Setting a price for your goods and services can be difficult. If you overprice your products, you will lose out on potential sales. If you set them too low, you will lose out on potential income. Fortunately, setting prices doesn’t have to be a gamble or a sacrifice. To assist you in better understanding how to determine the proper prices for your audience and revenue goals, there are dozens of pricing models and tactics available.
A pricing strategy refers to a framework or technique employed to determine the optimal cost for a good or service. It assists you in setting prices that balance market and customer demand with the goal of maximizing earnings and shareholder value.
There are many steps involved in pricing; if only it were as easy to understand as it is to define.
Numerous aspects of your organization, including target audience, brand positioning, revenue targets, marketing objectives, and product features, are taken into consideration by pricing strategies. They are also impacted by outside variables such as general market and economic trends, rival pricing, and customer demand.
It’s not uncommon for entrepreneurs and business owners to skim over pricing. They often look at the cost of their products (COGS), consider their competitor’s rates, and tweak their own selling price by a few dollars. While your COGS and competitors are important, they shouldn’t be at the center of your pricing strategy.
The best pricing strategy maximizes your profit and revenue.
Before we talk about pricing strategies, let’s review an important pricing concept that will apply regardless of what strategies you use.
Price Elasticity of Demand
Price elasticity of demand is used to determine how a change in price affects consumer demand. If consumers still purchase a product despite a price increase (such as cigarettes and fuel) that product is considered inelastic.
On the other hand, elastic products suffer from pricing fluctuations (such as cable TV and movie tickets).
You can calculate price elasticity using the formula:
% Change in Quantity ÷ % Change in Price = Price Elasticity of Demand
The concept of price elasticity helps you understand whether your product or service is sensitive to price fluctuations. Ideally, you want your product to be inelastic — so that demand remains stable if prices do fluctuate.
Cost, Margin, & Markup in Pricing
To choose a pricing strategy, it’s also essential to understand the role of cost, margin, and markup — especially if you’d like your pricing to be cost-based. Let’s dive into the definition for each.
Cost refers to the fees you incur from manufacturing, sourcing, or creating the product you sell. That includes the materials themselves, the cost of labor, the fees paid to suppliers, and even the losses. Cost doesn’t include overhead and operational expenses such as marketing, advertising, maintenance, or bills.
Margin (in this case, gross margin) refers to the amount your business earns after you subtract manufacturing costs.
Markup refers to the additional amount you charge for your product over the production and manufacturing fees.
Now, let’s cover some common pricing strategies. As we do so, it’s important to note that these aren’t necessarily standalone strategies — many can be combined when setting prices for your products and services.
How to Determine Your Brand’s Pricing Strategy?
Know your costs
The first step to determining your pricing strategy is to know your costs. This includes your fixed costs, such as rent, salaries, and overhead, and your variable costs, such as materials, production, and shipping. You need to calculate your break-even point, which is the minimum price you need to charge to cover your costs.
You also need to factor in your desired profit margin, which is the percentage of revenue you want to keep as profit. Knowing your costs will help you set a realistic and sustainable price range for your products or services.
Understand your value
The second step to determining your pricing strategy is to understand your value. This means identifying the benefits and features that make your products or services unique, desirable, and superior to your competitors. You need to communicate your value proposition, which is the main reason why customers should choose you over others.
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You also need to assess your perceived value, which is the amount of money customers are willing to pay for your products or services based on their expectations, preferences, and emotions. Understanding your value will help you set a competitive and attractive price point for your target market.
Research your competitors
The third step to determining your pricing strategy is to research your competitors. This means analyzing the prices, offerings, and positioning of other brands in your industry or niche. You need to identify your direct competitors, who offer similar products or services to the same customers, and your indirect competitors, who offer different products or services to the same customers.
You also need to evaluate your competitive advantage, which is the unique benefit or feature that sets you apart from your competitors. Researching your competitors will help you set a differentiated and relevant price level for your market segment.
Choose your pricing method
The fourth step to determining your pricing strategy is to choose your pricing method. This means selecting the approach or formula that best suits your brand goals, value proposition, and market conditions. There are many pricing methods to choose from, such as cost-plus pricing, value-based pricing, competitive pricing, penetration pricing, skimming pricing, and dynamic pricing.
Each method has its advantages and disadvantages, depending on your industry, product life cycle, customer demand, and competitive landscape. Choosing your pricing method will help you set a consistent and logical price structure for your product portfolio.
Test your pricing strategy
The fifth step to determining your pricing strategy is to test your pricing strategy. This means experimenting with different prices, offers, and discounts to see how they affect your sales, revenue, and profit. You need to collect and analyze data from various sources, such as customer feedback, surveys, interviews, focus groups, online reviews, and analytics tools.
You also need to monitor and measure key performance indicators, such as conversion rate, average order value, customer acquisition cost, customer lifetime value, and customer satisfaction. Testing your pricing strategy will help you optimize and refine your price decisions based on real-world results.
Review and update your pricing strategy
The sixth and final step to determining your pricing strategy is to review and update your pricing strategy. This means evaluating your pricing performance, challenges, and opportunities on a regular basis. You need to keep an eye on your costs, value, competitors, and market trends, and adjust your prices accordingly.
You also need to consider your brand positioning, customer loyalty, and product innovation, and align your prices with your brand vision and values. Reviewing and updating your pricing strategy will help you stay relevant, competitive, and profitable in the long run.
