Complete Guide to Pricing Strategies

Learn how to price your products and services to maximize profits or maintain market share. Includes best strategies, tips, and useful calculations.

Updated on March 31st, 2020

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Pricing strategies are the methods by which businesses set the pricing of their products or services. A pricing strategy is determined by a range of factors. These can include cost of production, consumer demand, consumer income levels, market conditions, and competitor pricing, among others.

Your pricing strategy will largely determine how much revenue you make, making it one of the key decisions in the management of your business. Ultimately, the best price for your product strikes a balance between maximizing profits and being affordable. There is a pricing model and strategy for every conceivable business case, with a host of variables having an influence on your final price. These include internal business elements too, as marketing goals and brand positioning will contribute to your strategy.

Despite this, pricing strategies don't always follow the logic of profit maximization. Sometimes businesses price their goods low to maintain their market share. Sometimes, a product priced below a competing product will suffer from a perception of being lower quality, or lower value, while more expensive products create the illusion of greater value. A customer without any knowledge of your product might unfairly judge it as inferior to the more expensive one, when in reality the two might be very similar. Price can create this illusion.

Types of Pricing Strategies:

Pricing Strategy

Description

Used by

Cost-Plus Pricing

The cost of producing the product plus a markup percentage for profit.

Netflix (before the rise in streaming services). They monopolized the streaming market and got to set their price on their terms. Most companies in noncompetitive markets use this pricing method.

Demand Pricing

The price of the product is determined by the level of consumer demand.

Starbucks. Most companies in service industries have things like happy hours or early bird specials, which are based on consumer demand.

Penetration Pricing

A short-term low-price strategy used when entering a new market.

OnePlus. They positioned themselves as a high-quality budget smartphone when they first entered the market, and gradually established themselves as one of the leading players in the smartphone market since.

Geographic Pricing

Pricing strategy based on location, determined by economic factors like income level.

Zara. Most clothing retailers price according to income levels and tax differences. They also have seasonal pricing.

Price Skimming

A high-price strategy that capitalizes on a company's competitive advantage.

Apple. They were first to the tablet market with the iPad, which was gobbled up by early adopters. They got to set their price without competition. Apple also enjoys a loyal fan-base who value the quality of their products, giving them a competitive edge.

Economy Pricing

A low-price strategy aimed at price-conscious customers.

Target. Most retailers have a line of products that are aimed at low-income consumers.

Psychological Pricing

Reducing the price of an item by a few cents to create the illusion of being low-cost.

Walmart, although you would struggle to find a company that didn't use this method.

Competitive Pricing

Pricing strategy that reflects your competition.

Verizon. Companies in highly competitive markets where the consumer is spoiled for choice use this method.

Bundle Pricing

Items are bundled together and priced lower than the sum of their individual prices.

McDonald's. A meal consisting of a burger, fries, and a coke will cost less than the sum of its individual parts.

Discount Pricing

Reduced pricing based on seasonal sales or product life-cycles.

Sephora. They might have a sale on Valentine's Day, prompting husbands to buy make-up for their wives, for example.

Cost-Plus Pricing

Also known as markup pricing, cost-plus pricing is a pricing strategy where the total cost of producing a product is added up, and a markup is added for profit. The sum of the markup and the total cost of producing the good will give you your price.

This cost is inclusive of a number of things, including the cost of raw materials, the cost of production, and the overhead costs.

Once the total cost of producing the good is calculated, the markup is added. This is also known as the profit margin. To calculate this, your first step is to determine how much profit you want to make on each item sold. Let's suppose you owned an ice cream store. Your cost of producing an ice cream cone is $2.00 and you want to make $1.00 on each cone, so you price your cone at $3.00. This gives you a markup of 50%.

This method is unsuitable for companies operating in a highly competitive market, as the pricing of your competitors should serve as the main reference point. Using this method in a competitive space runs the risk of overpricing your products.

The Cost-Plus Method – Free Template

Use our Cost-Plus Method spreadsheet in Excel to calculate your company's profit margin on each item sold.

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Demand Pricing

This strategy is where the level of demand for a product determines its monetary value. The logic of this method is fairly simple. The greater the demand for a product, the higher you can set your price. Low demand means people are less willing to fork out a small fortune for your product, resulting in a lower price.

Things that can affect demand are weather, natural disasters, holiday season, cheaper alternatives, and market trends.

Demand pricing falls under a pricing category called Dynamic Pricing. This is a strategy that responds to changing variables in the marketplace. Prices fluctuate regularly and there is a need to adopt a flexible strategy that responds to change.

