determines the price.

The exchange value price is the price of the customer’s best alternative plus the value of the difference between your offering and that best alternative (the reference offering).

If you want to set your price higher than your competitor’s, you need to deliver more value, through the additional benefits you offer – and be able to explain those benefits to potential clients.

This differentiation value takes two forms – monetary and psychological.  Monetary value is much easier to quantify but it requires a discussion with the client to clearly understand the client’s end benefits.  End benefits are not necessarily the same as the project deliverable (e.g. the sale of a business).  What are the savings, the revenue/income increases attributable to your service (and how you deliver it)? 

Some time ago, I was looking at how a merchant bank could tie the price of the legal service offered by its external law firm to the value delivered, where the merchant bank was developing a new financial product.  The project deliverable of the law firm was the documentation associated with the financial product.  It was up to the merchant bank to sell the product to the market.  The monetary value differentiator came from the experience of the firm with the regulator, and the ability to maximise the likelihood that documentation would be approved quickly.  In turn, the reduced approval time was going to save the merchant bank considerable cost, and likely improve revenues by getting the financial product to the market quickly.  These were the end benefits.

Psychological benefits are harder to identify and quantify.  Examples are satisfaction and security.  These benefits are identified in a good value conversation.

And any conversation with a client about differential benefits needs to take into account the impact of psychological heuristics such as framing and anchoring, in order to assist the client’s understanding of the benefits – the subject of another blog post!