Types of Pricing Strategies
1. Competition-Based Pricing Strategy
Competition-based pricing is also known as competitive pricing or competitor-based pricing. This pricing strategy focuses on the existing market rate (or going rate) for a company’s product or service; it doesn’t take into account the cost of its product or consumer demand.
Instead, a competition-based pricing strategy uses the competitors’ prices as a benchmark. Businesses that compete in a highly saturated space may choose this strategy since a slight price difference may be the deciding factor for customers.
With competition-based pricing, you can price your products slightly below your competition, the same as your competition, or slightly above your competition. For example, if you sold marketing automation software, and your competitors’ prices ranged from $19.99 per month to $39.99 per month, you’d choose a price between those two numbers.
Whichever price you choose, competitive pricing is one way to stay on top of the competition and keep your pricing dynamic.
Consumers are primarily looking for the best value which isn’t always the same as the lowest price. Pricing your products and services competitively in the market can put your brand in a better position to win a customer’s business. Competitive pricing works especially well when your business offers something the competition doesn’t — like exceptional customer service, a generous return policy, or access to exclusive loyalty benefits.
2. Cost-Plus Pricing Strategy
A cost-plus pricing strategy focuses solely on the cost of producing your product or service, or your COGS. It’s also known as markup pricing since businesses who use this strategy “markup” their products based on how much they’d like to profit.
To apply the cost-plus method, add a fixed percentage to your product production cost. For example, let’s say you sold shoes. The shoes cost $25 to make, and you want to make a $25 profit on each sale. You’d set a price of $50, which is a markup of 100%.
Cost-plus pricing is typically used by retailers who sell physical products. This strategy isn’t the best fit for service-based or SaaS companies as their products typically offer far greater value than the cost to create them.
Cost-plus pricing works well when the competition is pricing using the same model. It won’t help you attract new customers if your competition is working to acquire customers rather than growing profits. Before executing this strategy, complete a pricing analysis that includes your closest competitors to make sure this strategy will help you meet your goals.
3. Dynamic Pricing Strategy
Dynamic pricing is also known as surge pricing, demand pricing, or time-based pricing. It’s a flexible pricing strategy where prices fluctuate based on market and customer demand.
Hotels, airlines, event venues, and utility companies use dynamic pricing by applying algorithms that consider competitor pricing, demand, and other factors. These algorithms allow companies to shift prices to match when and what the customer is willing to pay at the exact moment they’re ready to make a purchase.
Dynamic pricing can help keep your marketing plans on track. Your team can plan for promotions in advance and configure the pricing algorithm you use to launch the promotion price at the perfect time. You can even A/B test dynamic pricing in real-time to maximize your profits.
4. High-Low Pricing Strategy
A high-low pricing strategy is when a company initially sells a product at a high price but lowers that price when the product drops in novelty or relevance. Discounts, clearance sections, and year-end sales are examples of high-low pricing in action — hence the reason why this strategy may also be called a discount pricing strategy.
High-low pricing is commonly used by retail firms that sell seasonal items or products that change often, such as clothing, decor, and furniture. What makes a high/low pricing strategy appealing to sellers? Consumers enjoy anticipating sales and discounts, hence why Black Friday and other universal discount days are so popular.
If you want to keep the foot traffic steady in your stores year-round, a high-low pricing strategy can help. By evaluating the popularity of your products during particular periods throughout the year, you can leverage low pricing to increase sales during traditionally slow months.
5. Penetration Pricing Strategy
Contrasted with skimming pricing, a penetration pricing strategy is when companies enter the market with an extremely low price, effectively drawing attention (and revenue) away from higher-priced competitors. Penetration pricing isn’t sustainable in the long run, however, and is typically applied for a short time.
This pricing method works best for brand new businesses looking for customers or for businesses that are breaking into an existing, competitive market. The strategy is all about disruption and temporary loss … and hoping that your initial customers stick around as you eventually raise prices.
(Another tangential strategy is loss leader pricing, where retailers attract customers with intentionally low-priced items in hopes that they’ll buy other, higher-priced products, too. This is precisely how stores like Target get you — and me.)
Penetration pricing has similar implications as freemium pricing — the money won’t come in overnight. But with enough value and a great product or service, you could continue to make money and scale your business as you increase prices. One tip for this pricing strategy is to market the value of the products you sell and let price be a secondary point.
6. Skimming Pricing Strategy
A skimming pricing strategy is when companies charge the highest possible price for a new product and then lower the price over time as the product becomes less and less popular. Skimming is different from high-low pricing in that prices are lowered gradually over time.
Technology products, such as DVD players, video game consoles, and smartphones, are typically priced using this strategy as they become less relevant over time. A skimming pricing strategy helps recover sunk costs and sell products well beyond their novelty, but the strategy can also annoy consumers who buy at full price and attract competitors who recognize the “fake” pricing margin as prices are lowered.
A skimming pricing strategy can work well if you sell products that have products with varying life cycle lengths. One product may come in and out of popularity quickly so you have a short time to skim your profits in the beginning stages of the life cycle. On the flip side, a product that has a longer life cycle can stay at a higher price for more time. You’ll be able to maintain your marketing efforts for each product more effectively without constantly adjusting your pricing across every product you sell.