The Ultimate Guide to Pricing Strategies
Learn how to set a product pricing strategy that will drive revenue and increase your profits.
Remember the story of Goldilocks and the three bears? She might have been onto something, even though her story didn’t end so well.
As a business owner, you’re well aware of the issues that can result from poor pricing strategies. Price things too expensively and customers won’t purchase from you. Too cheap and your cash flow will suffer.
How can you perfect your pricing methods so that you stay in the comfortable ‘Goldilocks zone’ in the middle?
Find out as we break down the essentials of product pricing strategies below!
What is a pricing strategy?
A pricing strategy is a methodology that a business uses when ascribing the cost for their products or services.
There are three fundamentally different pricing strategies:
- Set the price above your competition
- Set the price the same as your competition
- Set the price below your competition
When you choose to make your prices more expensive than your competition, it’ll mean two things. First, it may allow you to make more money than the competition. But, secondly, it’ll require you to offer better features or terms than your competitors. It goes without saying that customers won’t be very likely to pay more for the same service. You’ll need to be better than your competitors if your pricing strategy will mean higher prices than the competition.
On the other hand, a competitive pricing strategy that has your goods or services coming out as more affordable than your competitors may seem counter-intuitive since your profits might take a hit. But, the reason you may want to use pricing methods like that is that an attractive price on a product may get customers through the door where other, more expensive goods or services can be offered.
Finally, product pricing strategies that place yourself in line with your competitors are useful if you’re able to make up for the likeness with a unique marketing strategy. For example, social media marketing allows for a great degree of individuality to be expressed, which can help you stand apart from the crowd even if the goods you’re selling are comparable to your competition.
How does pricing affect the marketing mix?
The marketing mix is a basis for creating a business model and is composed of what are referred to as the ‘4 Ps’.
The 4 Ps are:
For the sake of this article, we’ll focus on the second ‘P’ – price. In relation to the overall scheme of the marketing mix, the price factor can refer to several concepts. Yes, it relates to the monetary cost that customers pay in order to obtain what you’re selling. But it also might refer to the secondary costs that customers will have to pay such as the time taken to make the purchase, the amount of effort it takes to complete the transaction, the lost opportunity of earning money during that period of time, and so on.
Besides the actual costs involved, you must also consider the perception of value that customers hold with respect to your goods or services. It’s not just about the dollar amount or the other losses that customers may or may not be willing to take to make the purchase. A pricing strategy must also be shaped around the way customers view your value in comparison to the rest of the market.
What does all of that have to do with the rest of the marketing mix?
All four factors in the marketing mix are interrelated. The pricing strategy you choose for your business will ultimately affect and be affected by the other three factors.
- The details of your product (quality of material, packaging, services,etc.) will influence the price
- The price may impact the investment you want to make in promotion – is Facebook enough or should you advertise with a billboard?
- The place of business can make a difference to which products you choose to offer and how you price them as well
This is a fairly cursory overview of the marketing mix and how pricing fits into it. If it’s still a bit abstract for you, just scroll down for our list of the top types of different pricing strategies.
6 types of pricing strategies
Stressed about coming up with a pricing strategy for your business?
There are many different pricing strategies that you can pick from – so there’s no need for you to reinvent the wheel. With dozens of pricing methods out there, we’ve done the work of narrowing it down to a list of 6 strategies so that the selection will be easier for you. Keep in mind though that you can mix pricing methods together, it doesn’t necessarily have to be one or the other.
Top 6 pricing methods for small businesses:
- Psychological pricing
- Cost-plus pricing
- Penetration pricing
- Value-based pricing
Let’s take a closer look at each one of these product pricing strategies…
Price skimming is a pricing strategy used to recover the cost of the initial investment of a newly released product or service. In essence, that means entering the market with a high price tag in order to capitalize on the relatively short period of time that customers view the new goods as unique, exclusive, and/or high quality. As time passes and competitors release similar products or services, the price gradually gets reduced in order to maintain the volume of sales.
We’ve all seen price skimming strategies in action – just think back to the release of any new video game console. For example, the introductory retail price for the Sony Playstation 4 was $600, and within 48 hours of the 2006 release day, there were more than 600,000 units sold. Today, the price for a PS3 console on Amazon is under $150.
♦ The benefits of price skimming are that it helps recover the funds that were put towards product development by maximizing revenue. Another benefit of this pricing method is that the customers who were initially unable to afford the product will be drawn in to make a purchase when the prices finally do drop. By then, they feel that they’re getting an incredible deal on a product that ‘should have’ cost more.
