The 5 Most Common Pricing Strategies
Today’s customers have higher expectations when it comes to price. They have more choices, more technology and more information, and they expect you to offer something that is more than just a “me too” product. Your customers are looking for value, and you need to meet the expectation.
For many people, the reason they start their own business is to create a product or service that they believe in. However, to become a success, or even just stay afloat, it’s crucial to price your product or service properly and get it into the hands of as many people as possible. However, pricing is far more complex than you might think, and there is no one-size-fits-all solution—different things cost different amounts, depending on how they are used.
There are 5 main strategies for setting up the right pricing.
Cost-plus pricing is a pricing strategy that involves adding a fixed mark-up percentage onto the sum of your purchase costs to create your selling price. To calculate your price you would add up your direct material costs, labour costs and overheads, to determine how much it costs to deliver your product or service and convert this into a price per unit.
The mark-up percentage is profit earnt over your direct unit cost, therefore it is important to ensure you understand your cost base as any ‘one off’ costs can give an inaccurate trend which might mean you either under or overprice, therefore continually reviewing the accuracy of your costs is key to keep consistent profit over a period of time.
Competitive pricing is the art of pricing a product or service competitively with other companies that are selling a similar product or service. With an evolving digital presence and an increase in online platforms, pricing is becoming one of the most critical factors in certain industries, as research has shown that customers will visit at least 3 websites before deciding their purchasing decision.
That being said not all purchasing behaviour is based on pricing, customers do not always purchase the lowest value product or service, but the value offered has to be carefully determined against your competitors to be able to market a competitive price.
In its simplest form, value-based pricing focuses more on what ‘value’ you offer the customer, rather than the time taken to deliver it. This is often common in service-based industries and is an alternative pricing to traditional ‘hourly’ or ‘day’ rate pricing.
This approach requires careful thinking as you have to be confident that you clearly understand the requirements of the service upfront, to be confident you are charging an appropriate rate.
For example, let’s say two companies deliver a similar project and they both charge £400 per day. Company ‘B’ only take 2 days to do the job but company ‘A’ take 3 days. The client would pay £1,200 to company ‘A’ and only £800 to company ‘B’, both companies are qualified and delivered the same quality of work.
If both companies sold at a time-based approach, it is likely the customer would choose the lower rate, as what extra value do they get for paying for 3 days rather than 2? However, if the customer sells the project on a value-based approach in the first place, the customer mindset is not focused so much on the time but on the value they perceive at the end, therefore if company ‘B’ sold their project for £1,200 in theory they could make an extra margin.
A value-based approach is not designed to ‘rip’ off the customer but to understand that a company’s value is not just based on the time taken but also the level of expertise and experience behind the service delivered.
Price Skimming is often used when a new product enters the market. The aim is to make as much revenue as possible when demand is high and other competitors have not yet entered the market.
Once the demand for the product declines, the seller can reduce the price point so it still attracts a certain market, whilst keeping the price competitive against other similar items within the industry.
Generally, price skimming is only used for a short period of time, therefore sellers should be confident the market is there and that consumers will pay a premium for the product they are launching. A detailed analysis of the lowest price point is useful if using a price skimming technique, as a reduced price will reduce margins so if sales volumes are lower than expected, this will have an overall consequence on the total profits after the product is launched.
Penetration pricing is the opposite of price skimming, it is achieved by setting a very low price point when the product is launched, often seen in ‘special promotional offers.’
The aim of penetration pricing is generally to gain a high market share. Often the launch prices will generate lower margins (sometimes even at a loss) but sellers rely on brand loyalty and recommendations, which assumes an attractive price will increase sales volumes and over time the price point will slowly increase and still be competitive.
Sellers using this approach should be mindful of their cost prices prior to launch, small changes in unit costs can be detrimental to the longer-term profits of the products, as if the cost price rises, then the medium price point could be less profitable than originally thought and delay profits. Sellers should also be confident in their marketing and their product will still be viable as the price rises.
Frequently Asked Questions
Pricing strategies are used by companies to become competitive in their markets by affecting the price of their products and services and influencing consumer demands. In contrast to the traditional methods of setting prices, strategic pricing is concerned with the implementation of a system that will result in an optimal price, taking into account the following: ·
- Competitor’s prices
- Value perceptions of customers
- Costs of the product
- Costs of distribution
- Competitive strategy
- Impact of the product’s price on the market
Pricing is the process of determining the cost of goods or services in order to determine their affordability for potential buyers, while also considering the profitability of the business.
It is important to consider what your customers will be happy to pay and assess your market accurately, to ensure that the value you charge will convert the ‘type’ of customer who is willing to pay for your product or service.
The benefits of cost-based pricing are that it is simple and transparent. Salespeople do not need to negotiate since the price is the price. You can use cost-based pricing to sell a wide variety of products and services. This pricing model is easy to set up and maintain, which makes it a popular choice among small businesses, however, having clear visibility on cost is key to ensure you mark up the price accurately.
Value-based pricing is a pricing strategy used to increase a company’s revenue and profit margins. This strategy focuses on the value provided to customers instead of a traditional time or cost-based approach.
A price range provides the flexibility to set a low price that brings in new business while allowing higher prices that drive sales growth.
Over the years, businesses have noticed that pricing strategies can have an impact on the bottom line in terms of profit margins, cash flow, and customer loyalty. As a result, it has become increasingly important to assess business pricing strategies to determine if they are effective and valuable in delivering the results needed to grow your business.
There is no ‘right’ strategy, the pricing strategy you choose will depend on what you offer, who your ideal customer is, how much investment is required and what your long term goals are.
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