When it comes to pricing your product or service, there are a variety of paths you can take. This guide is designed to help you understand each unique pricing model while deploying key techniques to help you grow your business.
Why Businesses Need a Pricing Strategy
You’ve just put the final touches on your new product, and you’re ready to introduce it to your target market. While you’re confident about the offering itself, you’re unsure of what a proper price should be and nervous about how the decision will impact your revenue. Price too high, and you run the risk of scaring customers away – something that could be devastating when breaking into a new market and trying to make a strong first impression. Price too low and you could not only be leaving money on the table but also crippling your business from being able to thrive and survive. So, what do you do? How do you figure out which price is right?
Key Elements of Pricing to Consider
First, it’s important to understand some of the key elements that go into a pricing strategy. While not all pricing strategies will dive deep on each of these components, it’s still paramount that you have at least a basic understanding of where your business slots in with each. When we break down each pricing strategy further below, you’ll notice that the majority of them take at least one of these factors into consideration.
What market are you selling your goods or services in? What do those conditions look like? Is it oversaturated, or are you presenting something new that hasn’t been offered there before?
Is the perception of your brand important? Do you want to drive awareness and build an emotional connection with your target users? You’ll soon realize the way you price your business and the way you market your brand go hand-in-hand.
Who are your ideal customers? What are their demographics and psychographics? Do you have multiple customer segments, and if so, how do they differentiate from one another?
Production and Distribution.
What are the costs associated with actually producing and distributing your product? Whether you’re selling a physical or digital good, knowing what the costs of creating and actually getting your offering to the customer or end user will impact your price.
How many competitors are you competing against? What are the similarities of their product compared with yours? What makes theirs different? How are they pricing their products? How fiercely do you think they’ll pivot to try and capture some of your market shares if you offer a different price than them?
As you’ll soon see below, some strategies flex more to support one or two of these elements while neglecting others, which isn’t necessarily a bad thing as it is done with a specific goal in mind.
Price Elasticity of Demand
One last thing to be very cognizant of is how sensitive your product may be to fluctuations in price, and what the impact would be on product demand should there be an increase or a decrease in price. This concept is known as Price Elasticity of Demand and is a quantitative way of determining consumers’ likelihood to buy your goods or services at various prices in your target market.
For example, when it comes to gasoline – people will always need to purchase it whatever the cost may be (whether it’s increased or decreased). This is known as an inelastic – which means that demand will not be hindered over price adjustments. After all, cars will always need fuel, and they will always be necessary for getting to destinations.
On the other hand, if you’re selling a technical gadget like a smartphone or a tablet, the chances are that the product will only decrease in value as time progresses, which means that raising the price will likely have a major impact on demand. In this case, the product is considered elastic.
Here is a simple formula to better understand price elasticity of demand:
% Change in Quantity / % Change in Price = Price Elasticity of Demand.
Unlike its elastic counterpart, inelastic products maintain a stable, continuous amount of demand, even if there is a change in price, making it the preferred option for many business and retailers. By knowing the elasticity of your product, you will have a better idea which of the strategies listed below makes the most practical business sense.
Now that you have a solid grasp of how demand and pricing impact one another, as well as some of the key components that go into forming a pricing strategy, it’s time to dive into six commonly used pricing strategies that are being leveraged in the real world.
It’s important to understand that there is no absolute cookie-cutter method to implementing a pricing strategy – you may find other methods that aren’t listed here, or you may even want to combine some of the concepts you’ll learn about below. The essential thing is to understand exactly what the short-term and long-term goals of your business are and build out a plan accordingly with some of these techniques in mind.
A penetration pricing strategy revolves around taking an early loss in market revenue by offering your product or service at a much lower price to try and maximize as much new business as possible, then eventually raising the price once you’ve accumulated enough of a following. This is typically utilized by companies who are trying to capture market share from competitors in their respective space, and also involves doing some analysis around your production capacity and manufacturing costs to determine the lowest possible price you can assign to your offering without taking a loss.
This pricing technique is very effective for larger businesses that have a surplus of products, as well as business who want to break into a new market with lots of competition that have premium prices. On the flip side, this approach also runs the risk of your competitors following in your footsteps by lowering their prices as well, ultimately creating a price war that you could run you right out of the market if you’re not adequately equipped to weather the storm.
