Introduction
When starting a company, most entrepreneurs focus their creative energy on developing an idea and turning it into a product that can be sold. However, before you 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 of determining the price of a product. An effective pricing strategy takes into account revenue, profit, consumer behavior, and business goals. It also requires you to consider human psychology and how it affects price perception.
Read more 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 is the easiest way to determine the price of a product. You create the product, add a fixed percentage above the costs, and sell it for the total. For example, if you just started an e-commerce business selling t-shirts online and want to calculate the selling price for a t-shirt. The cost to make the t-shirt is: Material costs: $5 Labor costs: $25 Shipping costs: $5 Marketing and overhead costs: $10
Then you can add a profit margin – say 35% – to the total cost of $45 to manufacture the product. Here’s how the formula looks:
Cost ($45) × [1 + Percentage (1.35)] = Selling Price ($60.75)
Advantages: The pros of cost-plus pricing are that it is easy to calculate. You are already tracking production and labor costs. Next, just add a percentage above that to determine the selling price. It can provide consistent returns if all your costs remain stable.
Disadvantages: Cost-plus pricing does not take into account market conditions such as competitor pricing or perceived customer value.
2. Competitive Pricing
Competitive pricing refers to using competitor pricing data as a benchmark and setting your product prices slightly lower. For example, in businesses that operate 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 can negotiate a lower unit cost from your suppliers while trimming costs and actively promoting your pricing.
Disadvantages: This strategy can be challenging for small retailers. Lower prices mean lower profits, so you will have to sell a larger volume of products than your competitors. Depending on the products you sell, customers may not always turn to the cheapest item on the shelf.
3. Value-Based Pricing
Value-based pricing, also known as price-to-value, refers to setting a price based on what the customer believes the product or service is worth. It is an approach that considers the wants and needs of the target market when determining product value. Companies that sell unique or high-value products are in a better position to leverage value-based pricing compared to those selling standard everyday products.
With value-based pricing, customers are more concerned about the perceived value of the products (such as how it enhances self-image) and are willing to pay for it. For this pricing strategy, the positive impact of branding is particularly important.
Advantages: Value-based pricing allows you to charge higher price points for your products. Art, fashion, collectibles, and other luxury items generally perform well with this pricing system. It also motivates you to create innovative products that are well-received by the target market and increase brand value.
Disadvantages:
It can be difficult to justify the added value of ordinary products. You need a special product to apply a value-based pricing strategy. Perceived value is subjective and can be influenced by cultural, social, and economic factors beyond your control.
4. Price Skimming
Price skimming strategy is when a company sets the highest initial price for a new product that customers will pay; then it lowers the price over time as competition increases and the market becomes saturated. As a result, there are higher short-term profits.
The goal is to increase revenue while demand is high and competition is low. Apple uses this pricing model to cover the costs of developing new products like the iPhone. The price skimming strategy also works when there is product scarcity. For example, products with high demand and limited supply can be priced higher, and when supply recovers, prices will decrease.
Advantages: Price skimming can lead to high short-term profits when launching a new and innovative product. If you have a prestigious brand image, skimming also helps maintain that image and attract loyal customers who want to be the first to access or enjoy an exclusive customer experience.
Disadvantages: It is not the best pricing strategy in crowded markets unless you have some unique features that no other brand can replicate. This strategy can also attract competition. Finally, if you lower prices quickly or significantly, it may leave a negative impression on early users and affect brand perception.
5. Discount Pricing
It is no secret that shoppers love discounts, coupons, seasonal discounts, and other reduced pricing. For this reason, discount pricing strategies are among the most important pricing methods for retail across all sectors, as one study found that 28% of shoppers typically look for coupons before shopping online.
There are many benefits to discount pricing strategies, including increased traffic to your store, clearing unsold inventory, and attracting more price-conscious customers.
Advantages: Discount pricing strategies are effective in attracting more traffic to your retail store and clearing out old or seasonal inventory both in-store and online.
Disadvantages: If used excessively, discount pricing can give your brand a reputation as a discount retailer and create reluctance among consumers to purchase products at regular prices. It can also limit your customer base and negatively affect your brand’s value due to the belief that low prices mean low quality.
