Pricing is one of the most important aspects of your business. You will miss out on many sales if you price it too high. If you price it too low, you may also struggle to make a good profit margin.
It is essential to find the perfect price point for your product if your business is to make maximum profits. Fortunately, there are many excellent and proven pricing strategies that you can model for your business. These strategies have worked and still work for countless companies.
Before you can use a pricing strategy, you need to understand your audience and the psychology behind the strategy. Avoid basing your decision solely on the number of businesses that use it and get results. A pricing strategy that works for a manufacturing company may not work for a service company.
In this article, you will learn about the importance, benefits, and examples of different pricing strategies.
What is a pricing strategy?
A pricing strategy refers to the pricing method that companies use to determine the selling price of their goods or services. It is used to determine the best pricing strategy for a product or service.
Although pricing is recognized as one of the most important aspects of a business, companies often overlook its importance. Many businesses do not pay attention to this undervalued revenue lever (pricing) that directly impacts their profit margins.
Business owners often focus more on business factors such as the cost of goods manufactured(COGM), cost of goods sold (COGS), and competitor pricing. While COGM, COGS, and competitor pricing are important, they are a small part of the bigger picture.
The right pricing strategy
To choose the right pricing strategy for your business, you need to fully understand three critical factors: Your product, your market, and your customers. The right pricing strategy is the one that finds the sweet spot that suits these three entities.
The perfect pricing strategy helps maximize your profits, revenues, and shareholder value. It maintains a price that the market and your customers are willing to pay.
Many factors come into play when choosing the best pricing strategy for your business. Your company’s pricing strategy is an all-encompassing term that considers several factors. These include market goals and conditions, brand positioning, sales targets, product attributes, input costs, consumer willingness to pay, markup, production and distribution costs, and variable costs.
External factors such as competitive pricing, consumer demand, and market trends such as product seasonality can significantly influence your pricing strategy.
Pricing strategies vary from company to company. Companies may have more than one pricing strategy, mainly if they sell multiple products or services. They may also sell a single product to different target groups with different pricing strategies. Weave offers all the tools a small business needs to be successful.
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Balancing your competitive pricing strategies
Although businesses generally use pricing strategies to maximize their profits and sales, this is not the only purpose for using them. Some companies, such as Amazon, have used pricing strategies to maintain their market share by lowering the selling price of their goods or services. They can also use pricing strategies to keep competitors out of the market.
As a small business owner, you need to be careful about sacrificing your profit margins. You can take control of a significant market share by focusing on low prices, but note that this can lead to the bankruptcy of your business.
Remember that while your customers will not buy your products or services if the price is too high, your business will not pay its bills if the price is too low. Finding a balance between these extremes is best for your business and your target audience.
Benefits of a thorough pricing strategy
Implementing a rigorous pricing strategy for your products and services is essential for businesses that want to achieve long-term success.
Many companies do not take the time to implement a thorough pricing strategy but evaluate their products and services on an impulse basis. To implement a comprehensive pricing strategy, you need to research your competitors, understand your target audience, and track market trends and changes as they occur.
Businesses, regardless of size, can reap huge benefits from implementing a thorough pricing strategy. Here are some of the benefits.
1. Higher success rate
Businesses with a thorough pricing strategy have a higher success rate than those that do not. If you want your business to grow and succeed, you must correctly implement the right pricing strategy. It is not uncommon for companies to experience a quick boost in sales and profits by simply applying the right pricing strategy.
Entrepreneurs need to assess the long-term impact of their pricing strategies. In most cases, if you do not implement the right pricing strategy, you will not achieve your financial goals.
It is impossible to implement a thorough pricing strategy without thoroughly researching the market and your competitors
2. Prevents market losses
One of the benefits of a thorough pricing strategy is that it helps prevent market losses. You can lose your customers and market share to competitors if you use the wrong pricing strategy.
A good strategy allows you to set competitive pricing that your target group can afford. With a competitive pricing strategy, your customers will be less inclined to buy your competitors’ products and services.