We can sympathize if you aren’t a big fan of words like ‘guesstimate’ – but freemium (a combination of the words free and premium) is one of the most effective types of retail pricing strategies. If you have any games on your smartphone you’re probably familiar with the concept. The product or service (the game, in this case) is accessible with no associated cost; you can play as much as you want without spending a dime. But in order to gain access to more exclusive features, you need to pay.
Become also uses something similar to the Freemium pricing strategy. Small business owners can apply for financing through Become at absolutely no cost. Customers of Become only ever have to pay if they decide to proceed with a loan offer.
♦ The benefits of the freemium pricing method are:
- Ability to increase audience size quickly and with no risk on behalf of the customer
- Opportunity to turn that audience profitable through upselling
- Potential to monetize the free service by advertising for other businesses
- You also get a free audience to run beta tests
3. Psychological pricing
Have you ever wondered why supermarket price tags almost always have a number like $19.95? Why don’t they just write $20? The underlying reason is the core principle of psychological pricing.
This pricing strategy is based on the idea that people will often make purchases based on emotion rather than logic. There are several approaches to psychological pricing. One of the theories is that since people read prices from left-to-right, the number at the beginning of the price registers before the number at the end. So if someone sees a sign that says $20 and a sign that says $19.95, it’s not the actual price difference that pushes them towards the latter – it’s the fact that the ‘1’ registers in the brain as cheaper than the ‘2’.
There’s another theory of psychological pricing that claims a price ending in an odd number (1, 3, 5, 7, or 9) appears more attractive to the customer than a price ending in an even number. So, according to this theory, a price tag that reads $19.99 will generate more sales than a price tag that reads $20.00.
♦ The benefit of this retail pricing strategy is that you, the business owner, aren’t really losing anything in the process (just a few pennies here and there). Some of the other pricing strategies require you to make some sort of sacrifice such as alienating a certain segment of customers who won’t be able to afford the cost of your product or services. Psychological pricing doesn’t necessitate taking a significant loss on your part, nor does the customer get the short-end of the stick.
4. Cost-plus pricing
Of all retail pricing strategies out there, cost-plus pricing is one that business owners find to be most intuitive. As the name of this pricing method suggests, you’d calculate the overall production cost of your goods and then mark up the price by however much you want to profit.
For example, if you make hats that cost $20 to produce and you want to make $15 profit from each hat you sell, you’d set the price at $35 and be making a profit of 75% the cost of production.
♦ The benefit is that you can set a clear goal and be certain that your pricing strategy is contributing directly to that end. The reason this is one of the more popular retail pricing strategies is that it works well with selling physical goods. On the other hand, service-based businesses generally provide much higher value than the cost of producing the service, which is why it’s not the greatest pricing strategy for those industries.
5. Penetration pricing
Penetration pricing is essentially the inverse of price skimming. Where skimming starts high and drops the price over time, penetration pricing is the practice of starting with a very low price when you enter the market and then gradually raising the price as time passes. As the name suggests, the goal is to penetrate the market and draw lots of customers away from your competition, and then hopefully maintain their loyalty as you bring the price up incrementally.
♦ The benefit is that you’ll disrupt the market and potentially take a big chunk of the business away from your existing competition, even if you miss the opportunity to make more profit in the process.
6. Value-based pricing
Also referred to as perceived-value pricing, this pricing method is focused on the value that customers feel your product or service offers. This contrasts sharply with cost-plus pricing, which takes into account the production cost of your goods. So, if you make hats that cost $20 to produce, with the value-based pricing strategy you would sell the hat at the price that your customers are willing to pay. That might mean selling for just a bit more than $20, or it could mean setting the price at much more than $20.
Some of the best examples of value-based pricing can be seen throughout the fashion industry. It’s no real secret that high-end brands such as Armani Exchange can sell t-shirts for $80, while stores like Gap sell their t-shirts for around 25% the cost. It’s not that Armani is using gold threads in their clothing – it’s the customer’s perception of value that allows them to sell their items at a much higher price than their more affordable competitors.
But it’s not all about marking up the price just because you can. In fact, value-based pricing can meant the exact opposite. If the market shifts in such a way that competition rises or a recession hits, you may choose to reduce the cost of your goods or services to express your solidarity with your customers.
