Pricing strategies: How to price products and services
A robust pricing strategy will create a strong foundation for your business.
July 14, 2022 8 min read
One of the first things consumers check when shopping is the price of a product, and it can make or break a sale. A price point that’s too low may cast doubts on the quality of your product (and compromise your earnings). At the same time, a price point that’s too high may deter consumers—unless you’re already an established and coveted brand or a business that sells inelastic necessities.
Pricing strategies should help businesses of all sizes remain competitive and optimize profits. An effective strategy can help increase your overall cash flow so you can invest in other things, such as product development, business expansion or staff benefits. Because different businesses require various factors to be successful, understanding different pricing strategies can help you develop a plan that fuels your success. In this article, you’ll learn about some of the most effective strategies, their importance and how to create one that works for your business.
What is a pricing strategy and why is it important?
A pricing strategy refers to the model your business follows when setting prices for its goods and services. Pricing strategies should account for market prices and trends, competitor strategies, target audience and business costs.
A pricing strategy doesn’t always center on maximizing profits. It should be formulated with your business’s goals in mind, such as maintaining market share through competitive pricing or expanding profits. Typically, you want to set prices high enough to maintain your business, increase profits and fund endeavors such as business expansion and product research. However, you want to avoid pricing out your target audience. This may be less of a concern for high-end brands, but less-exclusive businesses should develop pricing strategies that don’t exclude the average consumer.
Your pricing strategy should also consider your business’s performance and market position. For small or new businesses, this may mean running regular sales to attract first-time buyers, helping build a loyal customer base. For large and established businesses, this may mean regularly analyzing your products’ demand, production and supply to ensure that the price keeps you competitive as well as profitable.
How to price a product or service
Determining how to price products and services may be one of the most important aspects of managing and growing your business. It requires careful consideration of numerous factors, and you’ll need to revise your strategy as those factors develop and change over time.
1. Evaluate your costs
Your entire pricing strategy can be influenced by how much it costs to make and sell your product or service. Create a list of each expense your business has—including material, labor and overhead costs—and divide them into fixed and variable categories.
Fixed costs stay consistent regardless of business operations or sales numbers. They include payments for rent, insurance, loans, software subscriptions and similar expenses. Labor that doesn’t fluctuate (such as a salaried accounting professional) and one-time expenses (such as equipment purchases) also qualify as fixed costs.
Variable costs do fluctuate—much like product demand. They include expenses related directly to product assembly and individual sales—such as raw materials, waged labor and shipping costs. Services or products—such as credit card payments and marketing deliverables—may also be variable.
Material costs include the materials you need to assemble, package and distribute your product or service—such as wood, fabric and shipping containers. Labor costs are the wages and benefits provided to your staff. Overhead costs are the miscellaneous expenses that may not fall under those categories but are necessary to run your business—such as shipping fees and office supplies.
To estimate monthly variable expenses, add your total expenses for the past fiscal year and divide them by 12 to determine a rough monthly average. To estimate your total monthly average, do the same for fixed expenses and add it to the monthly variable estimate.
To estimate your total cost per unit, add the fixed and variable expenses from the past fiscal year together and then divide that by the number of products sold within the same period. This will give you a rough baseline for the absolute minimum you can charge.
2. Determine your profit margin
Once you understand your expenses, the next step in pricing your product is deciding on a profit margin. Your profit margin is the amount you charge on top of the product’s cost per unit. If you’re unsure how large your profit margin should be, a good place to start is by researching and comparing the profit margins of other businesses in your industry.
This information may be provided by an industry-specific organization or in an annual statement study from the nonprofit Risk Management Association, which compiles reports on the health of varying industries based on data relating to small and midsize businesses.
Remember: If your profit margin is too low, your business may struggle to sustain itself. If prices are too high and your business is small or new, you may risk alienating consumers or pricing out your target audience. Large, high-end and in-demand brands can usually embrace wider profit margins without detriment; but if you own a startup or a smaller business, you may want to aim for the average pricing in your industry.
3. Research your customers and competitors
Understanding your target audience is imperative to get a sense of what they may be willing to pay and what they value most in products. Consider comparing products elsewhere in your industry to get a sense of the offerings and price ranges competitors provide. These comparisons can help you determine a comfortable price range for your products and services and help identify unique offerings other companies are providing.
