You’re confident about the product or service your business is offering, right? But how confident are you when it comes to pricing what you’re selling? Deciding how much to charge customers is about more than just calculating the cost of the resources you’re putting in, adding a markup, and hoping for the best. It should actually take quite a bit of thought on your part; after all, there’s a very delicate balance when it comes to pricing: set your prices too low, and you won’t be maximizing your profit potential; set them too high and you could end up driving away customers. So where do you even start? Well, you need an understanding of your target audience and competitors, but also an understanding of different pricing strategies, so you can decide which pricing strategy is best for your business.
What Is Pricing Strategy and Why Is It Important?
As with a lot of complicated ideas, there is a simple definition behind the term “pricing strategy”: basically, it’s the method that businesses use to determine the best price for their product or service in order to maximize profits. Ok, sounds easy enough, but how do you land on that “best price?” Well, you not only need to consider consumer and market demand, but you also need to remember that however you choose to price your product will give signals to your customers about how much you value your product, brand, and the customers themselves.
In fact, the whole thing is really all about perceived “value” and tapping into the things that drive consumer behavior: according to Eric Dolansky, Associate Professor of Marketing at Brock University in Ontario, “How much the customer is willing to pay for the product has very little to do with cost and has very much to do with how much they value the product or service they’re buying.”
So, a strong pricing strategy should both build trust with your customers, as well as help you work towards your business goals. If you get it right, your pricing strategy will:
- Represent value for your customers – Think about the word “cheap”: it can mean either “lower priced” or “poorly made,” right? Your pricing strategy should not simply be making your product as “cheap” as possible while still scraping by with a profit; a slightly higher price will give the impression that your product or service is of higher value, while a price that is too low can send the wrong message.
- Convince people to buy – While a price that is too low can mean that your product or service will seem “cheap” in the wrong sense of the word, a price that is too high can also drive people away. Your pricing needs to be competitive, and not be more than your target audience is willing to pay.
- Target the right customers and make them feel more confident in your product – Your pricing strategy should take into account whether your customers are seeking value or luxury, so you can price your product or service accordingly, and will make your customers feel that they are making the right choice.
All of this can add up to measurable changes in your revenue and growth rate: some studies have even shown that small differences in pricing can raise or lower revenue by as much as 20-50%, and pricing your products or services correctly can be up to 7.5% more powerful than customer acquisition. Pricing is indeed a big deal for growth, so it’s important to get a handle on which strategy is right for you; that means studying up on popular pricing strategies and deciding which is right for you!
Top Pricing Strategies to Consider
So we know what pricing strategy is, and why it’s important for the growth of your business, but how do you choose the strategy that is right for your business? First, look at different pricing strategies; there are multiple options you can choose from, so let’s take a look at the major ones; they all have different strengths, meaning it depends on what you’re selling, and who you’re selling to.
Value-based pricing
With this strategy, you set your prices according to what consumers think your product is worth; in order to set value-based prices, you must have a deep understanding of your target audience, as well as your brand’s own reputation, and you’ll need to take into account how the state of the market affects how people perceive value.
This is a very common, and often recommended pricing strategy, especially for businesses that lean more towards offering service as opposed to a product, like SaaS businesses, although you can see it being used in cases like a wedding dress being worth thousands dollars more than a prom dress. This strategy can boost customer loyalty and sentiment, but it does require that you really stay on top of who your customer base is, and their buying behavior.
Competitive pricing
This strategy basically means that you’re constantly tracking what your competitors are charging, and setting your prices in order to beat them. It can be very useful if you’re just starting out and trying to attract customers with low prices, if you’re operating in a highly saturated market and need to stand out, or if you want to build a loyal base of customers who are price-conscious. But this strategy can also be hard to sustain, especially since it requires that you have low production costs and don’t have to worry too much about your costs.
Price skimming
Businesses should be cautious about using this strategy, which dictates that you set your prices as high as possible, and then slowly lower them over time. While it can attract higher-end customers who consider themselves trendsetters, and can help you break even more quickly, this strategy can end up annoying customers who paid premium prices only to see them lowered later on, and drive them to your competitors.
Penetration pricing
Similar to competitive pricing and on the opposite end of the spectrum to price skimming, with this strategy, you’ll set your prices very low to begin with and gradually raise them – it’s almost like offering a free sample to get customers interested. The issue with this strategy is that you’ll need to make sure you build a very loyal customer base that is sure to stick around when you eventually raise your prices to start increasing your revenue.
Premium pricing
This is similar to value-based pricing, but more focused on customers who are looking for a luxury experience and are willing to pay more for something that they perceive as high-end. This strategy requires you to build brand awareness, and a reputation as selling something that is luxurious, rare, and exclusive – or even just seen as higher quality than a more generic brand (think drug store products like painkillers).
Freemium pricing
A combination of the words “free” and “premium,” this pricing model is used by businesses (especially those selling software or subscription services) that offer a basic version of their product in the hopes that they will upgrade to a higher-priced product with more features. You can use this strategy to build customer trust in your product, but you need to be careful that you don’t make the price jump to a premium version of your product unrealistic.
Cost-plus pricing
This is probably the simplest of all pricing strategies; with this model, you focus solely on the cost of your product, and add a markup in order to make a profit. For example, if you sell handbags that cost $25 to make, and you want to make $25 profit on each, you would simply price the bags at $50. This strategy really only works for physical products, and only when your competitors are using the same model, so make sure to conduct a pricing analysis (see below) to see if this model will work for you.
Dynamic pricing
You might also know this strategy as “surge pricing,” a model that allows for fluctuating prices based on demand. You’ll probably need to use an algorithm to keep up with this type of pricing, so you can take into account things like customer demand and competitor pricing in real time. This strategy doesn’t work well for subscription products, because customers will expect consistent monthly or annual payments.
Psychological pricing
Products are priced at $9.99 instead of $10 for a reason! You can use human psychology to your advantage with strategies like the “9-digit effect” (charging $99.99 instead of $100), placing a more expensive item next to the one you’re more focused on selling, putting the original price next to the sale price (“anchor pricing”), offering “BOGO” deals, or changing the font, size, or color of your pricing information. If your strength is knowing your customers’ motivations, and knowing how to appeal to those motivations, especially if these motivations are price or value-based, this strategy can be a big boost to sales.
After you’ve chosen a strategy and have begun to think more specifically about how you’re going to price your product, conduct a pricing analysis to evaluate your pricing strategy against market demand. You should do the following four things:
- Calculate the true cost of your product or service by looking at all of your fixed and variable costs, and then subtracting them from what you plan to charge for your product or service.
- Conduct market research, perhaps by using focus groups or surveys, in order to understand how your target customer base responds to your pricing strategy.
- Examine the prices set by both your direct competitors (businesses offering the exact same product or service), and your indirect competitors (those offering alternatives to what you’re offering).
- Make sure you’re following the law and being ethical, paying special attention to the ideas of price-fixing and predatory pricing.
Growth takes work! Nailing the right price for your product or service can be tough, but by thinking about what pricing strategy is right for your business, and by conducting a little analysis to make sure you’ve hit on the right one, you can boost your profits, revenue, and sales volume.