Introduction
When starting a company, most entrepreneurs focus their creative energy on developing an idea and turning it into a sellable product. However, before you can start selling any product or service, you need to determine its value. This is where pricing strategy comes into play.
A pricing strategy is a method for determining the price of a product. An effective pricing strategy takes into account revenue, profit, consumer behavior, and business objectives. It also requires you to consider human psychology and how it affects price perception.
Read on to learn about the importance of competitive pricing and how to choose the best pricing model for your business.
Table of Contents
15 Common Pricing Strategies for Small Businesses
How to Choose a Pricing Strategy
Examples of Pricing Strategies
Find the Best Pricing Strategy for You
FAQs About Pricing Strategies
15 Common Pricing Strategies for Small Businesses
1. Cost-Plus Pricing
Cost-plus pricing, also known as profit pricing, is the easiest way to determine a product’s price. You make the product, add a fixed percentage on top of the costs, and sell it for the total. For example, if you just started a business selling t-shirts online and want to calculate the selling price of the shirt. The cost to make the t-shirt is:
Material cost: $5
Labor cost: $25
Shipping cost: $5
Marketing and administrative costs: $10
Then you can add a profit margin – for example, 35% – to the total of $45 it cost to make the product. This is what the formula looks like:
Cost ($45) × [1 + Profit (1.35)] = Selling Price ($60.75)
Advantages: The pros of cost-plus pricing are that it is relatively easy to calculate. You are already tracking production costs and labor costs. After that, just add a percentage on top to determine the selling price. It can provide consistent returns if all your costs remain stable.
Disadvantages: Cost-plus pricing does not consider market conditions such as competitor pricing or perceived customer value.
2. Competitive Pricing
Competitive pricing refers to using competitors’ pricing data as a benchmark and setting your product prices with the intent to price them lower than theirs. For example, in industries with very similar products where price is the only distinguishing factor, you may rely on price to attract customers.
Advantages: This strategy can be effective if you are able to negotiate a lower unit cost from your suppliers while reducing costs and actively promoting your prices.
Disadvantages: This strategy can be challenging for small retailers. Lower prices mean lower profit margins, so you’ll need to sell a larger volume of products than your competitors. Depending on the products you sell, customers may not always turn to the cheaper item on the shelf.
3. Value-Based Pricing
Value-based pricing, also known as price to value, refers to setting prices based on how much a customer believes a product or service is worth. It is an approach that takes into account the desires and needs of the target market when determining a product’s value. Companies that sell unique or high-value products are better positioned to leverage value-based pricing compared to those that sell standard everyday items.
With value-based pricing, customers are more interested in the perceived value of the products (such as how it enhances self-image) and are willing to pay for it. For this pricing strategy, positive brand value is especially important.
Value-based pricing is common in markets where the product enhances the customer’s self-perception or offers a unique life experience. For example, people consider luxury brands like Gucci or Rolls-Royce to be high value. This gives the brand a chance to apply value-based pricing.
Advantages:
Value-based pricing allows you to charge higher price points for your products. Art, fashion, rare pieces, and other luxury items typically perform well under this pricing system. It also encourages you to create innovative products that resonate with the target labor market and enhance brand value.
Disadvantages: It can be difficult to justify the added value for consumer goods. You need a unique product to implement a value-based pricing strategy. Perceived value is subjective and can be influenced by cultural, social, and economic factors that are beyond your control.
4. Captive Pricing
The captive pricing strategy is when a company charges the highest initial price that customers can pay; then lowers it over time as competition increases and the market saturates. As a result, there are higher short-term profits.
The goal is to increase revenue when demand is high and competition is low. For example, it is believed that Apple uses this pricing model to cover the costs of developing new products like the iPhone. Captive pricing strategy also works when there is product scarcity. For example, high-demand products with limited supply can be priced higher, and as supply increases, prices decrease.
Advantages: Captive pricing can lead to high short-term profits when launching a new and innovative product. If you have a prestigious brand image, captive pricing also helps maintain it and attract loyal customers who want to be the first to access or enjoy an exclusive customer experience.
Disadvantages: Captive pricing is not the best strategy in crowded markets unless you have some unique features that no other brand can imitate. This strategy can also attract more competition. Finally, if you lower prices quickly or by a large amount, it may leave a negative impression on early users and affect brand image.
5. Discount Pricing
It’s no secret that shoppers love discounts, coupons, seasonal markdowns, and other reduced pricing. For this reason, the discount pricing strategy is one of the most important pricing methods for retailers across all sectors, with one study finding that 28% of shoppers typically look for coupons before making an online purchase.