Companies that implement the right strategy retain and increase their market share. By monitoring and responding to your competitors’ price changes, you can avoid potential market losses.
3. Improve profit margin
Implementing a strong pricing strategy will help you improve your profit margin. You don’t always have to price your products or services at the lowest point in the market. Low prices often make the market assume that your product or service is low quality.
Pricing your products and services correctly will improve your profit margin. As a business owner, you want to attract as many customers as possible but with a substantial profit margin. The sweet spot you want to reach is a medium price range compared to your competitors.
4. Generate more sales
Every entrepreneur, irrespective of size, has one main financial goal: to generate more sales. KPIs and OKRs are designed to help achieve this goal. For almost all businesses out there, this is why they adopt a pricing strategy.
5. Make the product more attractive
Many companies have seen an increase in purchases for their products and services simply because they have implemented a thorough pricing strategy. They don’t necessarily have to change or improve the product or services to experience this increase in customer interest.
With the right pricing strategy in place, companies can focus their buyers’ attention on targeted items, ranges, or services.
6. Ability to compete with competitors.
With a thorough pricing strategy, you can compete with your competitors on an equal footing for customers and market share. You do not necessarily have to offer your products and services at the lowest price in the market.
7. Build customer loyalty
Implementing a thorough pricing strategy can build customer loyalty for a business. Once your target market realizes they are getting a bargain or an excellent price offer from you, they will keep coming back for more.
A happy and satisfied customer is the best marketing tool any business can have. Your satisfied customers will share their positive experiences with your product through word of mouth. They will be happy to recommend your products to friends, family, work colleagues, and even strangers.
Types of pricing strategies
Here are 2 of the best pricing strategies used by various businesses in all industries, including drop shipping. They have been proven to work and produce excellent results when executed carefully.
1. Cost-plus pricing strategy
A cost-plus pricing strategy refers to a simple pricing method where you add a fixed percentage to the production cost of a unit of your product. The price you get from this addition becomes the selling price of the product.
Another name for a cost-plus pricing strategy is markup pricing strategy. It is the oldest and most straightforward method of setting prices for a product.
A cost-plus pricing strategy embodies the basic idea behind doing business: you make a product and sell it for more than your cost of production to make a profit. This simple strategy involves very little market research.
This pricing method focuses on your product’s cost of production or your COGS (cost of goods sold) rather than the price competitors set for similar products. It ignores consumer demand and competitor prices and does not consider external factors.
Retail shops, especially grocery, clothing, and department stores, use this pricing strategy to price their products. A cost-plus pricing strategy is not a good fit for service-based companies such as those selling Software as a Service (SaaS). The reason is simple: the cost of producing services is usually challenging to determine or lower than the value your product provides.
You can calculate the price of your products using the cost-plus pricing strategy by adding up the labor, material, and overhead costs and then multiplying the total by (1 + markup amount).
Cost-plus pricing formula = labour cost + material cost + overhead x (1 + mark-up amount)
OR
Cost-plus price formula = cost + mark-up percentage
Labor costs refer to the money you pay to workers who contribute to the production of your product. Material costs refer to the amount of money spent on materials to make the product. Overhead costs refer to operating expenses incurred in producing a product that cannot be directly attributed to material or labor costs.
Markup
Markup refers to the percentage difference between the unit cost and its selling price. You can calculate it by subtracting the unit cost of a product from the selling price and dividing the result by the unit cost. Then multiply the result you get by 100 to get the markup percentage.
Mark-up = selling price – unit cost / unit cost x 100
Advantages of the cost-plus pricing strategy
1. Easy to use
The cost-plus pricing strategy is a simple method to implement. It does not require extensive research into market trends, consumer demands, or competitor pricing. All you need to do is analyze your company’s production costs, such as labor, materials, and overheads and use these to set a price for your product.
2. Simply justify your price
Another advantage of the cost pricing strategy is that you can easily justify your price. You can quickly tell your consumers why you have increased the price. An explanation of why you have increased your price is easy to justify.
