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Business owners must choose the best pricing strategy for their products and services to maintain a competitive edge with healthy profit margins. There are many different types of pricing strategies to choose from, including those that adjust to demand, change with the seasons, or aim to penetrate new markets.
Finding the right pricing model is pivotal to business growth. By pricing their offerings efficiently, a business can tap into valuable customer markets and successfully pitch products and services for increased profit.
Learn more about how pricing fits into your retail strategy and how to determine the best pricing strategy for your business.
A pricing strategy is a tactic that businesses use to determine how much they should charge for their products or services. The purpose of a pricing strategy is to drive revenue, improve efficiency, and position your business competitively among your target audience.
After all, pricing, profitability, and brand perception are interlinked. Businesses need to charge appropriately to create healthy profits. This will depend on the cost of goods sold (COGS), appropriate markups in relevant industries, and other manufacturing or production costs, such as marketing and staffing.
How customers perceive a business’ prices is important, too. Buyers have a perception of value and the amount they’re prepared to pay for an item. A value-based pricing strategy takes this into account. Certain brands are synonymous with high cost and high value, while others are associated with affordability. If an affordable brand began charging the same prices as a high-end competitor, customer loyalty could quickly decline.
A business’ pricing strategy should also factor in competitor pricing. Getting this right can help businesses carve out a secure place in the market. Businesses should consider how products or services differ from their competitors, how they can undercut existing competitors, and/or how they can justify higher prices for a premium offering.
Some of the most common business pricing strategies include:
Cost-plus pricing is the process of adding a fixed percentage or markup to the existing COGS and production expenses. This percentage chosen should be based on the expected profit from a product or service.
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Value-based pricing is the process of pricing goods based on what customers are willing to pay or what they think your products are worth. This can be influenced by market positioning and how prices compare to close competitors.
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Competitive pricing is the process of pricing goods to match or undercut competitors' rates. This is effective if similar goods and services can be purchased elsewhere.
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Penetration pricing is the process of entering a new market with a rock-bottom price. Businesses will maintain this low price for a short period and then raise their prices once they attract customers.
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Price skimming is the opposite of penetration pricing. It involves entering the market with a higher price and then lowering it as interest or relevance declines.
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Psychological pricing involves using human psychology to convince customers they’re receiving a better deal. An example of this is charging $99.99 instead of $100, or offering ‘buy one, get one free’ and two-for-one deals.
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Bundle pricing is the process of combining products and services at a lower price if purchased together. Bundle pricing can introduce customers to complementary offerings, as well as increase the average order value (AOV).
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Dynamic pricing is the process of changing prices in response to market demand, whether that’s based on season, location, or relevance. Transportation apps like Uber use dynamic pricing to raise or lower their prices depending on how many people are seeking rides in a particular area.
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Premium pricing is the process of setting lofty prices to establish the perception of a high-quality, high-value, or luxury brand. This strategy is often used for businesses appealing to high-income customers.
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Freemium pricing is the process of offering a free product or service for a limited time and then motivating customers to upgrade to a paid version with additional features. Freemium is a common pricing strategy for software companies that might provide different tiers or plans to access their services.
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Project-based pricing involves setting a fixed price for each project or service. This is a common pricing strategy for freelancers and consultants who provide services such as content writing, design, and software development.
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Economy pricing involves setting low prices for products to target customers looking to save money. Big box stores are often able to use the economy pricing strategy because of their low production costs and high sales volumes.
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There are pros and cons to every pricing strategy, and not all strategies will be appropriate for every business. It's important to consider these pricing strategy factors before choosing the best approach for your needs.
Pricing strategies are influenced by what the rest of the market charges for similar products and services. Market research teams will be able to find out what customers think of price points, what they’re willing to pay, what they’re paying for competitors’ products, and where a business can position itself in relation to these factors. Market research removes the guesswork and replaces it with meaningful data.
Cost analysis will predict how much revenue a business could generate compared to its overall costs. This is a helpful way to compare different pricing structures and test how they could impact profits. For example, your overall costs might include manufacturing, labor, raw materials, inventory storage, and shipping.