6. Penetration Pricing
Penetration pricing strategy is useful for new brands trying to enter the market. This is done by offering a new product at a low price in an attempt to gain market share, then increasing the price over time.
Advantages: This method can help you stand out in an already crowded market and build brand awareness. In the process, you may gain new customers, including luring some from the competition.
Disadvantages: By introducing a product at a lower price to attract customers, it may be difficult to raise prices later without risking losing customers. Additionally, short-term price reductions can sacrifice profits and revenues.
7. Pillar Pricing
Pillar pricing is a product pricing strategy where you simply double the selling price based on the wholesale cost paid for the product. The simplest way to think about pillar pricing is:
Wholesale Price × 2 = Selling Price
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For example, if the product costs you $15 from the manufacturer, your selling price would be $30.
Advantages: The pillar pricing works as a quick and easy rule of thumb to ensure there is a sufficient profit margin.
Disadvantages: Depending on the availability and demand for a particular product, it may be risky for a trader to double their pricing, exposing them to the risk of losing customers and sales.
8. Manufacturer’s Suggested Retail Price (MSRP)
As the name suggests, the Manufacturer’s Suggested Retail Price (MSRP) is the price that the manufacturer recommends retailers charge when selling a product. Manufacturers started using MSRP as a pricing strategy to help standardize prices for the same product across multiple locations and retailers.
Retail traders often use the Manufacturer’s Suggested Retail Price with high-value products such as consumer electronics and household appliances.
Advantages: The MSRP standardizes costs for consumers, meaning shoppers know they will not be able to find the product for a lower price anywhere else.
Disadvantages: Retailers using the MSRP cannot compete on price. With the MSRP, most retailers in a particular industry will sell that product at the same price. You must consider your profit margins and costs. For example, your company may have additional costs that the manufacturer does not account for, such as international shipping.
Remember that the MSRP is a relatively niche pricing strategy. While you can set any price you want, a significant deviation from the suggested retail price may result in the termination of the relationship with the manufacturer. It depends on your supply agreements and the goals that manufacturers have with their suggested retail prices.
9. Dynamic Pricing
Have you ever tried to book an Uber on a Friday night and noticed that 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 such as competitor pricing and consumer supply and demand. The goal is to increase the company’s profit margins.
For brands like Uber, the price of a ride depends on variables such as the time and distance of the trip, driver availability, and the current demand from riders. Prices are determined by self-optimizing rules or algorithms that take these variables into account when making pricing decisions.
Advantages: Dynamic pricing strategies allow retailers to automatically price products and services according to current market conditions, using machine learning to address pain points. They can tailor prices to meet current market conditions and save time through automation while maximizing profits – enhancing customer satisfaction.
Disadvantages: Managing dynamic pricing can be a financial challenge for small businesses, as there are initial costs such as software and investment in market research. A dynamic pricing strategy is likely to be better suited for large retailers that have thousands of products across retail and e-commerce. When dynamic pricing leads to frequently fluctuating prices, consumers may respond negatively, impacting revenue.
10. Bundle Pricing
It is common for grocery stores, clothing companies, and e-commerce businesses to adopt bundle pricing strategies, where retailers sell more than one product (think of socks, underwear, and t-shirts in the clothing section, where items can be sold five for $30 or buy one, get one free) at one price. This approach is also known as product bundling.
Advantages:
Merchants use this strategy to create higher perceived value at a lower cost, ultimately leading to increased purchase volumes. 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.
Cons: If the bundle does not increase sales volume, it may lack profits.
11. Loss Leader Pricing
Loss leader pricing is when consumers are drawn into the store with the promise of a discount on a hot product, leading them to buy that product along with many others. With this strategy, merchants attract customers with a discounted item and encourage them to purchase additional products.
A good example of loss leader pricing strategy is reducing the price of peanut butter in the grocery store and promoting complementary products such as loaves of bread, jelly, and honey at regular prices.
