When starting on your own, determining the price of a product or service can be challenging. However, pricing is important because it will have a huge effect on the health of your small business. In fact, 82% of businesses have failed because of cash flow problems.
Before you make any decisions, it’s good to become familiar with common pricing strategies so that you set the right price the first time. Educating yourself about how to set pricing can give you a competitive advantage. This guide will walk you through different pricing methods and how to find the right strategy for your business.
What is a pricing strategy?
At its simplest, a pricing strategy is how you decide what to charge for your goods or services. For most, it starts with considering the cost of production and labor and market conditions.
Getting your price point right from the first client or sale is important. If you have set pricing too high, customers may find what you offer somewhere else for a lower cost. If it’s too low, you won’t have enough profits to stay afloat. Once pricing is set, it also might be more difficult to make changes because you’ve set the tone for the perceived value of your service or product.
How to Determine the Best Pricing Strategy for Your Business
Determining the best pricing strategy can be complicated, especially for a new business owner. To find the right one, you need to consider your business costs and what you need to stay afloat — but you also need to consider the effects on your business model and your competition.
A couple of things you should understand include:
- Pricing affects volume. An increased price will likely lower the number of sales you make. A lower price will lead to a high volume but decrease your profit. The sweet spot inside what economists call price elasticity will depend on your business.
- Pricing sends a message. You’ve probably heard the phrase, “You get what you pay for.” Some businesses may set a slightly higher price to send a message to their consumer base that their product is of a higher quality than the competition. On the other side, some businesses will set prices lower, either through their regular pricing or the use of sales and discounts. Setting prices lower than the competition brings customers in and allows a business to build a loyal base before raising prices.
Price Elasticity of Demand
To understand the price elasticity of demand (PED), you’ll need to do a little math. Tempting though it might be to skip over the math, stay with us — this is an important concept for any business. It’s also one that could give the greatest benefit to your profitability.
Price elasticity measures the responsiveness of demand after a change in pricing. In other words, it reveals how the demand for a product increases or decreases based on a price change. There’s a formula you can use to determine it:
% Change in Quantity ÷ % Change in Price = Price Elasticity of Demand
So, what do the results mean?
- If the PED is 0, demand is perfectly inelastic, meaning customer demand doesn’t change if you change your price.
- If the PED is between 0 and 1, demand is inelastic, meaning customer demand doesn’t change if you change your price.
- If the PED is 1 or greater, demand is elastic, meaning customer demand changes if you change your price.
Knowing the PED helps you figure out whether you should raise or lower your price. If demand is elastic, you’ll generate more revenue by reducing your price. If demand is inelastic, you’ll generate more revenue by raising your price.
Types of Pricing Strategies
Now that you understand some of the concepts that go into determining the right strategy, it’s time to look at the common strategies. Below, we’ll give an overview of 14 different pricing strategies.
1. Competition-Based Pricing Strategy
Competition-based pricing is one of the most common strategies because it uses the pricing of competitors to price similar products or services rather than starting from scratch. You use the pricing of your competition to set a benchmark. You then base your pricing off that — but remember to consider your elasticity scale.
Pricing higher will likely mean higher profit margins but a lower market share. Lower pricing will mean a higher market share but lower profit margins. If you use this strategy, remember that price won’t likely attract customers. You’ll also need a strong marketing strategy to get their attention.
This strategy will also require research. If you’ve done your business plan, you likely have a list of competitors. Make sure it’s up to date. The next step is to research how they price their products or services. You’ll want to look at more than just the listed price — look at what features are included at what levels of price. You’ll also want to find the average price. Once your research is done, it’s time to decide where you fit with the competition.
2. Cost-Plus Pricing Strategy
This strategy, also called markup pricing, includes the cost it takes to make the product or service and adds to that for the profit. For this strategy to work, you have to know your business’s exact costs, including labor, materials, and overhead (don’t forget marketing costs). Once you have that, you multiply it by the markup percentage for the price.
Because your product or service costs are often set in stone, determining the markup percentage may be the more difficult part. How you set that will depend on your business, the market, economy, and demand. This model also doesn’t consider your competition, so you’ll probably want to do a little legwork to ensure you aren’t pricing too high or too low.
