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How To Set An Effective Pricing Strategy For Your Business
Estimated reading time: 10 minutes
Many a business owner has torn their hair out over pricing. How much to charge? Will people pay that? Am I going to be competitive and still make a profit? In this capitalist world, this one simple number that represents the amount of money required to obtain your goods or service can cause so much anxiety and put literal lines on our faces.
But hereâs what most people never tell you about pricing: you donât set the price, the market does â and whether that price is deemed to be âworth itâ is a decision made purely in the minds of your customers. Crazy, huh! Thatâs why the process of weighing up the perceived value, usefulness, quality, sustainability, and a whole host of other factors, when it comes to designing your pricing strategy is far more nuanced and important than it might seem at first glance. So, what are the things to consider and whatâs the right path for you and your business?
What Is A Pricing Strategy?
Your pricing strategy is an articulation or reasoning behind the price of your goods or services; a method used to determine the best possible price point for your ideal customers. Too high and you might not make any sales, too low and you might not make any profits. A pricing strategy that enables you to maximise profits and minimise risk, all whilst aligning with your business goals and objectives, is what we should be striving for as smart and savvy business owners.
âThe market is like Goldilocks. It decides if your price is too hot, too cold, or just right.â
â Peter Porcelli
What Do I Need To Consider?
When you are building the business of your dreams, the strategy behind your pricing needs to take into consideration what your costs are, what others are charging for similar products/services, what youâre trying to achieve with your business, and how you want your brand to be positioned in the market (i.e. budget-friendly to prestige pricing). We see a lot of small business owners setting a price by assessing their costs, looking at their competitors pricing and then settling somewhere in the middle. While both factors are very important, this method of price setting neglects one of the most critical components of doing business, your customers, and their needs!
There are more than a few options to consider, so letâs unpack how some of these strategies work so you can try them on for size!
But First, Why Is It So Important That The Price Is Right?
Remember us letting you in on the secret that pricing is in the eyes of the customer? What that basically means is that they are the ones to make a decision about whether or not to buy your goods or services by weighing up its value, both actual and perceived. Therefore, itâs your job to identify and communicate that value and how it solves a problem for them, without making too many costly mistakes along the way. As Katharine Paine says:
âThe moment you make a mistake in pricing, youâre eating into your reputation or your profits.â
â Katharine Paine
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When it comes to pricing strategy thereâs no one size fits all, and itâs important to remember that no one strategy is inherently better than another. On top of that, many of the different strategies to choose from are not mutually exclusive, so you might even employ several at a time or develop a hybrid strategy for different products, services, or verticals.
âIt can help to think of your pricing kind of like a game of chess; one strategy on its own is probably not likely to win you the game.â
â Emma Bowdler
Different Types Of Pricing Strategies
Remember how we said there were a heap of choices? Well, weâve gone ahead and sorted them into four well-known groups, because weâre helpful like that! Starting with marketplace strategies; then Software as a Service (SaaS) strategies; competition strategies; and finally; service-based strategies, letâs unpack some of their key strategic differences and the types of strategies that fall underneath them:
1. Marketplace Strategies
Largely based on supply and demand and consisting of strategies like âcharm pricingâ, âdynamic pricingâ and âpremium pricingâ.
â Psychological Pricing
Strategy Explanation:Â
âPsychological pricingâ, also sometimes referred to as âcharm pricingâ, is when the price setter marginally changes the price to reflect what feels like a âpsychologically higher/lower priceâ in the eyes of the consumer. While the consumer may only be paying one to ten cents difference on the original price tag, these subtle changes can change how the value is perceived by the consumer.
Strategy Use-Case:
This is a highly versatile pricing strategy that can perform well almost anywhere, but particularly in retail environments, and is easily combined with other strategies.
â Penetration Pricing
Strategy Explanation:Â
âPenetration pricingâ (sounds awful, doesnât it?!) is where the price setter chooses an intentionally low price with the intent of gaining market share. Normally, this strategy will provide minimal profit rather than a direct loss, but that can be offset by large volume.
Strategy Use-Case:
This strategy works well when youâre new to the market, or when demand is heavily affected by market conditions such as price (or for you Econ101 nerds out there when the demand is elastic).
