Effectively pricing your products or services requires more than simply calculating your costs and adding a mark-up. The prices you set for your products and services affect more than your bottom line. Your prices are part of your marketing.
“How much the customer is willing to pay… has very little to do with cost and has very much to do with how much they value the product or service they’re buying,” says Eric Dolansky, Associate Professor of Marketing at Brock University in St. Catherines, Ontario.
You want to find the pricing “sweet spot” – the perfect place that matches what you charge with the value your customers believe your product or service has.
Price it right and you’ll generate good sales and high profits.
Price too high or too low and you risk losing customers and revenue.
So how do you determine the right pricing strategy?
Do Your Homework
Do a bit of market research. What are others charging for similar products? How often do they offer promotional discounts or other price changes? You don’t need to have the lowest price, but you do need to be aware of where the market stands in your industry.
Also take a look at average profit margins in your industry. Start with a Google search. Ask former business owners or non-competitive establishments in your industry.
Next, you need to figure out what it costs you to run your business. Knowing what your product costs you is important, but your business incurs many other expenses, too. These all must be factored into your pricing. You can download our Profit Planning Guide to walk you through this process here.
Pricing Strategies
Pricing strategies are based on various factors, including:
- Market conditions
- Production & distribution costs
- Indirect costs (such as operating costs)
- Industry margins
- Competitor activity
- Customers’ ability to pay
and others.
Maximizing profit margin is not the only reason for pricing strategies. Other motivations might be maintaining your hold on market share to prevent competitors from encroaching on your territory, or market penetration.
Here are 4 of the most common pricing strategies:
Economy Pricing
Low or discount pricing on products that don’t cost you much to produce or provide. Economy pricing is often used on lower quality products or products with a limited range or very basic packaging.
This strategy works well when you have lower overhead costs than your competitors. It can help you to survive unstable economic seasons by offering an affordable option to customers with tighter budgets. If you’re able to price your product lower than your competitors, you gain a competitive advantage.
The danger in economy pricing is the potential to lose profit. Unless you can sustain a high volume of sales using this strategy, it’s not sustainable long term.
Customers looking for the lowest price are not typically customers who will remain loyal to your business. As soon as a competitor undercuts you, you’ve lost your clientele. It’s not a comfortable position to be in.
Penetration Pricing
Entering a competitive market is a prime opportunity for penetration pricing. Set your price low at first, then raise it later. Win market share quickly and establish yourself as a force to be reckoned with.
Attracting buyers with a good deal (e.g. “special introductory offer”) can be a good way to get started in your business or with a new product. It raises brand awareness and loyalty, hopefully leading to repeat customers.
The risk of penetration pricing is that you may initially lose income. In order to price your product low enough to gain a competitive advantage and penetrate the market, you may need to sell that product at a loss. You must consider it an investment in future business, but it is a risky investment.
Particularly as a start-up company, you need to know the limitations of your financial backing. How many units are you able to sell at this low price? Rather than setting a time limit on this strategy, it may be better to set a limit on the number of sales you’ll make before raising your prices.
Over time, increased awareness should drive profits and set your business apart from your competitors. Penetration pricing is considered a temporary strategy. Once you’ve successfully launched your product or business, it’s time to take a look at other strategies.
A word of caution: Don’t set your price so low that your business is perceived as low quality. This will cause your strategy to backfire.
Price Skimming
This strategy prices new products high for maximum revenues off the small number of buyers willing to pay the price. The price is then reduced over time. Tech companies and book sellers are famous for this. (Ever notice how the latest tech gadget is expensive for the first several months – until the next product becomes the “new thing”? Or that new book releases are available only in the pricey hardcover version initially?)
One of the best advantages of price skimming is that your costs are more than covered. It allows you to take advantage of the initial high price, even though it will be short-lived, better positioning you to “skim” revenues from different market segments as demand and prices inevitably fall.
With this strategy, timing is everything. Don’t keep your price high for too long. It will stunt your growth as customers lose interest.
Premium Pricing
Premium pricing for a premium product. High price, high quality product. Maybe your product is unique or your business has no competitors. This puts you in the ideal position for the premium pricing strategy.
This model isn’t a “get rich quick” scheme. This is not high pricing on low-cost products. Premium pricing is for products with a high perceived value – quality product, exceptional packaging, available in a quality establishment, and marketed well. Luxury cars fit well into this category.
The potential for a high profit margin and enhanced brand identity is excellent. The downside is the difficulty of initiating and maintaining this strategy.
High costs for you + high cost to your customer = lower sales volume.
Over- or under-producing could potentially destroy your profit. So plan carefully!
Adjust As Needed
Choosing a pricing strategy is not a permanent decision. Monitor the market. Keep tabs on how your strategy is working for your business. Get feedback from your customers. Be aware of what your competitors are doing. Keep your profit margins healthy.
Pricing is About People
Pricing is one of many aspects of your business. It’s an important one, to be sure. But focusing on pricing alone will lead to failure. A successful business involves attention to the 4 Ps:
- Pricing
- Promotion
- Placement (or distribution), and
- People
Businesses need to generate a profit to pay staff and provide a living for those who run the business. Naturally, you need to price your products with the intention of generating a profit. (Profit is not a dirty word.) Your business won’t survive otherwise.
But keep in mind that your pricing is for people. People are particular and you can’t please everybody. Know your target market (your ideal customer) and price your products with them in mind. The cost of promotion must be factored into your pricing. The purpose of that promotion is to clearly communicate the value of your product to your target market.
Without people who need or want your product and are willing and able to pay your price, healthy profits will be merely a dream.
Know your people. Do your research. Then sell your product or service at the ideal price for business success.
