The price of a product or service connotes the value resulting from a set of complex calculations, research, understanding and risk. The pricing strategy, therefore, takes into account market conditions, competitor actions, trade margins and input costs amongst others.
External factors like the market, consumer demand and overall economic trends have significant roles to play in any pricing strategy, but so too do businesses themselves, their customers and competitors. Business factors like revenue goals, marketing objectives, brand positioning, target market and product value; each lead the way to the most fitting pricing strategy. The very best pricing strategy maximises your revenue and profit.
Many entrepreneurs, typically those new to the game, tend to cut corners on their pricing strategy by considering their costs, taking a look at competitor pricing and tweaking their own selling prices accordingly. The COGS and competitor consideration are key factors in pricing, but they’re not to be the sole and centre determinants of the strategy.
The importance of your pricing strategy
Before we take a look at all the elements to be factored in, there are a few pricing concepts that will invariably make an impact on your prices, regardless of the strategy you use. They ultimately highlight the importance of generating and implementing a pricing strategy.
Price elasticity of demand is a simple economic concept that will help you understand if the demand for your product or service is sensitive to changes in its price. Ultimately, its the aspect of your strategy that should help you maximise your revenue by setting the right price.
Will a change in price affect your consumer demand? If consumers maintain the same demand for your goods and services, despite a price increase, your product is considered inelastic. Such products include tobacco, fuel, water and oil. The demand for elastic products, on the other hand, fluctuates in accordance with prices. Such include theatre tickets and electronic devices.
Calculate your price elasticity using this formula:
% change in quantity demanded ÷ % change in price = Price elasticity of demand
A result of less than 1 means it is inelastic. The more inelastic your product, the more stable your demand will remain if prices fluctuate.
The importance of your pricing strategy cannot be understated In fact, it has the capability of affecting your customer perception, business growth and your ability to build a successful venture. Prices set too high defer customers who turn to more competitive prices. When set too low, profits are minimised and your ability to expand is compromised.
Pricing strategies to use
As we consider some of the pricing strategies available, it should be noted that these aren’t necessarily stand-alone strategies. Many of them can be combined to form the perfect strategy for your business.
There are many pricing strategies to choose from and can be manipulated into the four main basic strategies as follows:
Premium pricing
In simple terms, the premium pricing strategy is used when companies want to charge more than their competitors for their products. It helps to categorise the business into a different market by creating the perception that the products have a higher value than others- given their higher prices.
The success of this strategy depends on marketing tactics to compel consumers to believe that the brand should assure them of high quality. The main advantage of this strategy is that is can produce higher profit margins, creates barriers to entry for competitors and elevates the brands positioning in the market.
Not any company can enter a market and whack high prices on its products. It’s an exclusive club that requires marketing research and is most effective when a product is first introduced to the market. In other words, an increase in an established price, which consumers have committed to will not be received well in terms of demand.
Businesses considering this strategy should understand that their products should be unique enough to enter the market and differentiate their merchandise at higher prices. Consumers typically automatically believe that a product is one of luxury when a higher price is attached. It should be of high quality with exceptionally good design in order to work.
A top tip for this pricing strategy is to know how to manage supply. A seller can create exclusivity by controlling the amount of product available in the market. Of course, this should be met with patents and steps to avoid competitors copying the product- which dampens your exclusivity.
Step by step guide to establishing premium pricing
- Identify and implement your high-end features- from the product itself to the store layout and employee uniform.
- Demonstrate to your customers the worth of your product to justify spending more. Utilise online content and carry out physical demonstrations of how your product can provide a solution.
- Go the extra mile and consistently improve your product for the highest paying consumers in your market.
- Project stability and let customers know that your business isn’t going anywhere to enhance the value image.
Establishing a premium pricing strategy takes time, effort and commitment from all members of a business. From members of the finance department to those in marketing- everyone must be engaged in order for this strategy to prove successful.
Economy Pricing
This volume-based pricing strategy enables businesses to price goods lowe than the competition and increases revenue based on the number of sales made. It works exceptionally well for commodity goods like groceries and mediation that don’t have extensive marketing costs.
Essentially you take a product with low production cost and set a price for it that gives you a small profit. Aim to sell as many as possible to boost revenue. Setting economy pricing can be done by using the following formula:
Production cost + profit margin = price
Economy pricing is a volume game. The only way to make it work is to sell many units. Meaning, it’s greatly important to spend time getting your brand name under as many noses as possible. Utilise the online space as a cost-effective way of letting your target market know you exist.
Consider the pricing strategy of budget airlines. Many will provide economy pricing to fill seats at lower prices, and scale up the prices as availability decreases- this incorporates elements of premium pricing.
It can be a valuable strategy for SaaS, amongst others, and subscription businesses- but as they tend to rely on repeat customer relationships; the economics of selling t low prices make it difficult to build revenue over time.
However, its a strategy worth considering because it’s easy to implement, appeals to price-sensitive customers and keeps customer acquisition costs low.
Penetration pricing
Prices here, are set artificially low to gain market share. This is a strategy typically used when a new product enters the market. Generally, consumers and competitors understand that the prices will be raised once the promotion period is over.
It’s a strategy that works well to support the launch of a new product and works best when the product enters the market will little differentiation combined with elasticity in demand. In such cases, lower prices than competitors is a winning strategy.
Penetration pricing encourages word-of-mouth recommendations, making the promotion more effective. The lower the price, the harder it will be for competitors considering a similar entry. However, it can also create an expectation for continued low prices, which once increased might deter customers. It’s a strategy therefore, that should be cautiously considered.
Skimming strategy
An effective strategy used to maximise profits when a new product is introduced. The goal is to generate maximum profit in a short period of time before the increased competition and pricing pressures come into play.
In such cases, a company will release a new product or service at premium prices to maximise profits before they eventually reduce the price to match the market.
The diagram illustrates the skim price set at (P1) for a lower quantity demanded (Q1). Over time the price is reduced to the follow-on price at (P2) matched by an increase in quantity sold (Q2).
This strategy can be seen in the new release of mobile phones for example. The latest devices are always released at a premium price but the price falls when new phones are released. It’s an effective way for companies to recover their costs of development.
However, if the company is unable to justify high prices, consumers will be less inclined to make the initial purchase. It’s not a long term strategy and one which only works when there are no similar and cheaper alternatives.
As mentioned, these strategies aren’t exclusive and can often be combined. For example, following a skimming strategy, a company may wish to deploy economy pricing. Alternatively, premium pricing may follow. Think Apple for example, who successfully promote their products as higher in value than their competitors. Whichever strategy you chose, remember to consider your place in the market, your competitors and the elasticity of your product or service.