3. Value-Based Pricing Strategy
This pricing strategy is based on the customer more than costs or competition. You set your prices based on what the customer thinks the value is. You use research to learn what the consumer uses to decide on your product. Understanding what they value helps you set an appropriate price and determine the right marketing strategy.
One thing that makes this strategy difficult, especially for smaller businesses with smaller budgets and staff, is that the customer’s mindset is always changing, so it’s not research you do one time and are done. To stay competitive, research must be ongoing.
4. Dynamic Pricing Strategy
Dynamic pricing is most used for service-based companies, but it is also sometimes used for products. With this strategy, the pricing is never firmly set but changes based on different factors. Some industries use segmented pricing, where one set of customers may be charged more than another based on demand. This is common with airlines, which may charge more to fly one day of the week than another.
Peak user pricing means setting prices higher when more people will want to use them — this is a practice used most by transportation or utility companies. Service time is another example of a dynamic pricing strategy. You can set prices higher for the faster service or lower for the volume of work.
5. High-Low Pricing Strategy
With high-low pricing, a business will set a high price — called a reference price — and use sales or promotions to lower the price for a period. The price alternates between high and low. This is a good way to attract bargain hunters to your brand. If you have a brick-and-mortar retail location, it can also bring customers looking for the deal and subsequently buying additional items.
There are a few downsides to consider with this strategy. The success of your sale or promotion requires strong marketing, which will create additional expenses. If you run too many sales, your customer base may begin waiting on the sale opportunity and not purchase at full price. It’s also possible that the “you get what you pay for” mentality will affect your business. If people think your product is on sale because it’s not very good, it could impact your entire business.
6. Hourly Pricing Strategy
Hourly pricing is a popular strategy for consulting-based services because there are no labor and materials costs to consider. With it, you charge an hourly rate. When you set the rate, you should consider your level of experience first, but you also want to consider any travel expenses, equipment, and overhead costs.
7. Skimming Pricing Strategy
The skimming strategy mainly works for technology companies. With a price skimming strategy, you set the price higher from the product’s release to cover costs. You also put money back into making more. A price skimming strategy works well for the technology field because tech companies can usually count on early adopters to purchase those products.
8. Penetration Pricing Strategy
A penetration strategy means that you price your product or service lower to find customers — to penetrate the market. A company would use this strategy to build a loyal customer base through its quality and friendly and helpful service. Eventually, the company would begin to raise prices to secure a larger profit margin.
9. Premium Pricing Strategy
A premium pricing strategy is the opposite of a penetration strategy. Instead of setting a low price to grow your base, you set a high price and set the expectation that the higher price means a higher value than your competition. A great example of this strategy is the car industry. This strategy is most effective for a business when a new product is introduced, if it is unique somehow, when the product will be limited, or has no true competition due to patents or other protection.
10. Project-Based Pricing Strategy
Unlike hourly based pricing, you set a flat fee per project with project-based pricing. You base your pricing on the value of the finished project or the amount of time you estimate a project will take.
11. Freemium Pricing Strategy
Even if you’re not familiar with the term, you’ve likely seen “freemium” in practice. This strategy — which has become commonly used in the tech and app development world — means that you use a product’s basic features for free and pay for additional functions, usually through a subscription fee. This strategy works because it allows a business to build its customer base with no additional costs, with monthly subscriptions being a reliable income source.
12. Bundle Pricing Strategy
If you’ve worked with a cable company recently, you should know what bundle pricing is. Using this strategy, your business will have separate goods or services. By packaging them together, you sell them at a lower price than they could be purchased individually. The goal is to have a higher profit margin and give consumers a discount at the same time.
13. Psychological Pricing Strategy
Psychological pricing is one strategy with a lot of options. The basic idea is that some prices will impact customers more than others. For example, with charm pricing, you might have a product priced at $10, but you would make it $9.99. This can trick someone’s brain into seeing it as a $9 value instead of a $10 value.