Companies now use sophisticated algorithms that track consumer demand and change prices accordingly, aligning prices with what they think customers are willing to pay. If you manage a hotel, utility company, or transport company, you will most likely need to adopt this method.

Consumer Demand Formula – Free Template

Use our Consumer Demand spreadsheet in Excel to calculate consumer demand for your products and services.

Download Now Instant download. No email required.

Penetration Pricing

Suppose you're launching a new product in a competitive market. Your competitors are well-established with a loyal consumer base. How do you win over their customers? Enter penetration pricing.

Penetration pricing is the process by which a new company temporarily prices its products far below the industry average, in the hopes of persuading customers to make a purchase. In theory, your product is promising but no one has ever heard of it, so you make it very easy to buy. You put your product in consumer hands by making it cheaper than the competition in the hopes that it makes an impression on them beyond affordability, and good word-of-mouth starts to spread. Once it owns a piece of the consumer's mind, you gradually restore its price to a profitable one. With penetration pricing, you're sacrificing in the short-term in order to be profitable in the long-term.

This method can be risky if your short-term losses exceed the expected time-frame and the product hasn't yet garnered attention or gained any traction in the market. In this event, there are a number of working capital loans available to small businesses to keep your company operational during rough patches.

The 'Freemium' Method works in a similar way to penetration pricing. With 'Freemium' Pricing, companies sell a basic version of their software with a limited set of features and a low price point. Once the customer sees the value of your product, they would typically consider upgrading to a more expensive version; one with extra features. They wouldn't necessarily have done so had they not been exposed to the product in some limited way.

Geographic Pricing

You might sell only one product, but you very likely will sell the same product at different prices, depending on where you sell it.

Different markets have different dynamics, so you have to understand what customers are willing to pay in each market before setting your price. Geographic pricing takes into account the diversity of income levels, market conditions, taxes, tariffs, shipping costs, and socio-economic factors that characterize each market.

Geography might also affect supply and demand. A company selling winter clothing, for example, would price their clothing higher in cold-climate countries and lower in warmer climates, as there is more demand for them in colder countries.

Transportation might also play a role in pricing. If you're selling clothing to a country on the other side of the globe, the cost of shipping your products might increase your prices.

Geographic pricing can apply both to global markets and markets within a country, state, or city.

Price Skimming

There are two scenarios where price skimming should be employed; when a company has a competitive advantage that justifies higher margins, and when a company has a monopoly on a product.

A company with a competitive advantage is one that has a natural advantage over its competitors. Their underlying economics or brand value allows them to either over-charge to maximize profits, or under-charge to maintain market share, shielded by something their competitors can't offer. For example, an ice cream shop that uses their own dairy products from a farm will use less money to produce an ice cream, allowing them to price their ice cream below their competition while enjoying the same profits.

Businesses primarily use price skimming when they are the first to market with a new product. Their monopoly or intellectual property over their creation allows them to charge a high price before competitors enter the market, after which it is reduced. This strategy is often targeted at early adopters who will pay over-the-odds for something new before making it affordable for the majority of the market.

The Price Skimming strategy hits two birds with one stone. It both allows your company to make good on most of its production costs and creates an initial impression of superiority, based on an exorbitant price.

Economy Pricing

This is a low-price strategy that targets the bottom end of the market. Commonly used by retailers and wholesalers, Economy Pricing ensures that the cost of production is low, so that the product can be affordable. The product sold is ultimately of an inferior quality and a low price.

Economy Pricing is a strategy employed by large companies and is not recommended for small businesses. They do not generate the same sales volume as larger retailers so they cannot afford to lower their prices.

Psychological Pricing

This method marginally lowers the price of a product to create the appearance of a lower price. You've likely seen this somewhere today. A product is priced at $9.99 instead of $10.00, toying with the customer's emotions. Psychological Pricing works because the difference in price is not as great as the impression it creates on consumers.

Competitive Pricing

This strategy mirrors the pricing of your competition on similar products. Use this method when operating in a highly competitive market, where a slight difference in price might persuade customers to buy your product over your competitors'.

Do some research on your competitors and set your price marginally lower than theirs. Remember that your production costs might not be the same, so setting a similar price might result in lower profit margins. Only lower your price if you can justify it. Determine what profit margins you're aiming for and use your competition as a reference point for realistic pricing.

Bundle Pricing

Price Bundling is the process of pairing two or more products together and selling them at a combined price that is lower than the sum of their individual parts.

