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How to Determine the Next Best Alternative Price for Value-based Pricing Strategy

Posted by PriceBeam on December 5, 2018

Psychological Concept - Profile of Head with Cogwheel Gear Mechanism on the Brick and Plastered Wall.

Determining the next best alternative price is an important factor of value-based pricing. The next best alternatives price serves a comparison point for companies when they determine a value-based price for their new products. Firms determine the value of their product or service by comparing to the next best alternative product or service. A product is seen as valuable if it has better features and performs better than other products in the market, regardless of what the alternative product actually costs.

Businesses use the price of an alternative as a reference point for their product, where the value of their new product is calculated by adding value to the additional features or removing value from features that have been taken away from the product. Some might think that being less valuable than the alternative is a bad thing, but if a firm feels that alternative is too expensive, then it doesn't matter if the economic value of their product is less than their competitors. 

The key here is assessing the value of the additional features offered by the product, common features with a competitor's product are not important in this case. For example, businesses need to assign values to additional features to their smartphone like its better camera or faster processor. If a competitor is willing to pay £500 for a smartphone that doesn't have those features attached, there is no need to recalculate the value of the new product the business is going to put to market because they won't pay more than £500 based on those common features the two products have. What should also be mentioned is that firms should consider reviewing the features their product offers and how each feature is better than the next best product option and estimate the difference in performance between products and decide how much these performance differences are worth to their potential customers. 

Customers will evaluate the value of two products by using another one as a reference point for the other. If one product is out of their price range, then they will choose to buy the other one. Companies need to put themselves in the shoes of customers when trying to understand what customers may decide are the next best alternatives and then set a price that reflects the value of their product relative to the next best alternative product. The use of next best pricing methods works best for businesses in markets where customers are able to buy a competitor's product instead of their own.

One thing that firms also need to consider when evaluating next best alternatives is how easy it is for potential customers to potentially switch to their product. Just because a business offers a better product than what customers currently have does not necessarily mean they will or can switch on demand. Some of the different barriers to switching products include financial, cognitive, and behavioral.

A customer may not want to switch between products for financial reasons - they made a large enough commitment to the current product or service they are using and switiching to another would seem like a waste given the investment they made on the first product. Regarding cognitive barriers, consumers may be used to doing something in a certain way and feel that a new solution is not an improvement to the current solution they are using, despite it being superior or cheaper. Examples of behavioral barriers include difficulties switching to different products or services due to existing rules or regulations where switching may be a challenge. It is vital that companies take the time to think about different switching barriers so they can predict how large the market is for their new product. 

Topics: Pricing Psychology, pricing research, value-based pricing

Written by PriceBeam

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