Even the best-laid business plans can be critically derailed by the execution of a sub-optimal pricing strategy. The price of your products or services has a far-reaching impact on virtually all aspects of your business – especially its future sustainability.
If your business is small and recently launched, pricing acquires increased critical significance, too. Given the scarce resources available to fledgeling business organisations, even a short run of lacklustre sales can be lethal.
As with many essential things in business, finding the right price is a balancing act; you have to juggle various priorities such as costs, profitability, neutralising the competition and, of course, attracting enough customers as well. But how do you know which approach is the best one to take?
Different Types of Pricing
With so many factors to keep an eye on, there is no single universal roadmap to finding the right price for businesses. Instead, there are several different types of pricing strategies in business management, each with their own strengths, weaknesses, and applicability in specific contexts.
To point you in the right direction for your particular business, we've detailed the main points of some of the most popular below:
1. Cost-Plus Pricing
This is one of the most straightforward pricing strategies. Also called markup pricing, it is a very insular approach that focuses entirely on the costs incurred by your organisation in producing and selling the goods or services.
The approach is quite basic; you find out how much it costs to produce, package, market, store, and sell one unit of a product or service, and then add a percentage on top of that. The extra percentage will be your reward or profit for creating that product for the customer.
This is a common strategy used in retail business sectors. Organisations here often set high markups on products of up to 100% or more, depending on the type of the product and how easy it is to sell (the turnover rate).
2. Penetration Pricing
With an increased focus on external factors such as customer preferences and current prices offered by rival businesses, penetration pricing is an aggressive strategy ideal if your business is looking to expand sales at any cost.
It sacrifices profitability for short term gains in sales, so it is not ideal for long term use; rather, this strategy aims to grab the attention of the market with low prices. It is typically used by new companies or existing businesses entering a new market.
Another term for this kind of pricing strategy would be disruptive pricing. To be truly successful, it requires a product that offers quality and value to the customer. This will help initial customers stay loyal even after you raise the price in future.
3. Value-Based Pricing
When businesses offer products or services that may have a higher value than the actual operating costs, simple approaches like markup pricing will prove to be inadequate. A more customer-focused approach is required, of which value-based pricing is one option.
The focus here is on finding out what your target customers are willing to pay for a product. To find out, you have to first take a look at similar products and services in the market and their sales at various price points.
Then, you need to compare your product or service to existing products and services focusing on the unique features (if any) that might provide value to customers. Put a price percentage on each advantage that your product has, while also taking into account any weaknesses.
Finally, add everything up and arrive at a final price for your product. This kind of approach will only work in sectors where products can be easily differentiated from those of your rivals. If all businesses sell largely identical products, it will be hard to justify the premium to your customers.
Value-based pricing is often more effective in the services sector, high-tech and software fields, and unique niches such as handcrafted and artisanal products, as the value perception in the minds of customers are usually much higher in these areas.
4. Economy Pricing
Though a popular option among large businesses and corporations in the retail sector, this approach only deserves a passing mention here as it is not particularly small business-friendly. Instead, you will find this pricing strategy at work in big-brand stores, such as Walmart, Target, and Primark.
These businesses put a heavy emphasis on cutting costs across the board, driving down the prices of most products on the shelves. The focus is on bringing the maximum number of price-conscious buyers to their stores with discounts.
Small businesses lack the brand recognition or economies of scale to extract maximum value from this approach.
5. Premium Pricing
An approach which has much in common with value-based pricing, a premium pricing strategy is used by businesses that have a significant advantage on the competition. If your company has a product that is so obviously superior or differentiated from the rest of the market, you can adopt this pricing strategy.
Apple is perhaps the best example of a massive brand that has adopted a premium pricing strategy; their products have a unique design, tech, and innovative edge that allows them to set a premium price and still achieve massive sales.
Luxury brands are also common examples of premium pricing at work. For a small business, this approach will work only if your product is incredibly unique or innovative.
6. Dynamic Pricing
Some businesses are forced to exist in highly competitive and crowded market segments, and a slow and static pricing strategy may not be enough to stay relevant in such situations. Dynamic pricing is a strategy that adapts itself based on market factors.
In service sectors such as hotels, travel, airlines, and other utilities, businesses use a dynamic pricing strategy. The prices in these segments are continually fluctuating, based on customer demand and input costs.
7. Price Skimming
In direct contrast to penetration pricing, this particular strategy will involve your business setting a high markup price on a newly launched product or service. As time goes on, the purchase cost of the product is gradually reduced to sustain customer interest in it.
This approach works for businesses who have a brand new product on the anvil with unique features. Tech companies and software developers often use this technique, with the video games and consumer electronics markets serving as easy examples.
The advantage here is quite clear; in the early phases of a product launch, you can get maximum revenues from early adopters, while still reaching price-sensitive buyers later on. Therefore, it is often a good choice for small businesses in these sectors.
Why do You Need a Pricing Strategy?
As a business owner, your aim should be to set an “attractive” price for the products or services offered by your company.
Of course, the ultimate aim of any business (and, by extension, it’s pricing strategy), is to drive sales while generating profits. But depending on short term considerations, pricing can be tweaked to address other issues, such as countering rivals, clearing old stock, or entering a new market sector.
A pricing strategy will usually be based on a combination of some of these factors, such as the costs and expenses involved, customer budgets and preferences, market conditions of demand, pricing plans of rival businesses, and the profit and revenue targets of the company.
Typically, each pricing strategy will afford more importance to certain factors while sacrificing on other fronts. The aim is to arrive at a price that sits within the so-called Goldilocks principle: that is, nothing too high (driving the customers away), or too low (leading to losses).
What other pricing strategies would you recommend? Let us know in the comments section below.