Value-based pricing requires a lot of research on your various customer segments, but the rewards will likely be worth your efforts as you’ll gain a very rich understanding of what their needs and price sensitivities are. This approach analyzes what your target audience is willing to pay for your product or service, while also recognizing what similar items competitors may be offering and establishing a relevant price point.
Businesses who utilize this format could find themselves gaining the added benefit of strong customer loyalty, as well as some additional knowledge around how to build future products or features that meet current needs in the market. As mentioned above, however, there is a lot of research to be done upfront, which will consume a lot of resources initially.
Also known as markup pricing, cost-plus pricing is a relatively simple pricing strategy that takes the sum of your direct material cost, direct labor cost, and overhead cost, then adding a markup percentage based on how much of a profit you want to generate to determine your final price.
This is a good format to consider if you’re entering an oversaturated market where competitors are offering lots of similar products at completely different prices (clothing stories are a great example of this). It’s also nice because you don’t have to invest too much time or energy doing analysis or customer research. With that said, a lack of research around competitors and customer needs could be a dangerous way to navigate into a new market, so keep that in mind.
Price skimming aims to capitalize early off of the launch of your new product or service, while value and demand is at its peak, then lowering the price over time as the item becomes more dated and competitors release their own counterparts. This typically applies to elastic products (which we covered earlier) that are never more valuable than they are at their release (like technological products such as smartphones or video games).
For business who have products with a limited shelf-life and want to maximize their revenue early, this is a good method to consider. It also can help you quickly recuperate your development costs, causing you to get your return-on-investment much sooner than other pricing strategies. If you lower your price too quickly, however, you run the risk of causing frustration and brand damage with your early adopters, which are your most loyal customers!
While one of the more complex pricing strategies to implement, dynamic pricing can be a powerful way of driving continuous revenue if deployed correctly. This pricing strategy involves constantly adjusting the prices based on your market and the demand for your goods and services.
Commonly seen in the airline and hotel industries, this method requires the implementation of automation and algorithms to determine exactly what consumers are willing to spend and when, as well as what competitors may currently be charging for the same item. And while this may be a daunting thing to build from the ground up (unless you outsource it), it is perhaps one of the most effective pricing strategies out there.
Unlike any of the above pricing strategies, psychology pricing follows less logical patterns. Instead, business who follow this direction base their price off a customer’s emotional response, increasing and lowering prices based on a consumer’s impulses. One commonly used example of a psychological pricing tactic is known as charm pricing, which is when a business uses prices such as $299, instead of $300 to give the perception to consumer’s that they’re paying much less than they’re actually paying.
This is one of the best pricing strategies to supplement with another one of the methods above, but to do it effectively time and effort will need to be put into understanding what the emotional impulses of your target customers may look like.
Choosing the Right Strategy
Knowing some common pricing strategies like the ones above will help position you one step closer to success, but you may also be finding that there are a variety of options that could be relevant for your business. So which strategy do you choose, and which elements will make the most significant impact on your bottom line?
Firstly, your pricing strategy will likely be quite different depending on if you’re selling a physical product or a digital one. With physical products, you have additional costs to ensure you’re factoring into the equation like shipping, storage, and production costs. It’s important that the model you use and the price you set can be decreased or increased to some degree depending on market activity.
If you’re selling a digital product, you don’t have to think about production or shipping, but – depending on the type of offering you’re selling – you may have other costs that you need to account for, like hosting, data security, and developmental resources. There are additional tactics you can deploy in the digital ecospace, like free trials (if you’re a subscription business) or an inferior “freemium” version of your product.
With all of this in mind, it’s important to realize that businesses seldom get their price right on the first try. The path you choose does not have to be set in stone, so don’t get too overwhelmed trying to have answers to all of the elements listed above. Even if you do happen to have a successful price right out of the gates, you’ll want to ensure that you’re establishing some sort of recurring cadence that involves assessing your current price and making adjustments as necessary.
At the end of the day, businesses that are continuously evaluating their pricing tactics and market conditions stand to benefit the most – even if that means making some dramatic changes to your business model.
If you have any questions about the pricing strategies listed above, or want to learn more about how PayMotion can help you position your business for success by simplifying the way people are transacting with your brand, do not hesitate to reach out and contact us. Our team of support specialists will be happy to provide you with tips and tricks, and more information on how you can spend less time worrying about price and payments, and more time growing your business.