Common pricing strategies
While there are many pricing strategies you can use, here are some of the more common ones.
Cost-plus pricing is a pricing strategy in its simplest form. You set your price by calculating the cost of creating your product or providing your service and adding a fixed percentage markup on top of that.
- Example: The food industry often uses a rule of thumb of cost plus a 10% markup. Whatever the food costs to produce, vendors add a profit margin of 10% in pricing.
- Advantages: Cost-plus pricing makes pricing physical products simple. When it’s easy to calculate the cost of production, you can establish standard, well-defined profit percentages for your business.
- Disadvantages: This strategy doesn’t take into consideration competitors’ prices or how much consumers are willing to pay—or how much they value the product—in the current market.
Competitive pricing refers to setting prices based on what your competitors are charging for similar products or services. You can set prices slightly lower, equal to, or slightly higher than the competition, depending on where you want to be in the market’s price range.
- Example: Some large retailers—with a broad catalog of products—offer prices that are slightly lower than the competition.
- Advantages: This can be a very effective strategy if your organization operates in a highly competitive market, directly competing with other businesses for sales.
- Disadvantages: It fails to take actual production costs into account or consider how much consumers are willing to pay for the product or service in the current market.
In a value-based pricing strategy, prices are set based on how much consumers are willing to pay for a product or service. Pricing depends on perceived market value rather than on actual value or competitors’ prices.
- Example: The art world uses this strategy. The price of art is never based on the cost to produce it, but rather on what art enthusiasts think it’s worth.
- Advantages: This works best for products that are not easily mass-produced and that consumers perceive as having a high value.
- Disadvantages: This strategy can be highly subjective. It requires a lot of research to calculate, and you must continually monitor customer perception.
Price skimming means charging a high price when a product is first released and then gradually lowering it over time. Customers pay a premium to be the first to support a brand, and then additional clients are attracted by offers, sales, and incentives as the price is strategically lowered.
- Example: This pricing strategy is often used for new technology.
- Advantages: Profits can be maximized on initial customers before lowering the price to attract the more cost-sensitive segments of the market in greater numbers.
- Disadvantages: Early adopters might become displeased if they know the price will decrease in the future and may even decline to buy at the initial price.
Penetration pricing means offering a lower price than competitors when initially entering the market in order to capture a large market share. As your client base grows and you establish your reputation in the industry, you raise your price gradually until it’s equal to or higher than your competitors’.
- Example: You might use this method when you open a restaurant in a market with more established competitors.
- Advantages: You can quickly grab a large share of the market by offering a favorable price to consumers.
- Disadvantages: Initial prices may earn you little to no profit, and you might even incur a loss. It may also be difficult to raise prices once customers become accustomed to lower prices. You must build customer loyalty first, so that customers are willing to pay increased prices.
In this strategy, you market your product or service as “premium,” or perceived as high-end and of very high quality, and price it accordingly.
- Examples: Organic food is perceived as better than other choices (and more costly to produce), thus it can command premium prices.
- Advantages: If you have a distinct competitive edge in the market or a unique product or service, premium pricing negates a competitor’s strategy of undercutting your share of the market with lower-priced versions of a product or service. Yours is marketed as premium, effectively in a class of its own.
- Disadvantages: This strategy depends heavily on consumer perception of your product or brand in the market, thus requiring a great deal of effort and investment in marketing and branding.
This strategy involves pricing your product or service to have relatively small profit margins, hoping for a rapid turnover based on volume. It targets price-conscious consumers who are looking for the lowest price possible.
- Example: Some large chain stores rely on huge turnover and volume with lower prices rather than high profit margins per unit.
- Advantages: Economy pricing works best for generic products that are easily replaceable and target audiences who either can’t afford or don’t want to pay for a premium product.
- Disadvantages: Profits are insufficient if you don’t sell enough volume. Your customer base is limited to those choosing inexpensive products and services; therefore, the value set by consumer perception is also low.
Bundle pricing means grouping several products together and pricing the bundle lower than purchasing each item individually. This offers the customer the perception of value.
- Examples: Examples of this strategy include combo meals at restaurants, cable channel bundling, and product bundling in retail stores.
- Advantages: This works best for bundling complementary products, selling slow-moving inventory together with more popular services or products, or getting customers to give a new product a try.
- Disadvantages: If your customers don’t want all the items in the bundle, that may dissuade them from buying the whole thing, opting for the individual product they need.
Other pricing strategies include:
- Dynamic pricing, which depends on surges in demand or constrictions of time
- Hourly pricing, which bills by the time it takes to complete a service
- Project-based pricing, an alternative to hourly pricing
- “Freemium” pricing, a variation on premium pricing
Within strategies, you can get more specific; for example, with psychological pricing. This involves deciding on specific price points that customers perceive a certain way. Products with prices ending in .99, for example, are perceived as less expensive than products with prices ending in .00, even if the difference is only one cent.