3. Constant return on investment
The cost-plus pricing strategy helps businesses achieve a consistent profit return. If you calculate the price correctly, it will cover all your production costs and help you achieve your profit margin.
Disadvantages of the cost-plus pricing strategy
1. The possibility of high price
Since the cost-plus pricing strategy takes into account competitive prices and willingness to buy within a specific price range, this can lead you to set a selling price that is too high for the market.
Selling at a high price can cause you to lose many sales. If your competitors sell at a lower price, they will take a larger share (if not all) of the market.
2. No guarantee that all your costs will be covered
A significant problem with this strategy is that sales volume is forecast before the product is priced, and expenses are allocated to units. It is often difficult to accurately estimate production costs.
A problem arises if you overestimate the sales volume the market is willing to expect and end up selling only a few products. You will not cover your production costs and end up hurting your company’s finances.
3. No incentive to work efficiently
Using a cost-plus pricing strategy removes any incentive for your business to operate more efficiently since you base your selling price on your cost of production. Even if your cost of production increases, there is no incentive to lower it since you still make the same profit by raising the price.
If your company does not seize the opportunity to work more efficiently, competitors will pounce on it and profit massively.
2. Dynamic pricing strategy
The dynamic pricing strategy is a flexible method of pricing products and strategies where the price changes based on market and customer demand. It is also known as demand, surge, or time-based pricing.
Hospitality or tourism-based businesses such as hotels, event centers, and airlines use dynamic pricing to determine their products and services. Utility companies also make use of the dynamic pricing strategy.
These companies use price algorithms to determine the price of their products and services at any period. The algorithm considers the demand level, competitor pricing, and other factors to arrive at its price point. Thanks to these algorithms, companies can shift their prices quickly to match what their customers are willing to pay when they want to make the purchase.
Dynamic pricing strategies consider the calculation of different prices for customers depending on who buys your product or service or when they make the purchase. This strategy takes into account changes in supply and demand.
An excellent example of a dynamic pricing strategy practiced around the world is the airline pricing model in the airline industry. If you fly frequently, you have noticed how price ranges change depending on when you book.
Dynamic pricing is highly vulnerable to price fluctuations caused by external factors.
Time is one factor that causes price fluctuations when the dynamic pricing strategy is used. Hotels and airlines charge higher prices during holiday periods because consumer demand is high, but as soon as demand decreases in the low season, prices drop.
Advantages of the dynamic pricing strategy
1. Increase sales
Dynamic pricing strategy can help companies increase their sales. It allows companies to both increase and decrease their prices. Price reductions can help companies achieve their sales targets. A good example is the use of flash sales.
2. Maximise profits
You can maximize profits with a dynamic pricing strategy. If your competitors offer a product that you sell at a higher price, you can use this strategy to maximize your profit margin.
With a dynamic pricing strategy, you can adjust the price of your item based on the shopping behavior of potential customers. For example, if a customer wants to buy a pen and your competitor sells it for 2 USD per piece, you sell it for 1 USD per piece. You can increase the pen price to 1.5 USD with a dynamic pricing strategy.
Since your price is still lower than your competitors, customers feel they have saved money by buying from you.
3. Higher demand
A dynamic pricing strategy can be used to maximize the demand and revenue available to a business at any given time. Event centers, cinemas, and airlines sell their tickets at higher prices in high demand. But when the day comes, and there are still seats available, they can lower the cost to accommodate more customers.
Disadvantages of the dynamic pricing strategy
1. Price discrimination
Dynamic pricing strategy sells goods or services at different prices to different customers depending on the time purchased. Customers may perceive it as price discrimination, especially when they have bought the product at a higher price.
E-commerce, airline, and hotel companies use the dynamic pricing strategy to charge customers as much as they are willing to pay.
2. Irritated customers
Customers become irritated or angry with your business when they learn that you are subjecting them to price discrimination. This can have far-reaching effects beyond the loss of a single customer. That customer may pass on negative comments about your business to others.
