Editor’s Note: This post was originally published on July 5th, 2021 and has been updated for comprehensiveness.
Deciding how to price the product or service you’re selling can be one of the most difficult tasks in business. There are so many options available to brands looking to get their products out there, and a whole host of different ways of pricing those products in the hope of attracting loyal customers.
Pricing strategy offers business leaders insight into how their pricing decisions might be received, enabling them to decide which methods of price optimization would work best for their target demographics.
What is a Pricing Strategy?
Pricing strategies are different ways of pricing products or services, based on several potential benefits. Think of a pricing strategy as a comprehensive plan that outlines how a company will set and adjust its prices to achieve specific business objectives. It involves determining the optimal price point for a product or service that maximizes profitability while considering factors such as market demand, competition, and perceived value.
Many traditional ways of pricing, such as value-based pricing and cost-plus pricing, are very well-known and have been around for decades. But these aren’t the only ways to price products.
There are now several other, lesser-known pricing tactics that many brands are using to attract key demographics and expand their market share. These include the likes of penetration pricing strategy, dynamic pricing, and price skimming.
The core elements of a pricing strategy typically include:
- Pricing objectives: Clear goals that align with the overall business strategy, such as maximizing profit, increasing market share, or achieving a specific return on investment.
- Target market analysis: Understanding the needs, preferences, and price sensitivity of the intended customer base.
- Competitive analysis: Evaluating competitors’ pricing strategies and market positioning.
- Cost structure: Considering all costs associated with producing and delivering the product or service.
- Value proposition: Clearly defining the unique value offered to customers and how it justifies the price.
- Pricing methods: Selecting appropriate pricing techniques, such as cost-plus, value-based, or dynamic pricing.
- Price elasticity: Assessing how changes in price affect demand for the product or service.
- Price positioning: Determining where the product or service should be positioned in the market relative to competitors.
- Pricing policies: Establishing guidelines for discounts, promotions, and price adjustments.
- Monitoring and adjustment: Regularly reviewing and updating the pricing strategy based on market conditions and performance metrics.
With the guidance of these elements, a well-crafted pricing strategy can help businesses optimize revenue, maintain competitiveness, and achieve long-term success in their target markets.
The Importance of Choosing the Right Pricing Strategy
The old marketing breakdown of the key aspects of a successful business still holds true: the 4Ps.
Product
This is almost always the place where businesses start. Your product is the foundation of your business. It’s the solution that meets your customers’ unmet needs and creates market demand. When you choose your pricing strategy, consider the value your product brings to your customer, the costs associated with producing it, and the prices of similar products in the market.
Promotion
Once you’ve developed your product, you need to think about how and where you will communicate its value to potential customers. This includes advertising, public relations, and other marketing efforts. You’ll also want to consider how your sales organization manages its go-to-market processes. Consider how your pricing strategy will fit with your overall marketing and branding strategies, and how it will impact your ability to generate demand and differentiate yourself from your competitors.
Placement
Placement, or distribution, refers to the way a business goes to market. This could involve selling directly to customers, using intermediaries like wholesalers or retailers, leveraging eCommerce channels, partner alliances, or even various sales organizations to handle wide geographies. This also includes things like supply chain and logistics and distribution. Consider how your distribution strategy will impact costs and margins and your ability to reach and serve your customers.
Price
In some ways pricing seems the simplest thing to do after you’ve covered the first three P’s, but for B2B organizations, even the simplest and most uniform product often has a multitude of nuances and accompanying explosion of prices. A well-defined pricing strategy can help you increase profitability, generate demand, and beat your competition. When choosing your pricing strategy consider your costs, target market, the value your product provides to your customers, and the prices of similar products in the market.
Cost, Margin, and Markup: The Pillars of Pricing Strategy
Understanding the interplay between cost, margin, and markup is fundamental to creating an effective pricing strategy. Each element plays a distinct role in instructing the optimal price for a product or service.
