A quick guide to common pricing strategies

Posted in Business and entrepreneurship.

When it comes to selling products and services their prices play a role in influencing buyer behaviour. How to price things may seem like a simple endeavour to some and a complicated process to others. How about we simplify things and give a brief overview of a few common pricing strategies? It may show that there are other ways of doing things while also keeping it simple enough to not overwhelm you.

What are pricing strategies? They are the processes and methodologies you use to determine the prices of your products and services. If pricing is how much you charge, then pricing strategies are how you determine that amount. Some common ones include:

  • Cost-plus Pricing
  • Economy Pricing
  • Premium Pricing
  • Penetration Pricing
  • Price Skimming
  • Competitive Pricing
  • Value-based Pricing
  • Dynamic Pricing
  • Psychology Pricing

Some of these pricing strategies may overlap. Functionally, they may work the same, but contextually they may still be different. Even then, combining them into your overall plans can work as well. Nevertheless, knowing when to use each strategy is important. Sure, a blanket strategy can work, but it is less than optimal. Careful strategy will lead you to maximising your profits.

Cost-plus Pricing

Cost-plus pricing is considered to be the simplest pricing strategy. This is because pricing is based on a certain percentage of the cost to provide a product or service also known as “markup”. This markup is then added to the cost of the product or service. For instance, if a bag of apples cost your business $10 and you want to gain $10 profit from it, you would sell it for $20 which is at 100% markup. In other words, markup is how much of your cost you are getting as profit.

This pricing strategy is typically used to sell retail products. In practice, they are not well-suited to services-based companies as generally the value of the services is worth more than the costs it takes to provide them. Cost-plus pricing does work well if the competition is also using this strategy, but fails if they are more aimed at accruing buyers rather than gaining large profits.

In essence, cost-plus pricing is simple and easy to understand, but generally far from the most efficient pricing strategy.

Economy Pricing

Economy pricing is popular in the commodity goods sector. The general goal is to sell at a lower price but make up for smaller profits with more sales. You want to appeal to those looking for great deals and low prices. Food distributors, discount retailers, and wholesale retailers are good examples of usage of this price strategy.

Whether you use this pricing strategy or not depends on the overhead costs. Minimising these costs by reducing marketing or using plain packaging allows more room for economy pricing. The value of your product or service will also determine how economic your pricing is to buyers.

Larger businesses can work well with economy pricing. Businesses such as Wal-Mart or Target are good examples of this. Their quantity of sales can easily make up for the smaller profits they gain. Smaller businesses may find it harder to work with this pricing strategy since they generally lack large volumes of sales that makes this strategy truly effective.

Premium Pricing

If economy pricing appeals to money-savers, premium pricing appeals to luxury-spenders. In order to appeal to high-income buyers, premium pricing sets the stage for luxury. Other factors such as marketing and product value come into play, but without a lofty price tag buyers may not see it as being a luxury.

Premium pricing really comes into effective usage when your products or services are very niche – even new – or when supply cannot comfortably meet demand. Premium pricing is not generally about attracting more buyers. Instead premium pricing is meant to take advantage of an audience that is already willing to pay for a relatively expensive product or service.

When it is about attracting buyers, we sometimes refer to it as prestige pricing. As the name implies, the product or service is seen rather in terms of its brand as opposed to its pricing. These expensive items can market themselves as exclusives or prestigious luxury items carried by branding. Fashion and tech industries make use of this strategy as products are generally luxury and sometimes rare and exclusive.

Small businesses can definitely utilise this strategy if they provide unique products and services with moderate demand.

Penetration Pricing

In highly competitive markets it can be hard for new businesses to get a foothold. In order to compete, they may set their prices at a very lower price than their competitors. Once they have established a customer base, prices can slowly start to increase. This is what is known as penetration pricing.

Your business’s ability to take initial losses to establish a foothold as well as its ability to retain customer loyalty in the face of price increases are important when deciding to go with this pricing strategy.

The initial customer drive in the beginning has the potential to upstart a new business and many increase their prices to reflect their new position in the market. As part of the name, penetration pricing’s aim is to cause a temporary disruption in an already competitive market. Infiltrate the market using lower prices as leverage and then slowly merge with other market standards. However, if a butter knife works, why bring out the saw? As such, penetration marketing is not really needed when the competition is not as fierce.

Price skimming

If penetration pricing is starting off with low prices and gradually increasing them, then price skimming is the exact opposite – start off with high prices and gradually decrease them. The situations you might use this pricing strategy are almost opposite as well. Whereas penetration marketing allows your business to start off in an already competitive market, price skimming allows your business to capitalise on the lack of competition.

Price skimming works well in emerging markets as you leverage your supply over the demand. Once newer businesses break out into the scene, not only have you already cashed in on your initial success, but you have gathered a large customer base already that allows you to compete even as you skim your prices below the newer competitors’.

Price skimming can be used to recoup lost resources as part of the development of the product or services. Products with varying life cycles can benefit from price skimming so that it’s initial release can provide a burst of income.

Competitive Pricing

When you are using competitive pricing, you are basing your prices on competitors’ prices. Higher prices or lower prices? Just about the same? No matter how you decide to compete, if your prices are primarily based on what your competitors are selling for. This is regardless of demand or costs of production.

You may want to be more conservative and pick a range between the lowest competing price and the highest competing price. Going below everyone else requires a different sort of focus and target audience than raising prices above everyone else.

Competitive pricing can be really good when you are starting out, but it does not really leave a lot of room for growth.

Value-based Pricing

With value-based pricing, instead of using competitors as standards, you use buyers as standards. This strategy prices products and services according to what buyers value. This may seem like a difficult metric to measure, but there are various ways to obtain such information. A lot more research is required, however.

Customer surveys and competitor research can provide some insights. What is the competition providing? What does your product or service lack relative to the competition and what do they offer that the competition does not? It may take a bit more research and assumptions to decide how those differences translate into monetary worth.

Value-based pricing allows you to cater your pricing to various buyer personas. It is more effective when salespeople do most of the sales heavy lifting as varying prices need to be justified on the fly. Entrepreneurs selling unique goods or customised products and services may work well with this pricing strategy as is with artisanal goods or art.

Dynamic Pricing

With some industries, you could get away with frequently changing your prices. With this pricing strategy, prices are frequently changed based on numerous factors such as season, demand, supply, costs etc. Today, algorithms can take care of managing these factors to compute a price. The more prices are micromanaged the harder it can be to keep track of each and every factor.

Shifting prices to take advantage of a quick surge in demand and quickly shifting them again when supply becomes too much is key to dynamic pricing. This allows small merchants to sell products and services on a regular basis instead of during surges in demand.

Uber is a stellar example of this pricing strategy in action. During low periods Uber can be quite affordable. But when a rainstorm strikes during rush hour, prices skyrocket as demand and supply fluctuates.

Psychology Pricing

Psychology pricing may not seem like its own thing, but according to our definition of a pricing strategy, it qualifies. This strategy can be used in conjunction with the other strategies listed here. This strategy refers to techniques used that take advantage of the brain’s logical errors to influence buyer behaviour.

Additionally, this pricing strategy requires an intimate knowledge of your customer base so that you know best how to price things to appeal to your specific market. If quality is important to your buyers, then maybe low prices may give the wrong impression. However the situation is flipped if your buyers are more inclined to save money.

For a more detailed review of the techniques employed in psychology pricing, see our other article.