3. Less customer loyalty
Customers will trust your business less if they discover the discrepancies in your pricing structure, especially if they pay more than others for the same product or service. Instead of buying products or services repeatedly, they may consider other alternatives in the market that cost less,
4. Increased competition
Companies that adopt the dynamic pricing strategy encourage competition in the field. These competitors can conveniently charge lower fees to attract your customers. Price-conscious customers will not hesitate to move from one business to another in search of the best deals.
3. Premium pricing strategy
Premium pricing is a strategy where you artificially set a high price for your product so that customers or the market can associate it with luxury, value, or premium quality. It focuses on the perceived value of a product or service rather than its actual value.
This is a form of psychological pricing strategy, and it aims to appeal to the psyche of the ideal buyer. Although premium pricing may deter a large part of the market because of its high price, it attracts status buyers.
Status buyers buy a product, not for its surface value but its perceived value. Proponents of premium pricing believe that setting a high price for your product will create a quality market perception that will bring you more sales.
Brands that use this strategy offer high value and status through their products. This is the legitimate reason why they charge more than most of their competitors and still attract customers.
Using the premium pricing strategy guarantees that you will sell fewer products than with economy pricing, but the smaller number of customers who pay premium prices will more than justify the lower sales volume.
Advantages of the premium pricing strategy
1. Competitive advantage
One advantage of this strategy is that it discourages competitors from competing with you. These competitors will find it difficult to enter the market and charge your premium prices. As a result, they pose very little threat to your target group, high-value perception customers. Instead, they attract price-sensitive customers.
2. Brand awareness
Premium pricing is an effective strategy to increase your brand awareness. High prices make your products more desirable as customers assume high prices equal high quality.
3. Improved profits
You increase your profit margin and sales when you charge more for your product. For this premium pricing strategy to work, you need to market your services appropriately to your ideal target audience (those who can buy your products without worrying about the price).
Disadvantages of the premium pricing strategy
1. High marketing costs
The premium pricing strategy requires you to spend a lot of resources on marketing. Small businesses without the proper funding will find it difficult to promote their goods and services using this method.
2. Unsuitable for the competitive market
If you have many competitors and the product or service is similar to what your competitors sell, premium pricing will prove unsuccessful. Customers will easily navigate to your competitors who charge a lower price.
3. Limited customer base
The premium pricing strategy can give you a higher return on investment per product sold and leave you with a limited customer base. Premium pricing means you eliminate an entire customer base, the price-sensitive buyers.
Examples of pricing strategies
1. Dynamic pricing strategy: Uber
Uber uses machine learning technology to assess market conditions and adjust prices accordingly.
Ride-hailing services like Uber implement a dynamic pricing strategy.¹ Uber uses machine learning technology to assess market conditions and adjust prices accordingly.
The fares available to users change depending on demand and other factors like holidays, traffic, and weather conditions. During peak hours, Uber charges increase compared to when not many people are requesting rides.
Uber uses Dynamic Pricing to increase its transport prices and attracts more customers through discounts.
2. Premium price strategy: Apple
Apple has continued to pursue premium pricing for all its products since the introduction of its smartphones at premium prices.³ A typical example is the AirPod, which could range from US$159 to US$199.4 Customers buy Apple products because of the prestige that comes with the brand.
Set your pricing strategy for maximum profits
Your pricing strategy is critical to attracting more customers and increasing your profits. When setting your pricing, it is crucial to take a closer look at your business factors to choose the most effective strategy for your business.
The fact that a strategy has worked for your competitor even in your industry does not mean it will work for you. To set your pricing strategy for maximum profit, you need to know that the price is not for you but your target audience.
Properly defining your target audience and conducting market research is critical to choosing the right pricing strategy. One mistake you can make when choosing a pricing strategy is to target everyone. Even the best pricing models will attract some customers and deter others.
Determining the right pricing strategy for maximum profits is a continuous process. It is essential to continually evaluate your strategy because pricing factors can change at any time. The last thing you want to do is hold on to a pricing strategy that is no longer relevant. Watch a free demo to see how Weave will work for you.
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