Cost: The Foundation
Cost serves as the baseline for any pricing strategy. It encompasses all expenses associated with producing and delivering a product or service, including:
- Raw materials
- Labor
- Manufacturing overhead
- Distribution expenses
- Marketing and sales costs
Accurately calculating costs is essential for ensuring profitability and making informed pricing decisions.
Margin: The Profitability Indicator
Margin, or profit margin, is the percentage of revenue remaining after deducting the cost of goods sold (COGS). It’s an important metric to evaluate the profitability of a product or business. Margin is calculated as:
(SalesPrice – Cost)/SalesPrice = Margin
A higher margin indicates greater profitability per unit sold. Businesses often use target margins to guide their pricing decisions and evaluate financial performance3.
Markup: The Price Setter
Markup is the amount added to the product’s cost to determine its final selling price. It’s typically expressed as a percentage of the cost4. The markup formula is:
(SalesPrice – Cost)/Cost = Markup
Markup helps businesses ensure that their prices cover costs and generate the desired profit. Different industries have varying standard markup percentages, ranging from 5-10% in highly competitive markets to 200-400% in sectors like restaurants.
Balancing Act: Integrating Cost, Margin, and Markup
An effective pricing strategy requires a delicate balance between these three elements:
- Start with accurate cost calculations to establish a solid foundation.
- Determine target margins based on business objectives and industry standards.
- Apply appropriate markups to achieve desired margins while remaining competitive.
- Audit and adjust pricing based on cost fluctuations, market conditions, and performance metrics.
By carefully considering cost, margin, and markup, businesses can develop pricing strategies that maximize profitability, maintain competitiveness, and achieve long-term success in their target markets.
How to Choose a Pricing Strategy for Your Business
Choosing the correct pricing strategy is a bit of an oversimplification. Just as you will likely have many prices to manage, you will likely need at least a few pricing strategies to govern your tactics across your product lines and families. Rarely will a single pricing strategy be appropriate for every product for every customer. Your strategy should control the variations of nuances I mentioned earlier so there is clarity, understanding, and credibility for your sales team, your channel partners, and your customers.
When selecting a pricing strategy, consider these key factors:
- Align with business objectives: Ensure your pricing supports overall goals like profitability, market share, or brand positioning.
- Understand your costs: Analyze your cost structure to ensure sustainable profitability.
- Know your market: Evaluate your competitive landscape and unique value proposition.
- Segment your customers: Recognize that different customer groups may require varied pricing approaches.
Ideally, your pricing strategies should align with your overall business strategies so that your customers understand your value proposition at the highest and broadest level. But even with that objective, it’s necessary to manage the exceptions sometimes with additional strategies and almost certainly with variations of tactical execution that are appropriate for things like product lifecycle, sales regions, customer value, or other attributes that your business already understands as important to how your customers view you.
Types of Pricing Strategies
Start looking into different types of pricing strategy models and you’ll soon find yourself spoiled for choice, with so many different options available. But how do you decide on the best pricing strategies for your brand? The answer lies in the results you’re hoping to achieve, and of course, your goals can change over time.
Take a look at some greatly simplified descriptions of the most commonly used concepts below to explore the advantages of some of the most well-known types of pricing strategies.
Cost-Plus Pricing Strategy
One of the simplest pricing strategies to understand and execute is the cost-plus pricing methodology. This pricing tactic requires the use of well-known organizational information and is not particularly reliant on any other sources of information. With even a basic understanding of the cost structure, pricers can simply add some level of margin to ensure that each product is profitable. This can even be done on broad levels using simple rules like a standard percentage across all products.
Using cost-plus pricing can result in problems when broad standard rules don’t work in specific instances. For example, some product lines might need greater margin paybacks in order to justify investments previously made. Meanwhile, other products could be generating large dollar amounts essential for cash flow for the company with very low margin percentages. Just remember, while it might be easy to set up and start broad pricing adjustments with a cost-plus strategy, rarely will those broad rules work when taken to the real world of the market.
