Setting your business’s prices may seem simple: List your product for more than it costs you to manufacture or acquire it, and you’ll make a profit.
But your prices are more than just numbers. The way you price your products or services can be a reflection of your business’s identity, how you view and treat your competitors, and how you value your customers. That’s why it’s important to have a carefully planned pricing strategy.
What to consider when setting your pricing strategy
Setting your product or service’s prices shouldn’t be a haphazard decision focused entirely on profit. It should be a calculated, informed choice in which your business identity, brand, and financial stability are considered.
As with any business decision, determining your pricing strategy starts with assessing your own business’s needs and goals. This involves some commercial soul searching—what do you want your business to contribute to the economy and world? This could mean embracing a traditional retail strategy, establishing a service business mindset, or emphasizing personal customer relationships in your offering.
Once you define your goals and needs, do some research on the market you’re entering. Determine three to five main competitors in the industry by conducting online research or scouting out local businesses. No matter what pricing strategy you adopt, what your competitors are doing will impact your business’s success and future decisions.
Understanding your competitors’ strategies can also help you differentiate your business from other businesses in the market. In an economy where there are thousands of small businesses providing the same products and services, an effective pricing strategy can help you stand out.
A good final stage in your research is speaking with potential customers to get a feel for how they value your brand, product, or service. This can give you valuable insight into how to set your pricing. This kind of research can range from casual conversations with friends and family to formal surveys of potential buyers.
While you may have already done some of this legwork when developing your business plan, it’s good to have as much insight and information as possible before you decide what pricing strategy to adopt.
Pricing strategies to attract customers to your business
There are dozens of ways you can price your products, and you may find that some work better than others, depending on the market you occupy. Consider these seven common strategies that many new businesses use to attract customers.
1. Price skimming
Skimming involves setting high prices when a product is introduced and then gradually lowering the price as more competitors enter the market. This type of pricing is ideal for businesses that are entering emerging markets. It allows companies to capitalize on early adopters and then undercut future competitors as they join an already-developed market. A successful skimming strategy hinges largely on the market you’re looking to enter.
2. Market penetration pricing
Pricing for market penetration is essentially the opposite of price skimming. Instead of starting high and slowly lowering prices, you take over a market by undercutting your competitors. Once you develop a reliable customer base, you raise prices. Many factors go into deciding on this strategy, like your business’s ability to potentially take losses upfront to establish a strong footing in a market. It’s also crucial to develop a loyal customer base, which can require other marketing and branding strategies.
3. Premium pricing
Premium pricing is for businesses that create high-quality products and market them to high-income individuals. The key with this pricing strategy is developing a product that is high quality and that customers will consider to be high value. You’ll likely need to develop a “luxury” or “lifestyle” branding strategy to appeal to the right type of consumer.
4. Economy pricing
An economy pricing strategy involves targeting customers who want to save as much money as possible on whatever good or service they’re purchasing. Big box stores, like Walmart and Costco, are prime examples of economy pricing models. Like premium pricing, adopting an economy pricing model depends on your overhead costs and the overall value of your product.
5. Bundle pricing
When companies pair several products together and sell them for less money than each would be individually, it’s known as bundle pricing. Bundle pricing is a good way to move a lot of inventory quickly. A successful bundle pricing strategy involves profits on low-value items outweighing losses on high-value items included in a bundle.
6. Value-based pricing
Value-based pricing is similar to premium pricing. In this model, a company bases its pricing on how much the customer believes the product is worth. This pricing model is best for merchants who offer unique products, rather than commodities.
How do you know what a customer perceives a product to be worth? It’s hard to get an exact price, but you can use certain marketing techniques to understand the customer’s perspective. Ask for customer feedback during the product development phase, or host a focus group. Investing in your brand can also help you add “perceived value” to your product.
7. Dynamic pricing
Dynamic pricing allows you to change the price of your items based on the market demand at any given moment. Uber’s surge pricing is a great example of dynamic pricing. During low periods, Uber rides can be quite an affordable option. But when a rainstorm hits during the morning rush hour, the price of an Uber will skyrocket, given that demand is also likely to rise. Smaller merchants can do this too, depending on seasonal demand for your product or service.
Which pricing strategy is right for you?
Each of these seven strategies offers different advantages and downsides. At the very least, you must make sure your pricing strategy covers your costs and includes a margin for profit. Determining your needs upfront can clarify which strategies are ideal for your business.
Focus on finding the right range of costs, rather than pinpointing a specific number. “Don't waste time debating $500 vs. $505, because this doesn't matter as much until you have a stronger foundation beneath you,” wrote Profitwell.