There are many benefits to discount pricing strategies, including increased traffic to your store, clearing out unsold inventory, and attracting more price-conscious customers.
Advantages: Discount pricing strategies are effective for drawing more traffic to your retail store and clearing out old or off-season inventory in-store and online.
Disadvantages: If overused, discount pricing can give your brand a reputation as a discount retailer and cause consumers to hesitate to buy products at regular prices. It can also limit your customer base and negatively impact your brand’s value, due to the perception that lower prices mean lower quality.
6. Penetration Pricing
The penetration pricing strategy is useful for new brands trying to enter the market. This model offers a new product at a low price in an attempt to gain market share, then increases the price over time.
Advantages: This approach can help you stand out in an already crowded market and enhance brand awareness. In the process, you may gain new customers, including attracting some from competing companies.
Disadvantages: By introducing a product at a lower price to attract customers, it can be difficult to raise prices later without risking loss of customers. Additionally, lowering prices in the short term can sacrifice profit and revenue.
7.
Pillar Pricing
Pillar pricing is a product pricing strategy where the retail price is simply doubled by the wholesale cost paid for the product. The simplest way to think about pillar pricing is:
Wholesale Price × 2 = Retail Price
For example, if your product costs $15 from the manufacturer, the retail price would be $30.
Advantages: Pillar pricing serves as a quick and easy rule of thumb to ensure there is enough profit margin.
Disadvantages: Depending on the availability and demand for a particular product, it may be risky for a retailer to double their pricing, exposing them to the risk of losing customers and sales.
8. Manufacturer’s Suggested Retail Price (MSRP)
As its name suggests, the Manufacturer’s Suggested Retail Price (MSRP) is the price that the manufacturer recommends retailers sell the product for. Manufacturers began using MSRP as a pricing strategy to help standardize prices for the same product across multiple locations and retailers.
Retailers often use MSRP with high-value products like consumer electronics and home appliances.
Advantages: MSRPs standardize costs for consumers, meaning shoppers know they won’t find the product at a lower price elsewhere.
Disadvantages: Retailers using MSRP may struggle to compete on price. With MSRPs, most retailers in a specific industry will sell this product at the same price. You must consider profit margins and costs. For example, your company might have additional costs that the manufacturer doesn’t account for, such as international shipping.
Remember that MSRP is a relatively niche pricing strategy. While you can set any price you want, significant deviations from MSRP may lead to strained relations with manufacturers. It depends on your supply agreements and the goals that manufacturers have with MSRPs.
9. Dynamic Pricing
Have you ever tried to get an Uber ride on a Friday night and noticed the price is higher than usual? That’s dynamic pricing at work. Dynamic pricing is when a company continuously adjusts its prices based on various factors like competitor pricing, supply, and consumer demand. The goal is to increase profit margins for the company.
For brands like Uber, passenger prices depend on variables such as the time and distance of the ride, current passenger and driver traffic. Prices are determined by self-optimizing rules or algorithms that take these factors into account when making pricing decisions.
Advantages: Dynamic pricing strategies allow retailers to price products and services automatically, using machine learning to process pain points. They can tailor prices to meet current market conditions and save time with automated applications, maximizing profits while improving customer satisfaction.
Disadvantages: Managing dynamic pricing can be challenging for small businesses, as there are upfront costs like software and investment in market research. Dynamic pricing strategies are likely better suited for large retailers with thousands of items across retail and e-commerce. When dynamic pricing leads to frequent price changes, consumers may respond negatively, impacting revenue.
10. Multiple Pricing
It is common for grocery stores, clothing companies, and online businesses to adopt a multiple pricing strategy, where retailers sell more than one product (think socks, underwear, and t-shirts in the clothing section, where items can be sold five for $30 or buy one get one free) at a single price. This approach is also known as product bundling.
Advantages: Retailers use this strategy to create higher perceived value at a lower cost, which ultimately can lead to increased purchase volume. Another benefit is that you can sell items separately to increase profit. For example, if you sell shampoo and conditioner together for $10, you could sell them separately for $7 to $8 each, which is a win for your business.
Disadvantages:
If the bundle does not increase sales volume, profits may be lower than expected.
11. Loss Leader Pricing
Loss leader pricing is when consumers are drawn to the store with the promise of a discount on a hot product, and they buy that product along with many other items. With this strategy, retailers attract customers with a discounted item and then encourage them to purchase additional products.