Competitor-Based or Market Reference Pricing Strategy
A slightly more complicated but relatively easy-to-execute pricing strategy is the market reference or competitor-based pricing method. A competitive pricing strategy involves taking your main competition into account and seeking to outdo them where pricing is concerned.
This pricing strategy involves basing your price on what similar brands are charging for comparable products or services. It can be particularly useful when market information is readily available through third parties or easily harvested through competitive intelligence. However, this approach ignores any value differentiation your company or your products may have for your customers. While competitor-based pricing can help you stay competitive in the short term, it may also limit your ability to stand out from the crowd and grow over time. You should always consider this strategy as only one input for your pricing strategy and use it for the appropriate products and customers.
Value-Based Pricing Strategy
Value-based pricing centers around the perceived value of a product or service, to the intended customer. It’s a little more difficult to work out than competitor-based pricing, but it can be more advantageous when used correctly.
To calculate value-based pricing, brands need to analyze the pricing of their competitors and understand how their product differs from those of similar companies. A financial value should be applied to any differences, and any negatives should be subtracted from the final score.
Simple Segmentation Pricing Strategy
As your company’s pricing maturity grows, it’s natural to move from reactive pricing strategies to leading pricing strategy models. A good starting point in this journey is simple segmentation. The benefits of segmentation in this case are many. Simple segments are easier to explain to both sales teams and customers, increasing transparency and credibility in conversations. Simple yet thoughtful pricing constructs can be deployed formally in the selling process, providing clear policies on volume, price, incentives, and discounts from list prices, and can even touch on value-based selling at the simplest level.
However, it’s important to note that simple segmentation pricing strategy tends to be more administrative than reactive, sometimes informed by what’s happening in the market, but primarily a set of rules that may or may not have been tested against the real world. While this strategy can provide a good foundation for more complex pricing strategies, it’s important to continuously evaluate and adjust these rules to ensure they remain relevant and effective.
Optimized Segmentation Pricing Strategy
At the most advanced stage of pricing maturity, companies employ very granular and sophisticated customer segmentation, often with hundreds of customer and product segments. This segmentation is designed and validated by using customer attributes that predict willingness to pay, and segments are organized based on the combination of customers and products they buy, taking into account relevant factors and alignment with business goals and strategy.
At this level of segmentation, true value-based pricing can be deployed. Some customers for certain products will always be price-sensitive, and market-based pricing may be appropriate. Other customers will want to ensure they’re being held whole relative to their competitors, but some are more sensitive to the value they derive from your product and are willing to pay accordingly. With this highly granular segmentation, companies can develop pricing strategies that cater to each segment’s unique needs and preferences, providing optimal pricing for both the customer and the company.
Price-Skimming Strategy
Price-skimming strategies are perfect for brands looking to attract attention and position themselves as quality companies. The strategy involves setting prices at a high figure initially to create a buzz around a product – particularly while it’s brand new. Over time, this high price can be gradually reduced, making the product available to new layers of the market who might have lacked the budget to make a purchase initially.
Economy Pricing Strategy
Economy pricing (also known as volume pricing) involves setting a relatively low price point for a product or service while making sure that this low price point remains profitable due to the volume of the product being sold. When products are sold at lower price points, it encourages more buyers to make a purchase, therefore increasing the overall number of sales.
This opens up new opportunities for a company to benefit from wholesale purchasing at reduced rates, decreasing the cost price of the product and ensuring the profitability of the low price point.
Penetration Pricing Strategy
Penetration pricing models are widely used in the most competitive industries. It sees new brands position their products or services at low price points, in order to attract attention and encourage buyers to try a different brand. Over time, and once a loyal fanbase has been established, these prices are gradually increased to boost the brand’s profitability. While this strategy works well for some companies, it can be a risky one when the time comes to increase pricing.