Conducting online or in-person surveys to get real feedback on what people look for when buying—such as affordability, features, convenience or exclusivity—may also inform your pricing strategy. If your consumer prefers exclusivity, for example, you might be able to price your products higher. If they value affordability, selling cost-effective, bundled items may draw them in.
4. Choose a pricing strategy
Armed with consumer, competitor, product and pricing knowledge, you’re ready to choose a pricing strategy. There are numerous types of strategies you may use. Once you decide on a general strategy, you’ll then tailor it to the unique needs of your business. The following are five examples of commonly used pricing strategies.
- Penetration pricing: Penetration pricing attracts consumers by reducing the price of your product, helping you gain an edge over competitors. Introductory offers are often examples of penetration pricing; an example would be an internet provider offering new customers a 25% discount for the first year of a two-year contract. As one of the most popular pricing strategies in marketing, it can effectively expand the percentage of the market that you control. Your revenue will build over time, gradually increasing your product’s value and enabling a future price increase.
- Price skimming: Price skimming refers to putting an innovative product on the market for a high price, then lowering it as competitors emerge. One example would be virtual reality gaming devices, first released at very high prices due to their groundbreaking technology. Since their initial release, prices have gradually lowered as more businesses began offering them. This strategy helps you gain revenue quickly after launch to recoup research and production costs.
- Dynamic pricing: Also known as demand pricing, dynamic pricing allows for price fluctuations based on factors such as time, location and needs that influence demand. Dynamic pricing is why hotels cost more on high-demand weekends and holidays. While it works for some industries, this model may not be ideal for products or services that attract budget-conscious buyers, as price increases could drastically reduce sales.
- Competitive pricing: Competitive pricing models adjust product prices with competitors’ prices. It’s why discount store brands of popular food items increase in cost shortly after leading name brands bump their prices up. Competitive pricing can help businesses maintain their revenue stream and market share when competition is tough. This strategy requires near-constant monitoring of competitors’ products, which can drain time and resources, but it’s a popular and effective model.
- High price, high value pricing: High price, high value pricing is a hybrid strategy that involves adding value to your product—such as exceptional customer service—and charging a premium price for the product. This added bit of value improves the overall consumer journey when they experience your product or service. This is why a reservation-only wedding dress boutique with personalized service may charge more than a franchise store with limited customer service. The added value may not cost you much as a business owner, but consumers are often willing to pay more for a comfortable, positive experience.
5. Monitor and iterate
Every business has unique needs that influence its pricing strategy. What works for a competing business may not necessarily work for yours. Choosing a strategy now doesn’t mean you’re locked into it.
Sometimes your strategy may not achieve its desired results. For instance, you may be seeing fewer purchases and less profit than anticipated. In such instances, consider adjusting your strategy or adopting a new approach. It can take time to find a pricing model that works for you and your business, and even then your strategy may need to change and adapt alongside market trends. For example, if you were relying on a price-skimming strategy for an exclusive product but are now being edged out by competitors developing similar ones, adopting a high price, high value strategy by offering first-class customer service may help you maintain profits and regain clientele.
What is the simplest pricing strategy for small businesses?
The high price, high value model could be the most valuable and straightforward pricing strategy for small businesses. By enhancing the customer experience, you’re boosting the perceived value of the products and services you have to offer. This customer-centric approach can attract consumers and help you create valuable services that foster loyalty from your target audience. It also helps you account for any intangible benefits your business offers to consumers, such as convenience features, 24/7 support or dedicated account managers for large clients. These benefits have a value that may be difficult to include in other pricing strategies, but this model encourages you to account for more abstract value propositions.
Because small businesses are often known for their personalized service, they can easily add value to consumers’ experiences and adopt this model. However, it’s important not to price your target audience out of your product.
Stay on top of your pricing strategy
Developing an effective pricing strategy is a necessary process that never truly stops. As markets, consumers and your business change, your strategies will need to adapt, too. If you stay focused and flexible, you’ll reap the rewards of a thriving, successful business.