A prime example of loss leader pricing strategy is a grocery store that lowers the price of peanut butter and promotes complementary products like loaves of bread, jam, and honey at regular prices.
While the original item may be sold at a loss, the retailer can benefit from having a strategy to increase sales and encourage cross-promotion. This usually happens for products that buyers are already looking for, with high product demand, thus attracting more customers to the store.
Advantages: Encouraging shoppers to purchase multiple items in one transaction can increase overall customer sales and offset any loss from reducing the price of the original product. This method can also be an effective way to promote underperforming products.
Disadvantages: Similar to excessive use of discount pricing, frequent use of loss leader pricing can lead consumers to expect deals, making them hesitant to pay regular prices. It can also impact your revenues if you are reducing the price of something that does not increase basket size or average order volume.
12. Psychological Pricing
Psychological pricing, or charm pricing, uses prices to influence consumer buying behavior, with the goal of increasing business sales and revenue. A strategy to achieve this is pricing items so that they end in “99”; a product priced at $4.99 seems significantly cheaper at first glance than a product priced at $5.00.
Advantages: Charm pricing can stimulate impulse buying. Pricing items with odd numbers gives shoppers the sense that they are getting a better deal – and this is very hard to resist.
Disadvantages: The use of charm pricing can make consumers less likely to pay more in the future, negatively impacting sales.
13. Premium Pricing
With premium pricing, brands compare themselves to competitors and then set higher prices for their products to give the impression that they are more luxurious or exclusive. For instance, the premium price works in favor of Starbucks when people choose it over a cheaper competitor like Dunkin’.
Similarly, premium pricing has proven to be less effective for Netflix in some markets where consumers earn less and are more price-sensitive – reflecting the importance of understanding your target market.
Be confident and focus on the unique value you offer to customers. For example, excellent customer service and a strong brand can help justify higher prices.
Advantages: A premium pricing strategy can influence consumer perception of your business and products. Consumers view your products as being of higher quality compared to your competitors, because of the higher price. This pricing strategy has the potential to achieve higher profit margins and sales.
Disadvantages: The premium pricing strategy can be difficult to implement, depending on your target audience’s preferences. If customers are price-sensitive and have many alternative options to buy similar products, the strategy may not be effective. For this reason, it’s important to understand your target customers and conduct market research.
14. Anchor Pricing
Anchor pricing is when a retailer lists a lower price and the original price to create a savings impression that the consumer can obtain by purchasing.
Creating this type of reference pricing leads to what is known as the perceptual anchoring effect. In a study conducted by economist Dan Ariely, students were asked to write down the last two digits of their social security number and then consider whether they would pay those amounts for products like wine, chocolate, and computer equipment.
After
They were asked to present offers for those products. Ariely found that students with higher anchor numbers made higher offers than those with lower numbers. This is due to the higher price, or the “reference” number. Consumers set the original price as a reference point in their minds, then they relate to it and form their opinion on the listed discounted price.
You can also leverage this principle by placing a higher-priced item next to a cheaper item to attract the customer’s attention.
Many brands across various industries use anchor pricing to influence customers to purchase a mid-priced product.
Advantages: If you price the original price much higher than the sale price, it can influence the customer to make a purchase based on the listed deal.
Disadvantages: If the anchor price is unrealistic, it may lead to a breakdown of trust in your brand and erosion of brand loyalty. Customers can compare product prices online with your competitors, including price comparison engines – so ensure your listed prices are reasonable.
15. Economy Pricing
Economy pricing strategy is when you price products low and generate revenue based on sales volume. It is typically used for interchangeable goods with low production costs like food products or pharmaceuticals. This business model relies on selling a lot of products to both new and returning customers continuously.
The formula for economy pricing is:
Cost of production + Profit margin = Price
Advantages: The economy pricing strategy is easy to implement and is good for retaining customers who are price-conscious.
Disadvantages: Margins are usually lower, and you need a steady, continuous stream of new customers, and consumers may not view the products as high quality.
How to Choose a Pricing Strategy
Whether you are implementing your first pricing strategy or the fifth, there are key steps to creating a pricing strategy that works for your business. Here is where you should start:
1. Understand Costs
To know your product pricing strategy, you need to gather the costs associated with bringing the product to market. If you are sourcing products, you have a clear answer on how much each unit costs you, which is the cost of goods sold.
However, if you are producing the products yourself, you will need to determine the total cost of that work: what is the cost of the raw materials package? How many products can you manufacture?
Source: https://shopify.com/blog/pricing-strategies
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