Determining the right pricing strategy for your products and services can be challenging for startups and existing businesses. How you price your product, service or workshop can have a massive impact on your sales and profitability. So, it’s important to get pricing right.
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.
In the classic business world, pricing is an art form. Pricing gurus at major companies obsess over finding the perfect price to maximize profit from a given product or service.
In other words, that Gillette razor is priced the way it is for a reason. Not because it makes the most sense for the consumer, but because it maximizes shareholder value.
So, keep in mind that a pricing conversation is really about how you will get the most value from the product or service you decide to sell. Thankfully, independent business owners don’t have shareholders, so we can also take into account things like doing what’s right for the customer.
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 best price to charge, 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
The easiest way to understand price elasticity of demand is this: if all else remains equal, demand for your product or service will decrease with an increase in price.
As an example, imagine this: you can sell 100 units of a $100 dollar product to your current audience. If you increase the price to $105, you are able to sell 95 units. Your costs are $20 per unit. Should you sell at $105 or $100?
The answer: $105. Why? Because you’ll earn $8,075 profit as compared to $8,000 at $100 per unit.
Great. That’s all the theory you need to know. When price increases, demand goes down. There is an optimal pricing level you can reach to make the most money from your thing. Capiche?
Here’s a more scientific explanation to the concept:
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. In other words, what they’re willing to pay. 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 also known as rate-based pricing. It’s a popular strategy for freelancers, coaches, and 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.
The downside is that you have to trade time for money. The upside is that you’re guaranteed to get paid for every hour of work. Clients are sometimes hesitant about hourly pricing because they fear the incentive is to work more hours to make more money as opposed to being efficient.
7. 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. For this to work well, the scope of work should be well defined up front.
8. 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.
9. 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.
10. 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.
11. Luxury Pricing
Luxury pricing is a classic strategy used by brands like Louis Vuitton, Mercedes, and Rolex. The price has more to do with the aspirations and image of the person making the purchase than anything else. By buying a product or service at a luxury price, we are buying our way into a club. That club is a representation of how we want others to see us in the world.
12. 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.
13. 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.
14. Tiered Pricing Strategy
A tiered pricing strategy gives consumers the option of choosing between different versions of the same product or service. For example, imagine considering a single gear bike for $299, a three-gear bike for $399, and a seven-gear bike for $499. A tiered pricing strategy turns a yes or no decision into an either or decision for the potential customer. It also provides a price anchor (as a consumer, I can convince myself I am being frugal by spending $299 on the single gear bike as compared to $499 on the seven-gear).
15. 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.
16. 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.
17. Pay What You Want Pricing
Also known as a donation-based pricing strategy, pay what you want pricing allows the customer to make the decision on how much the product or service is worth to her. Pay what you want allows you to test market demand without knowing the price elasticity for your thing. When combined with a “suggested price,” a pay what you want pricing strategy can sometimes lead to more profit than a set price.
Pricing Models Based on Industry or Business
Some pricing strategies lend themselves to certain industries better than others. 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. Independent contractors and freelancers must consider their experience and quality of work, as they typically don’t have many production costs.
Pricing strategies to consider: Project-based, hourly, or value-based pricing models.
For digital products, pricing strategies range widely. From $.99 books on Amazon to $2,000 courses, digital products truly run the gamut. Your price should be a reflection of your industry, your customers, and the value provided through your product or service.
Pricing strategies to consider: Competitive Pricing, Value-based Pricing, Tiered Pricing, Pay-What-You-Want Pricing
Physical Product Pricing Model
If your business makes a tangible product, you likely need to consider the costs that go into production. While services like drop shipping, print-on-demand, and 3D printing are helping drive costs down, the physical product world is still very unique. It’s important to keep in mind unit economics when it comes to pricing physical products: if you lose money selling one product, you’ll lose more money with every successive sale. 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.
Pricing models to consider: Competitive pricing, cost-plus pricing, value-based pricing, tiered pricing, and premium or luxury 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.
Pricing models for restaurants 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.
Workshops and live events like conferences are highly dependent on the speakers or workshop leaders to deliver value. The experience of the attendee can vary greatly from session to session. Setting clear expectations up front helps frame the value of the event so that a potential attendee is ready to consider the price you’ve set for the ticket.
Pricing strategies for setting ticket prices include: 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.
Pricing models to consider: 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.
TThe best pricing models for real estate 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.
Pricing strategies for the manufacturing 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.
Pricing Strategy Matters, But a Great Product or Service Matters More
Hopefully this gives you a great overview of the pricing strategies available to you, and the ways you can use them to help price different kinds of products and services.
But if you take one thing away from this article, let it be this: no matter how well you price your product or service, nothing can make up for the importance of having a truly great product or service.
Your customers will tell you whether you have a great product. Make sure you listen
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.