â Dynamic Pricing
Strategy Explanation:Â
âDynamic pricingâ, sometimes referred to as âprice discriminationâ, sees the price setter choosing different prices for different groups and at different times. Uber has been doing this for years with surge pricing, or power companies with their âoff-peakâ and âpeakâ prices.
Strategy Use-Case:
This strategy works best when demand is time or event sensitive, like you need to get to that appointment fast or you need higher speed internet at a certain time of day.
â Premium Pricing
Strategy Explanation:Â
‘Premium pricingâ is where the price setter chooses a price that is higher than market standard but they are confident that they can still attract customers through a mix of aspirational branding and lifestyle cues (Rolex, Louis Vuitton and Moleskin come to mind).
Strategy Use-Case:
Often this strategy works best for new entrants to market; highly niche businesses where there is no threat of substitute or exact competition; and when there are high barriers to entry i.e. your product is one of luxury.
2. SaaS Strategies
Derived from companies that deliver âSoftware as a Serviceâ (SaaS) like Spotify or Xero and covering well-known tactics like âfreemium pricingâ and âprice anchoringâ.
â Decoy Pricing
Strategy Explanation:
âDecoy pricingâ, sometimes referred to as âprice anchoringâ, describes a strategy whereby the price setter uses âdecoyâ products to guide customers towards the one they actually want to sell. Subconsciously, this is designed to make customers think the cheapest option is poor quality, that the most expensive option is over the top -leaving the middle option (the desired sale), as the obvious choice for best value. Often, businesses using this strategy offer a choice of three similar but marginally different products – all at different price points. This strategy works particularly well online or when a store is selling many products that are similar (think: JB Hi-Fi or any appliance store youâve ever walked into).
Strategy Use-Case:
Often, businesses using this strategy offer a choice of three similar but marginally different products – all at different price points. This strategy works particularly well online or when a store is selling many products that are similar (think: JB Hi-Fi or any appliance store youâve ever walked into).
â Freemium Pricing
Strategy Explanation:
âFreemium pricingâ sees the price setter giving free access to a basic version of their product or service, hoping that once they get in the âdoorâ that they upgrade to a paid model. This strategy is implemented by most app developers and software products from MailChimp to Zoom. This is only really a viable option if you can make enough sales of the âpaidâ version to cover fixed costs, so this strategy is best suited to businesses that are predominantly online-only retailers or âclick-and-mortar businessesâ as opposed to your traditional brick-and-mortars. Thatâs because, online, thereâs less of a difference in scale.
Strategy Use-Case:
This is only really a viable option if you can make enough sales of the âpaidâ version to cover fixed costs, so this strategy is best suited to businesses that are predominantly online-only retailers or âclick-and-mortar businessesâ as opposed to your traditional brick-and-mortars. Thatâs because, online, thereâs less of a difference in scale.
â Price Skimming Pricing
Strategy Explanation:
âPrice skimmingâ, often thought of as the opposite to the cringeworthy âpenetration pricingâ, is a strategy whereby the price setter chooses a relatively high price when they enter the market, and then reduces the price over time once variable costs are covered and the business has broken even. This strategy can work well if demand is what we call â inelasticâ, or in other words â not sensitive or easily affected to other market conditions. While this strategy may work for juggernauts like Apple, itâs often really hard to execute for small businesses as markets are more crowded and demand is notoriously hard to predict.
Strategy Use-Case:
This strategy can work well if demand is what we call â inelasticâ, or in other words â not sensitive or easily affected to other market conditions. While this strategy may work for juggernauts like Apple, itâs often really hard to execute for small businesses as markets are more crowded and demand is notoriously hard to predict.
3. Competition-Based Strategies
Heavily based on your âcompetitorsâ and their actions with tactics like âpredatory pricingâ, which is as awful as it sounds.
â Predatory Pricing
Strategy Explanation:
âPredatory pricingâ is basically the more aggressive cousin of penetration pricing and is normally a strategy used to drive all other competitors out of the market and create a monopoly. Usually, it means running at a significant loss for a period to âstarve outâ competition.
Strategy Use-Case:
These strategies are not illegal, but they probably should be – and these kind of âanti-competitionâ tactics are certainly seen as ânot coolâ in the business world.
