Pricing is one of the biggest decisions your company will ever have to make. Few other things can impact your profitability as much as pricing – so it’s crucial to get it right. Studies have shown that optimizing pricing by even 1% can lead to an average boost of 11% in profits. A thoughtful, well-informed approach to pricing will help you to achieve your business goals. Keep reading to learn more about pricing strategies and how they impact your organization.
What is a pricing strategy?
A pricing strategy is a methodology a business uses to set pricing. It’s essentially the way that organizations decide how much to sell their goods or services for. Pricing strategy tends to be a commonly overlooked – but significantly undervalued – lever that businesses can pull to impact revenue. Carefully choosing the right pricing strategy requires a thorough understanding of your product, your market, and your customer base. There are many commonly used pricing strategies – and we’ll cover them further in this article!
Why is it important to get your prices right?
Most times, when companies think of growth, they think of obtaining more customers. While gaining more customers is certainly ideal, there’s an equally important component that adds revenue to the bottom line: pricing. Pricing is an often under-utilized lever that businesses can pull to ramp up their revenue without the necessary expense and effort of acquiring more customers.
Furthermore, pricing impacts customer retention as well as acquisition, and loyalty over the long term. Having an optimized pricing strategy provides a more efficient way to grow revenue. While many organizations only focus on client acquisition, changes to pricing and being more strategic in pricing products or services can produce higher revenue gains that often mean the difference between a faltering company and exponential growth.
Cost, Margin and Markup
Before diving into actual pricing strategies, it’s important to define the drivers that ultimately make up your pricing strategy. The three main elements you’ll need to determine are cost, margin, and markup.
Cost
In its simplest form, the cost is the expenditure required to create and sell products and services, or to acquire assets. Cost, along with markup, will be an important factor in determining margin and setting final prices. It’s important to note that margin and markup show two aspects of the same transaction.
Margin
Profit margin refers to the revenue a company makes after paying COGS. The profit margin is calculated by taking revenue minus the cost of goods sold. The difference is shown as a percentage of revenue.
For example, if a company sells an item for $100 and it costs $70 to manufacture that product, its margin is $30. The profit margin stated as a percentage is 30% (calculated as the margin divided by sales).
Markup
Many people confuse margin and markup, but they’re not the same thing. Margin refers to how much more a company’s selling price is than the amount the item costs the company. Generally, the higher the markup, the more revenue a business stands to make.
The key difference from the margin is that markup percentage is shown as a percentage of costs, as opposed to a percentage of revenue.Using the example above, the markup percentage would be 42.9%, or ($100 in revenue – $70 in costs) / $70 costs.
5 Common Pricing Strategies
As with most things in business, there’s no one-size-fits-all approach. Different strategies will be useful for different organizations, for different reasons. Here we’ll cover the basics of the most popular pricing strategies.
1 .Penetration Pricing
Similar to lose leader pricing, this model is the opposite of a skimming price strategy. An intentionally low price allows companies to gain market share by attracting customers away from other brands. The goal is to penetrate the market as quickly as possible and then raise prices without losing the early adopters you gained.
This strategy is smart for businesses in a price-conscious industry. Products should have a broad appeal and a focus on economies of scale. This strategy relies on a high volume of customers to make sense.
2. Premium pricing
With premium pricing, the focus is on image and prestige. Here, brands set a higher price to give the impression of superior quality or luxury. This can often communicate a favorable impression among buyers. Unlike some other strategies, there is no plan to lower prices eventually.
Only brands who can (or plan to) prioritize loyalty and reputation should try this pricing strategy. The product or service should have unique features and premium quality to justify higher pricing. Many companies also use a tiered pricing system with a premium option, for example, a “standard” option and a “deluxe” option.
3. Price skimming
For this strategy to work, providers need to understand the market and the pricing it will bear. Companies price new products at the highest initial price that customers will pay, then gradually lower it over time.
Think of products that are innovative or trendy. It’s important for them to appeal to early adopters and get in front of the competition before there are many players in the market. On the other hand, brands should be well-known in order to justify higher prices. Price skimming is common in the technology and fashion sectors.
4. Bundle pricing
Product bundling combines multiple services or products into a package deal. The package price is typically lower than what people would pay for each item separately, which is the appeal. The perceived value of the bundle is greater than the individual elements.
This strategy only works for companies with multiple products or services that are synergistic or complementary enough to appeal to users when bundled together. It’s important to understand how packaging can play a role in a bundling strategy, and to take those efficiencies into consideration. Working with a savvy fulfillment partner can help companies pack products together to gain more sales and make more money on each sale.
5. Loss-leading
Sometimes it makes sense to sell a product or service at a price that isn’t profitable in order to gain new customers or add on other products. Like a penetration strategy, this is helpful for brands that are new to the market – but it’s also a common practice in several industries with larger product offerings.
Large companies can afford to price a product with low or no margin because they have other products they can sell profitably to make up for the loss. That’s why you’ll often see this strategy employed at big-box stores, for example.
How to Choose a Pricing Strategy
Choosing a pricing strategy is an essential step in your business journey. Just like any important business decision, though, your ideas need to be backed by data. Make the time to take the following steps as you plan your pricing strategy.
Step 1: Quantify Your Buyer Personas
The personas you put together will inform not only pricing but other marketing strategies. They’re the start of ensuring you use the right channels to reach the right people. Start with deeply defined and well-researched personas that answer questions like this:
- What is the price each buyer is willing to pay?
- What is the average Lifetime Value of the customer?
- How much does it cost to acquire a customer?
- What are the marketing channels that you use to reach these customers?
- What features and value proposition do these customers care about most?
- Does anyone else need to approve the purchase of the product?
Step 2: Finding The Right Features For Each Persona
Which features need to be aligned to which persona? Have customers answer questions about which features they use the most and which are most valuable. You can use surveys or other tools to do this. Doing so will help to shape your pricing tiers. Avoid assumptions and start to shape pricing based on what users or buyers tell you directly.
Step 3: Determining the Best Value Metric and Bundling
After you’ve aligned features (or determined that there are no differentiable features), think about your value metric. That’s what you’ll charge per unit and it’s the basis of your pricing strategy. You want this metric to grow as your company grows. This step is also where you’ll decide if bundling is right for you, and what those product bundles will be. Don’t forget to research the product packaging options for bundling and ensure your strategy accounts for that fulfillment (tip: you can learn a lot about kitting assembly, shipping options, and 3PL services in our resource center here.)
Step 4: Actually Pricing Your Product
Using all of the answers that you’ve gathered so far, it’s time to actually set the numeric prices for your products or services. We suggest considering the following questions to get a better understanding of the perceived value of your product suite:
- Is the price so high that buyers would reconsider purchasing?
- Or, is the price getting expensive, but buyers will still consider purchasing it?
- At what point is the product considered a great deal?
- At what point is the product price so low that it impacts the impression of quality?
Efficiencies Can Impact Pricing
Remember that pricing is a process. Just because you set a price today doesn’t mean that those numbers can’t change – and impact your revenue for the better! The most important thing to know about pricing strategy is that it requires a thoughtful and well-researched approach. Don’t forget to consider the ways that partners and additional capabilities can impact pricing strategy.
For example, an effective 3PL provider can streamline several packing, shipping, and logistics processes so that you can gain efficiencies and cost savings. If you’d like to learn more about how a customized fulfillment strategy can help your business to grow and scale, contact us for a free consultation.