You can also attract bargain hunters with the “buy one, get one” strategy, where your customer pays full price for one item to get another free. Additional ways to use this strategy include putting two similar products with different prices together on display and ensuring a customer sees the sale price next to the full price.
14. Geographic Pricing Strategy
If your business works in different regions, you may want to consider geographic pricing. This is a more flexible model that recognizes how different areas or regions have different earning levels and different living costs.
With this model, you would set pricing differently for the different regions in which you do business. However, having different pricing for the same product or service can make your business more complicated, and your marketing will need to change based on the region.
Pricing Models Based on Industry or Business
Some pricing strategies lend themselves to certain industries better than others. Some industries lend themselves to particular pricing models. Below, we highlight pricing models that work well based on industry or business.
Services Pricing Model
Service industries can have difficulty pricing their services because they often base it on the individual delivering the service. In particular, independent contractors and freelancers must consider their experience and quality of work, as they typically don’t have many production costs.
For service industries, the recommended pricing model would be the project-based, hourly, or value-based models.
Product Pricing Model
If your business makes a tangible product, you likely need to consider the costs that go into production. You also need to consider your competition’s pricing and give yourself enough wiggle room to make a profit and develop new products to introduce to the market.
Several pricing models can work in this industry, including competitive pricing, cost-plus pricing, value-based pricing, and premium pricing.
Restaurant Pricing Model
Restaurant owners have a lot to consider when setting prices. There are fluctuating costs for food and beverage products, labor costs, and costs for the physical space the restaurant occupies. Beyond that, you have to understand your customers’ desires and have a strong grasp of your competition.
With that to consider, the pricing models a restaurant should consider include value-based pricing, cost-plus pricing, and premium pricing.
Event Pricing Model
Events also have a lot to consider before setting pricing. Beyond the costs of an event manager’s services, you also need to consider the production costs of the event and the costs that go into publicizing and selling an event.
To set pricing for tickets, consider the following pricing models: dynamic pricing, competition-based pricing, and value-based pricing.
Nonprofit Pricing Model
It may sound odd, but even a nonprofit needs to consider a pricing model to ensure it’s around to provide a service for a long time. Depending on the nonprofit’s goals, it will need to consider the costs to operate and what it needs to meet those and possibly expand its reach. Don’t forget to include the costs of licensing, volunteers, and stakeholder communication.
Nonprofits will want to consider the following pricing models: demand pricing, cost-plus pricing, competitive pricing.
Real Estate Pricing Model
The real estate market will find a lot of fluctuation in their considerations. Home values, housing demand, and the cost of living are always changing.
The best models to consider for the real estate market include premium pricing, value-based pricing, competitive pricing, and dynamic pricing.
Manufacturing Pricing Model
Determining pricing in the manufacturing industry means adding up production costs, sales volumes, demand, changes to keep your product competitive, sale price, and more. You also have to keep a close eye on your price elasticity to make the most profit.
The best strategies for the manufacturing industry include value-based pricing, competitive pricing, and cost-plus pricing.
Choose Your Pricing Strategy
Before picking one of the strategies discussed above, take a few additional steps to build the right strategy for your business.
- Quantify your buyer personas. Determine who your target customer is. To do this right, you need to know their expectations, what pricing they are willing to accept, and what marketing will reach them best.
- Find the right features for each persona. For example, you need to decide if your target customer prefers premium pricing or economy pricing. If you target premium customers, you’ll need to include product or service features to meet premium expectations, and you’ll need to market yourself to match those expectations.
- Determine the best value metric and bundling. A value metric is how you measure value in your product. You have to determine what value the customer assigns to your product.
- Price your product. Once you have this information, it’s time to assign a price. Because of the research and thought you put into a pricing strategy, you can assign the price knowing you have a coherent, thought-out strategy.
Once you have set the price, make sure you continue to monitor how the customer perceives your product or service. You may not get it right the first time, but because of the work you put into that initial decision, small adjustments should take care of it rather than starting from scratch and potentially confusing your customer.
If you’re looking for more information on starting, running, and growing your business, let us help. ZenBusiness has experts who can help you every step of the way. Don’t let the details of business formation overwhelm you — learn more today.