Although the original item might be sold at a loss, the merchant can benefit from having a strategy to increase sales. This usually happens for products that buyers are already looking for, with high product demand, bringing more customers into the store.
Advantages: Encouraging shoppers to buy several items in one transaction can boost the overall sales per customer and cover any losses from lowering the price of the original item. This method can also be an effective way to promote underperforming products.
Disadvantages: Similar to the excessive use of discount pricing, frequently using loss leader pricing can lead shoppers to expect deals, making them hesitant to pay full price. It can also affect your revenue if you are discounting something that does not increase basket size or regular order volume.
12. Psychological Pricing
Psychological pricing, or charm pricing, uses prices to influence consumer buying behavior – with the aim of boosting business sales and revenue. One strategy to achieve this is pricing items so they end in “99”; a product priced at $4.99 seems significantly cheaper than one priced at $5.00.
Advantages: Charm pricing can lead to impulse purchases. Prices ending in odd numbers give shoppers the impression they are getting a better deal – which is sometimes hard to gauge.
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 product prices higher to create an impression of being more luxurious, leading, or exclusive. For example, premium pricing works in Starbucks’ favor when people choose to purchase there over a cheaper competitor like Dunkin’ Donuts.
On the other hand, premium pricing has proven less effective for Netflix in some markets where consumers earn less and are more price-sensitive – reflecting the importance of knowing your target market.
Be confident and focus on the unique value you provide to customers. For example, excellent customer service and a strong brand can help justify higher prices.
14. Reference Pricing
Reference pricing is when a merchant lists the discounted price alongside the original price to highlight the savings the consumer might receive from the purchase.
Creating this type of pricing leads to what is known as the reference effect bias. In a study conducted by economics professor Dan Ariely, students were asked to write down the last two digits of their social security number and then consider whether they would pay that amount for items such as wine, chocolate, and computer equipment.
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They were asked to submit bids for those items. Ariely found that students with higher reference numbers submitted higher bids 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, which then gets “anchored” and shapes their opinion of 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 reference pricing to influence customers to purchase a mid-tier product.
Advantages: If you register the original price as significantly higher than the sale price, it can influence the customer to purchase the product based on the perceived deal.
Disadvantages: If the reference price is unrealistic, it may lead to a collapse of trust in your brand and erosion of brand loyalty. Customers can compare product prices online with your competitors, including using price comparison engines – so make sure your listed prices are reasonable.
15. Economic Pricing
The economic pricing strategy is when you price products low and generate revenue based on sales volume. It is usually used for consumer goods with low production costs, such as food or pharmaceuticals. This business model relies on selling a large volume of products to new and returning customers continuously.
The formula for economic pricing is:
Production cost + profit margin = price
Advantages: Economic pricing is easy to implement and is good for retaining price-sensitive customers.
Disadvantages: Margins are usually lower, you need a continuous and regular flow of new customers, and consumers may not perceive the products as high quality.
How to Choose a Pricing Strategy
Whether this is your first pricing strategy or the fifth one you are implementing, there are key steps to create a pricing strategy that works for your business. Here’s where to start:
1. Understand Costs
To determine your product pricing strategy, you need to gather the costs associated with bringing the product to market. If you are purchasing products, you have a clear answer on the cost per unit you have, which is the cost of goods sold.
However, if you are producing the products yourself, you need to determine the total cost of that work: What is the cost of the raw material package? How many products can you make from that package? How much time does it take in your work?
Some costs you may incur are: Cost of Goods Sold (COGS), production and packaging time (retail and e-commerce), promotional materials, shipping, and short-term costs like loan fees.
Your pricing strategy will take these costs into account to make your business profitable.
2. Define Business Objectives
Think of your business objective as a guide for pricing. It helps you navigate any pricing decisions and keeps you on track.
Ask yourself: What is my ultimate goal for this product? Do I want to be a luxury seller? Or do I want to create a stylish and trendy brand that ultimately sits at the affordable end of the spectrum? Define this goal and keep it in mind as you set your prices.
3. Identify Your Customers
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Source: https://www.shopify.com/ca/blog/pricing-strategies
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