Value-Based Pricing to Reach Full Market Potential – A lesson inspired from Private Equity

There are many lessons from Private Equity that Management Teams can learn to increase market share and improve profitability. Historically, private equity firms focused on understanding a company’s operational and commercial efficiency, how it generates cash, and how it compares to its industry peers. They mainly concentrated on reducing fixed and variable costs and on increasing volumes sold to improve profitability. This internal view which emphasized on product/service costs and volumes, typically improved profitability by about 500 basis points.

Lately, Private Equity investors have been adopting an external view which targets customers and competitors to analyze the drivers of demand and the rapid shifts due to technology, regulatory, and customer trends. Moreover, they are analyzing competitor moves and the value story to predict how this will affect company performance and market share. This external view is also important to introduce new thinking into a company, particularly during times when the market is changing or turbulent.

But how will this “External View” help a company make more money?

By gaining a thorough understanding of its external environment, a company can significantly drive profitability by fully capitalizing on the market potential of its products and services. This requires a strategic approach, including identifying the needs of target customer segments, assessing their willingness-to-pay, and optimizing the product portfolio and value proposition. This exercise is known as Value-Based Pricing.

Value-based pricing has proven to be a powerful lever for enhancing company profitability. In fact, optimization of pricing strategy offers the most effective opportunities to drive profitability growth.

• A 1% adjustment in price typically results in a 10-12% change in EBITDA.
• In comparison, a similar change in volume typically leads to a 2-3% shift in EBITDA.

This underscores the significant impact that value-based pricing can have on financial performance, making it a critical focus area for maximizing value creation.

Today, many companies continue to rely on a cost-based pricing approach, where product prices are determined by the cost of production—essentially, setting a price that covers costs while considering the maximum amount a customer is willing to pay. This approach is internally focused, with an emphasis on cost. In contrast, value-based pricing is driven by customer perception and competitive dynamics, while still ensuring that costs are covered. This customer-centric model aligns pricing with market value rather than just production expenses.

The diagram below illustrates how value-based pricing reverses the traditional cost-plus pricing model by acknowledging that it is the customer who ultimately determines the value of your product, or that of your competitors. Shifting from a cost-plus to a fully value-based pricing strategy has consistently led to sales growth of 1-5%, with the resulting improvements directly impacting the EBITDA line.

Secondary market research reports provide valuable insights into the broader market landscape, but they often rely on generic, off-the-shelf data that doesn't delve deeply into the specific demand drivers or the unique needs of various customer segments. To gain a more comprehensive understanding of these factors, private equity firms typically turn to consultants. These experts conduct in-depth research to uncover the key demand drivers and understand what customers are truly seeking when purchasing a product or service. This information is often gathered through interviews with large customers and surveys targeting smaller ones. Additionally, consultants may engage with competitors to gain insights into their strategies, operations, pricing, customer segments, costs, and product offerings.

Once the Private Equity firm gains a thorough understanding of both the customer base and competitive landscape, they can determine whether they position themselves as price leaders or align with the market price. In either scenario, a value-based pricing strategy can be effectively applied.

This pricing approach focuses on segmenting customers based on their specific needs and willingness to pay, while also factoring in competitor pricing. By aligning prices with customer value, firms can drive profit optimization and enhance shareholder value worth hundreds of millions of dollars through the following key strategies:

1.?Increasing market share by satisfying the needs of various customer segments

2.?Increasing retention rate and building lasting relationships with customers through the right service/product

3.?Improving customer satisfaction, service, and loyalty programmes for future growth and profitability

4. Increasing chances of success for new products or services by understanding the value-drivers of customers through choice-based conjoint analysis surveys, hence ensuring competitive advantage

5. Training and incentivizing the salesforce to understand customer needs and have conversations that are fact-based demonstrating the value of products/services they are selling

6. Tracking competitor moves and understanding the effect on the product portfolio (commodities vs differentiated) and price according to market conditions

7.?Reviewing prices regularly and by understanding the market dynamics, plan price changes – value-based pricing is not a one-off exercise and should be repeated periodically

Whether the company is privately owned, backed by a Private Equity firm, or publicly listed, this approach drives rapid, incremental top-line growth that directly impacts EBITDA within just six months. Private Equity firms particularly favor this strategy, as it delivers faster improvements in EBITDA and cash flow than any other investment option.

At 7SagesPricing, we specialize in driving value through pricing optimization programs, with a focus on value-based pricing and market analysis for both B2B and B2C sectors. We have a proven track record of helping Private Equity-backed companies, as well as businesses across various industries, achieve significant pricing improvements.

About Author

Dr. Hiba E. , Regional Director Middle East and Africa at 7Sages Pricing,15+ Years of Experience.