Regardless of which tactic you choose, pricing your inventory properly is essential for continued business success. You may have the best product in the world, an excellent team and a beautiful storefront, but if you can’t price your products effectively, your sales will ultimately struggle.
How do you know what a customer perceives a product to be worth? It’s hard to get an exact price, but you can use certain marketing techniques to understand the customer’s perspective.
How to test and validate your pricing
If you’ve already launched your business, you can experiment with these strategies until you determine what works best for your business. You can also vary strategies between products depending on the market for each good or service.
Approach validating your price point methodically. Keep in mind your business goal: Is it attracting new customers, increasing revenue, or building a healthy profit margin? Many businesses at first use their pricing strategically to enter a new market, and later raise prices to build profit.
Next, choose a test product. Pick a high-impact product that you know generates reliable demand so you can get enough data to inform your pricing strategy. Set the price variations that you wish to test with enough variation to be significant.
Then, use A/B testing, surveys, or tiered pricing to see how customers respond.
“For example, if you’re selling a book, you could create two landing pages—one with the book priced at $11.99 and the other offering it at $9.99 (with a low-cost add-on, perhaps). Then, you can measure which price attracts the most buyers to inform your strategy,” explained Salesforce.
A/B testing is one of the most straightforward ways to test your pricing. By isolating price as the only variable, you can see how customers respond over a controlled period of time. Make sure you aren’t running any marketing campaigns simultaneously that could influence the results of your test.
At the end of the testing period, look at key metrics such as revenue, sales volume, profit margins, and customer feedback to identify which price works best.
Psychological pricing techniques that work
Mature businesses looking for advanced pricing techniques can take advantage of psychological pricing strategies to entice higher revenue.
“Psychological pricing is a marketing strategy that leverages consumer psychology to influence purchasing decisions by setting prices that appear more attractive,” wrote Shopify. If you’ve ever seen a product marked $9.99 instead of $10, this is psychological pricing at work.
There are a number of different psychological tactics you can try to use, such as:
- Charm pricing: Remove one cent from the rounded dollar price to trick the brain into thinking the product costs less.
- Marking down the MSRP: The manufacturer’s suggested retail price (MSRP) is generally the standard price set at retail stores. Some businesses will show the MSRP next to a lower price to make customers believe they are getting a good deal on the product.
- Price formatting: Our brains often treat longer numbers as more expensive. For example, customers see $15.00 and think it’s more expensive than $15. Writing your price without the zeroes can be a simple formatting change with significant results.
- Flat-rate bias: Like bundling, simple, all-inclusive packaging is a great way to increase sales. For example, getting a flat-rate for a home phone, wireless, and cable connection all from one communications provider can often feel easier and more affordable than trying to pick and choose different providers for each one.
These are just a few psychological tricks that can help increase sales. Test a few on products with stable, consistent demand to see if any of them work for your business.
Pricing mistakes that cost businesses money
Today’s customers are particularly price-sensitive. Small pricing changes can therefore have a big impact on your bottom line. Avoid making these mistakes and the risk of alienating customers.
One way to show your customers that you value their business is by creating prices appropriate for different segments. Pricing your product or service in a way that treats all customers the same can leave money on the table.
“Start by analyzing data on customers and prospects to identify the different types of people who buy your offerings, then group them by purchasing behaviors, budget limitations, and other factors that affect how and why they do business with your company. From there, create pricing strategies tailored to each segment,” wrote Oracle NetSuite.
Similarly, remember the rule: 20% of customers will generate 80% of revenue. Without segmenting your customers, it’s hard to focus on the right pricing for the customers that will generate the majority of your sales.
Pricing should be based on data, not guesswork. Many business owners set a price based on intuition or partial data. In addition to monitoring your competitors’ pricing, send out surveys, ask for feedback, and periodically review your Google Analytics, customer data, and sales trends.
“Strike a balance between costs, perceived value, and competitors’ prices by using demand-based pricing. With this flexible approach, businesses adjust their prices so that they always reflect current market conditions,” wrote Oracle NetSuite.
Finally, don’t get too anchored in pricing based on the cost of your product. While cost is the right baseline, do some testing to see what the customer perceives to be the true value of your product or service. Value is in the eye of the beholder. “This value is subjective and can vary from prospect to prospect over time,” wrote Ed Kless, Senior Director of Partner Development and Strategy at Sage. “As an example, a quart of water is valued more highly at a sporting event than the same quantity if you are at home washing dishes.”
It takes time and testing to get your pricing strategy right. Don’t be shy about asking for feedback from your customers and trying different models until you find the right fit.
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