Dynamic Pricing Strategy
Dynamic, when guided by dynamic pricing optimization techniques, pricing sees brands increase or decrease the price of certain items in line with changing demand. While it makes sense in economic terms, this strategy isn’t usually the best in terms of customer experience.
Dynamic pricing certainly works well for some products, but it can have a negative effect on customer satisfaction. Consumers might feel alienated by constantly changing prices, particularly if the product is a subscription-based service or similar.
Pricing Models and Strategic Frameworks for Value Capture
While pricing strategies focus on specific tactics, pricing models provide broader frameworks for how businesses structure their offerings and capture value. These models often align with a company’s overall business strategy and can significantly impact customer relationships, revenue streams, and market positioning.
Subscription-Based Model
This model involves charging business customers a recurring fee for continued access to a product or service. It’s particularly popular in enterprise software and cloud services.
Benefits:
- Predictable, recurring revenue
- Increased customer lifetime value
- Opportunity for upselling and cross-selling
Example: Salesforce’s CRM platform offerings with various subscription tiers for businesses.
Freemium Model
In this B2B context, basic features are offered for free to businesses, while premium features require payment. It’s commonly used in collaboration tools and productivity software.
Benefits:
- Low barrier to entry for new business users
- Opportunity to demonstrate value before charging
- Potential for rapid user base growth within organizations
Example: Slack’s free tier for small teams and paid plans for larger enterprises.
Usage-Based Model
Businesses are charged based on their actual usage of a product or service. This model is common in cloud computing and data processing services.
Benefits:
- Aligns costs with value delivered to businesses
- Attractive to cost-conscious enterprises
- Encourages increased usage over time
Example: Amazon Web Services’ pay-as-you-go pricing for cloud resources used by businesses.
Tiered Pricing Model
This model offers different levels of product or service at various price points, allowing businesses to choose the tier that best fits their needs and budget.
Benefits:
- Caters to diverse business segments
- Encourages upgrades to higher-value tiers
- Simplifies decision-making for corporate buyers
Example: HubSpot’s different tiers of marketing, sales, and service hubs for businesses of various sizes.
Value-Based Model
Pricing is set based on the perceived value of the product or service to the business customer rather than on cost or market factors.
Benefits:
- Potential for higher profit margins
- Aligns pricing with business outcomes
- Encourages continuous innovation and value creation
Example: SAP’s enterprise resource planning (ERP) solutions, priced based on the value they bring to large corporations.
Outcome-Based Model
This advanced model ties pricing directly to the business customer’s achieved results or outcomes from using the product or service.
Benefits:
- Strong alignment of vendor and business customer interests
- Potential for premium pricing
- Builds long-term B2B relationships
Example: IBM’s cognitive solutions, where pricing is tied to specific business improvements or cost savings achieved by the client.
With the appropriate pricing model, businesses can create a strategic framework that not only supports their pricing strategies but also aligns with their overall business objectives, target market, and value proposition. The chosen model should be flexible enough to accommodate various pricing strategies and tactics while providing a consistent approach to value capture across the organization.
Can You Combine Pricing Strategy Models?
It is possible to combine pricing strategies. In fact, combining pricing strategy models can often lead to better results than relying on just one strategy. The key to successful pricing strategy implementation is optimized segmentation. This means using the right methodology for the right customer across the products that they are buying.
It’s important to note that optimized segmentation is not the same as customer segmentation or product segmentation. Customers may have different willingness to pay and buying behaviors for different types of products, and it’s only through sophisticated optimized segmentation that these differences can be discerned and the value generated for them can be maximized. By utilizing the right pricing strategies for each segment, companies can achieve better profitability, customer loyalty, and overall success.
How to Conduct a Pricing Strategy Analysis
Before any brand sets a price for its products, it should conduct a thorough pricing strategy analysis. This analysis will follow several steps to calculate the best possible price for a product, in terms of the sales and profitability targets that the company has in mind. Here’s how it works:
Step 1: Determine the True Cost of the Product
The first step is of course to establish the true cost price of a product. Brands must fully understand what their products cost to produce before any calculations can be made on the potential profitability of these items.