To help curb some of these costs, many businesses are turning to dropshipping. This involves selling products online but shipping them directly from the manufacturer to the customer. Meaning, businesses don't have to take on the costs and risks of storing their own inventory. A beauty retailer, for example, might market and sell makeup products on their e-commerce site but partner with a wholesaler to pack and ship the products to each buyer. As such, a dropshipping pricing strategy has the potential to deliver high profits with low overhead costs.
Researching how much competitors charge for similar products will help a business set its own prices. There may be a huge range of price points across an industry, depending on value and quality. Researching the competitive landscape can help businesses position themselves optimally.
The perceived value of your brand plays a pivotal role in determining how much customers are willing to pay. Luxury, high-quality, and personalized offerings will have higher price points compared to budget-friendly options. Establishing clear brand positioning can be important when developing a pricing strategy.
A business’ pricing strategy has a direct impact on its current and future goals. Offering rock-bottom prices won’t help a business become synonymous with quality – while a focus on quality could increase manufacturing costs and eat into profits. A pricing strategy should be developed in line with business goals and be adaptable as the market changes.
Once you've conducted your research and analysis, take the following steps to help determine the best pricing strategy for your business.
A chosen pricing strategy should consider your buyer personas – and cater to your customers’ needs, budgets, and expectations. Your strategy should also take the entire buyer journey into account. Some products, for instance, might be priced differently if they're used for retargeting campaigns, loyalty programs, or cross-selling and upselling offers after a customer makes a purchase.
Economic shifts and retail industry trends can change markets – and pricing strategies – considerably. For example, high living costs can make a product or service more or less desirable, depending on the price point.
Or consider a growing food truck business trying to stand out in a competitive field. Culinary trends, along with changing customer behaviors and preferences, can influence ingredients and menu offerings. Meanwhile sales can fluctuate significantly based on different seasons, neighborhoods, and even weather patterns. All these factors can impact a food truck pricing strategy.
The lifecycle of a product is generally divided by introduction, growth, maturity, and decline. The price point may be high initially, then level off, and eventually drop as it becomes less relevant. This calls for a flexible pricing strategy that adapts to sales.
Going further, let's dive into a few more factors to consider when pricing a product:
It’s essential to understand production, labor, and overhead costs before choosing a pricing strategy. Otherwise, a business’ pricing won’t cover the cost of expenses, and profit margins will erode over time. A break-even analysis will calculate how many units of a product or service need to be sold to cover expenses and make a profit. A cafe, for example, would need to determine how many drinks and pastries to sell to cover the costs of their lease, utilities, payroll, and inventory.
Before determining prices, businesses should study their customers’ willingness and ability to pay them. Fairly representing the value of products and services and pitching them as accessible to customers can be challenging. Market analysis can help determine market demand and customer affordability. The owner of a construction business, for instance, might research communities with booming house flipping industries, high real estate turnover, or large lots of land for sale.
Analyzing competitors’ price points can help determine an ideal price for your products and services. This could mean matching them, charging less, or positioning a brand as premium.
How consumers perceive the value of a product or service has a direct impact on price setting. Materials, manufacturing processes, and expertise may need to be communicated if prices are higher than expected. A boutique jewelry business, for instance, might want to communicate to customers how their products are ethically or locally sourced and crafted.
External pricing factors such as economic fluctuations, changes in technology, and other societal shifts will inevitably affect business operations and pricing strategies.
Economic shifts can play a part in how much customers are willing to spend, how they perceive value, and the cost of business overheads. This has a direct impact on how much a business can charge for a product or service.
Automation and machine learning have transformed manufacturing processes, supply chains, and other aspects of business operations. This can reduce overheads and cost structure, increase product values, and change pricing structures overall.
As society changes, the things we value change too. For example, sustainability was less of a concern for customers a decade or two ago. Now, the materials and processes used have a huge impact on perceived value and how much customers are willing to pay.1
Adapting to these dynamic forces helps ensure long-term competitiveness and profitability in an evolving market landscape. Furthermore, regularly evaluating your break-even point can help you make informed decisions about pricing.
Learn more about gathering metrics for measuring online performance and how to perform a break-even analysis.
In partnership with three expert business owners, the PayPal Bootcamp includes practical checklists and a short video loaded with tips to help take your business to the next level.
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