â Limit / Barrier-to-Entry Pricing
Strategy Explanation:
âLimit / barrier to entryâ pricing is similar to predatory pricing but instead of focusing on creating a monopoly, itâs focused on maintaining that monopoly. Essentially, rather than disrupting businesses already in the market, the price setter finds ways to prevent new players from entering the market at all. Also file this one under the ânot coolâ category.
Strategy Use-Case:
This strategy does not generally find its home in small business, as it is centred around keeping new entrants out of an already established monopoly.
4. Service-Based Strategies
Common, but not exclusive, to the service industry.
â Cost-Plus Pricing
Strategy Explanation:
âCost-plusâ, sometimes referred to as âmark-upâ pricing, is where the price setter adds a fixed percentage profit on top of the cost. For example, it costs you $10 to manufacture a lipstick and you want to make 100% profit, so you charge customers $20. (Hereâs a handy calculator to try mark-up pricing for yourself). Sounds simple enough, right? Well, yes and no.
Strategy Use-Case:
âCost-plusâ pricing is a trap we see a lot of small businesses fall into, as this strategy often does not take into consideration the many outside factors and overhead costs that your business faces. However, it is a strategy that is easy for customers to grasp and can contribute to more transparent prices and profits, which is becoming increasingly important for businesses.
â Value-Based Pricing
Strategy Explanation:
âValue-based pricingâ is where you attempt to set your prices based on the value (both perceived or gained) for your customers, above everything else. Most of us spend a lot of time doing customer journey mapping and creating in-depth customer personas, and so this customer-first pricing strategy aligns with the kind of operation we want to be running. A few challenges arise if your product is not that much different to anyone elseâs, you have a hard time communicating your value, or you donât know enough about your customerâs pain points and aspirations.
Strategy Use-Case:
This strategy is often easier to enact for service-based businesses, but it can still work for product-based businesses depending on how important the problem youâre solving for your customer, or how âaspirationalâ the item is.
âPrice is what you pay, value is what you get!ââ Warren Buffett
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READ: Supercharge Your Marketing With These Five Simple Principles
So, Which One Should I Choose For My Business?
While most of these strategies are not mutually exclusive, some work better together than others, and some work better for certain industries. It is perfectly normal (and even encouraged!) to borrow tactics from all four categories, and there are certainly no rules against changing strategies if things arenât working. In fact, thatâs what being nimble and agile in business are all about!
Here are four tips for setting an effective Pricing Strategy:
1. Know Your Costs
How much does it cost to run your business? What about each individual product or service? Are there costs, other than financial, to doing business â such as environmental, energetic, or ethical? Consider the entire value chain. And donât forget to factor in those taxes!
2. Put Yourself In Your Ideal Customerâs Shoes
Whether theyâre Louboutinâs, Vans or Crocs (hopefully not) â take the time to understand what your product or service is worth to your customers, and how much they are willing to pay for it. Customer journey mapping and qualitative research are great ways to do this. Go deep on figuring out why people buy from you. Hot tip: there are the âgoodâ reasons (better for the planet) and there are the real reasons (youâre on the shelf in front of my face). Try and find out what those reasons are in a way thatâs cheap and quick to test.
3. Get The Basics Right
Without knowing what levers you need to pull to fatten up the bottom line, you will struggle to make consistent profits and we donât want that! What are those levers? In a nutshell: leads, conversion and retention â and you should probably have a strategy for each. How are you going to generate leads? How and at what rate are those leads converting? And are those customers or clients coming back? Data is #queen here, so if you are not tracking these metrics, start today.
4. Know Where You Stand In The Market
Finding out information about your competitors, or others in the market, will allow you to best position yourself and stand out for all the right reasons. Even something as simple as bringing a âBuy Now, Pay Laterâ or BNPL service into your business could give you a competitive advantage. If others are overlooking something, it could become your niche, or there might be a reason. We suggest finding out! Remember, this is not about crushing your competition or becoming the Monopoly (Wo)man, itâs about seeing where the holes are in the market and filling them with your wonderful self.
So, there you have it â a crash course in pricing strategy and four steps to help you get started with one. Remember: getting the price right is all about balancing value + market conditions + cost, then youâll be ready to⊠COME ON DOWN!
If youâd like some help to refine your pricing strategy or even to build one from the beginning, you know we can help you do that, right?