This strategy is typically used when two or more products are not selling. The products are bundled together and presented to the customer as a bargain. 'Save $10.00 by buying this package,' or 'Two for the price of one.' The prospect of a bargain often gets unsold products off the shelf.

Restaurants will sell you a meal that is cheaper than if you bought each food item individually, or only bought two items when you could have bought a meal. This makes a convincing argument to the customer, who may feel as though they're getting more value for their money.

Discount Pricing

Discount Pricing is a strategy where businesses offer temporary price reductions on their products. These discounts are typically offered during holiday season or commercialized holidays like Valentine's Day, and include things like coupons, loyalty rebates, and 'buy-one-get-one' promotions.

Discount Pricing is a short-term strategy to offload products that aren't selling or to create a buzz around your business. Customers tend to see discounted items as a narrow window of opportunity in which to save money, incentivizing them to make a purchase or miss out.

How to Choose a Pricing Strategy:

Scenario

Pricing Strategy

My products aren't selling and they have a short shelf life.

Bundle Pricing or Discount Pricing.

I own a restaurant and I have plenty of leftovers that I don't want to discard. I'm considering re-purposing the leftovers as a new food item, or offering all the leftovers as a new meal.

Bundle Pricing.

I'm introducing my product to a saturated market. How do I compete with the established players?

Penetration Pricing and Competitive Pricing.

I sell seasonal clothing and I need to adapt to change.

Geographic Pricing and Demand Pricing.

I don't want to alienate my product by making it too expensive.

Competitive Pricing.

My production costs are lower than my competitors. How do I take advantage of this?

Price Skimming and Competitive Pricing.

My brand distinguishes me from my competitors. Do I price my products higher?

Price Skimming.

I've spotted a low-income gap in my market. How do I exploit this?

Economy Pricing.

I want to enter a new market but It's really far away from my nearest factory.

Geographic Pricing.

Key Questions to ask Before Setting a Pricing Strategy:

  1. How competitive is my market?
  2. Who are the big players and what are their pricing methods?
  3. Is my market homogeneous or heterogeneous? (are there varying levels of income?)
  4. What is my typical customer profile, and how much are they willing to pay?
  5. Are my customers willing to pay more for my brand?
  6. What are my production costs?
  7. How much revenue do I need to break even or achieve my profit targets?
  8. Should I make high-end and low-end versions of my product to appeal different customers, or target one?
  9. What is the current and future levels of demand for my products?
  10. When should I offer discounts?
  11. How similar is my current market to the country I want to expand into?
  12. Will I incur additional (unforeseen) costs by expanding into a new territory?
  13. For how long can I afford to keep my prices low while I enter a new market?

FAQs:

What is a product pricing strategy?

A product pricing strategy is the method by which the price of a company's products is determined. Pricing strategies are subject to a host of variables, and there is a pricing strategy for nearly every business model. Some of the main pricing strategies are Cost-Plus Pricing, Demand Pricing, and Price Skimming.

Why is a pricing strategy important?

  • Without the right strategy, you run the risk of pricing yourself out of the market.
  • The proper pricing strategy allows you to maximize profits.
  • Discover niches in your market you would have otherwise overlooked.
  • Take advantage of seasonal promotions.
  • Find creative ways of re-purposing products that aren't selling.
  • Segment your market into different income levels.
  • Win over your competitors' customers.
  • Maintain your market share.
  • Capitalize on the value of your brand.
  • Understand regional differences when selling across borders.

What is a pricing model?

Pricing models are synonymous with pricing strategies. Each pricing model you employ should be well-considered before being implemented, ensuring that it is aligned with your business aims and profit objectives, with consumers and competitors the two main factors.

How do you implement a pricing strategy?

  • Know your customer profile.
  • Determine how much they're willing to pay for your product.
  • Factor in your cost of production and competitor pricing.
  • Understand the different customer segments within your market.
  • Sell customers on your value.

What is an optional pricing strategy?

Used predominantly in the airline industry, optional product pricing involves using a low initial base price for a service but then offering useful complementary products that rockets the price upwards. An airliner will charge you for your ticket and advertise only the ticket price, then charge you extra for your luggage, insurance, food, and others.

What is a bundle pricing strategy?

Bundled pricing is a method where items are bundled together and priced lower than the sum of their individual parts. Products that are struggling to sell are typically bundled together and presented as a bargain.

What is a competitive pricing strategy?

Competitive Pricing involves setting your price based on what your competitors are pricing. In a highly competitive market, a slight price difference might persuade a customer to buy your product over your competitors'.