♦ The benefit of value-based retail pricing strategies is that, when used correctly, customers will be more likely to remain loyal to your business since they feel that you’ve remained loyal to them. Again, the focus of this pricing strategy isn’t about the objective cost of the product – the focus is on the subjective perspective that the customers have about the deal they’re getting. Of course, that requires you to invest more time in staying in touch with how your customers feel about the value of your goods or services.
Pricing strategies come in many other variations than the select few that we provide above. And even the handful that we did discuss can be combined in uniquely useful ways. With such a wide variety to pick from, how can you make the right choice?
We’ll cover the best pricing strategies for different industries next.
Choosing a pricing strategy: Which is best for your industry?
The same way that there’s a difference in the kinds of loans according to industry type, there are different pricing strategies that are better applied for different sorts of businesses. Likewise, just how you’d use certain business loans in certain situations and other types in other contexts, you should also weigh the differences between pricing strategies to find the one that’s best for your business’s needs.
Construction business pricing strategies
Construction pricing is full of variables that require careful calculation as well as consideration. There’s the cost of materials, labor, planning, and so on. You’ll also want to take into account the size of the project – if it’s very large you may want to take a construction business loan, which will bring the cost of the interest into the mix.
♦ Best construction business pricing methods: Cost-plus pricing, Value-based pricing, and Psychological pricing
eCommerce business pricing strategies
Picking the right retail pricing strategy for your eCommerce business may be easier than it would be for a brick-and-mortar store since you’re not factoring in rent, utilities, insurance, and many other expenses. But it’ll still take an effort to find the right balance for your online sales. Competition in the eCommerce industry continues to intensify as the number of eCommerce businesses has steadily grown over the past few years. The most successful pricing strategy for your eCommerce business makes the most of the advantages that digital technology presents.
♦ Best eCommerce business pricing methods: Cost-plus pricing, Psychological pricing, and Penetration pricing
Not sure if you’re e-commerce pricing strategy is working? You can use BeProfit – Profit Tracker to accurately measure your Shopify store’s expenses and revenue.
With a clear picture of your store’s complex data, it’s easy for you to pinpoint spikes or dips in your profits, and then compare those changes to adjustments you’ve made in your pricing strategy. The BeProfit Shopify calculator finally brings your finances into focus, allowing you to make data-driven decisions that optimize your profits.
SaaS business pricing strategies
Software as a Service (SaaS) doesn’t have ongoing production costs or expenses associated with conducting the service itself. Compared with other competitive pricing strategies, the cost you assign to your SaaS should reflect the value of the service provided along with competitor prices and the customer’s perceived value.
♦ Best SaaS business pricing methods: Freemium, Penetration pricing, and Value-based pricing
Trucking business pricing strategies
Choosing the right pricing strategy for your trucking business means including the variable costs of fuel from state-to-state, the value of the goods being shipped, the distance being driven, and many other dynamic factors. That’ll often mean taking principles from several pricing strategies to mix into one. If you’ve decided on your trucking pricing methods and you’re still having a hard time meeting your financial goals, consider trucking financing options that can give you the boost your business needs.
♦ Best trucking business pricing methods: Cost-plus pricing, Value-based pricing, and Psychological pricing
Product pricing strategies
Physical products have costs associated that don’t apply to service-based businesses, including production, shipping, storage, and more. Your product pricing strategy should cover those costs as well as the ongoing expenses involved in developing new/improved products, market research, and (of course) generating profit.
♦ Best product pricing strategies: Cost-plus pricing, Psychological pricing, and Skimming
Service business pricing strategy
Many service-based businesses such as contractor work have costs that can’t always be measured in an objective or consistent manner. For example, the project size may impact the pricing strategy, or the service you provide may be difficult to find elsewhere, or you might charge a higher rate to fit one more job into an already-full schedule.
♦ Best service business pricing methods: Value-based pricing, Skimming, and Cost-plus pricing
The price is right
You’ve got plenty of information here that’ll help you choose the right competitive pricing strategy for your business, now get to it! As a reminder, you may wind up using different pricing strategies at different times or even combine them together. Each business will find certain pricing methods to be more useful than others, so don’t feel pressured to pick one or the other – it’s also about doing some trial and error to find that ‘Goldilocks zone’ we referred to in the intro.
Picking the right pricing strategy requires insight, so be sure to share this article on social media with other small business owners so they’ll also have the info they need to make the right decision.