Step 2: Understand Customer Response to Pricing
Customer analysis comes next, and customer responses are key here. Brands should research how customers are responding to certain price points, evaluating how these responses differ as prices increase or decrease.
Step 3: Analyze Competitor Pricing
Competitors will always stand in the way of a brand achieving maximum profitability on any product, so they should play a role in any pricing strategy analysis. Companies are advised to complete detailed research into the pricing strategies of their competitors, to understand how competitors’ products are priced and how customers feel about these prices.
Step 4: Review Legal and Ethical Pricing Constraints
There’s one final step to consider before a brand can arrive at its optimal price point for any product. Brands should, at this point, review any pricing constraints that could apply to their products or their industry as a whole. These might be legal in nature, or they could be ethical. Consider how pricing will be perceived by customers before making any changes.
Benefits of an Effective Pricing Strategy
An effective pricing strategy provides endless benefits, no matter what a brand is selling or who it’s selling to. And many manufacturers and distributors see their pricing strategy as a core financial strategy. A study revealed that, 53% of manufacturers and distributors consider their pricing strategies very effective, while 34% say they are extremely effective. The most effective strategies allow companies to achieve the best possible level of profitability for their products. In doing so they enable companies to continue expanding and building on their successes.
An Effective Pricing Strategy Adds Value
The most effective pricing strategies put a value on products, cementing a brand’s position in the minds of consumers. Well-thought-out pricing strategies enable a company to position itself as a high-quality brand, selling products that can be relied upon. This adds value to the brand itself, ensuring that future products can be launched and promoted with ease.
When a brand is seen as a high-value company, it stands a far better chance of achieving good sales figures for any new product lines it chooses to launch. Thanks to its strong positioning, it’s also better equipped to increase prices over time – without alienating existing purchasers.
A Strong Pricing Strategy Persuades Customers to Buy
Pricing strategies can be used as a form of promotion – often very effectively. By pricing a product strategically, a brand can start to explore new markets and attract previously unknown demographics, thus expanding its market share considerably.
Optimizing prices allows companies to persuade existing customers to purchase new versions of products, or upgrade their existing purchases, further improving the profitability of a product line. This benefit also applies to brands offering subscription-based services. Such brands can easily attract greater numbers of users, simply by pricing their subscriptions in a strategic way that is centered around customer satisfaction.
The Best Pricing Strategies Increase Customer Confidence in Products
The perception of a product’s value and its true value aren’t one and the same. Pricing plays a strong role in how products are perceived, and therefore how customers value them. Great pricing strategies can therefore be used to sway customers’ opinions, giving them the impression that a product is of a higher value than they might otherwise have thought.
Well-designed strategies can be used to boost customer confidence in products, encouraging them to remain loyal to a chosen brand for prolonged periods. This boosts customer retention and also encourages existing customers to increase their average spending with a company once their confidence in the quality of the brand’s products grows.
Explore the Potential of Smart Pricing Strategies
A great pricing strategy can make a huge difference to the potential of any company, determining whether newly launched products sell out in minutes or are left languishing on shop shelves. Explore the opportunities of different pricing strategies to see how your pricing could be optimized to improve profitability, customer retention, and growth potential.
Pricing Strategy Examples
Understanding how successful companies implement pricing strategies can provide valuable insights for your own business. Here are several examples showcasing effective strategic pricing models:
Zapier’s Hybrid Approach
Zapier, an automation tool, combines tiered and usage-based pricing. They offer different plans based on the number of “zaps” (automated workflows) a customer can run per month. This strategy allows them to cater to both small businesses with basic needs and large enterprises requiring extensive automation.
Snowflake’s Consumption-based Model
The cloud data platform Snowflake uses a consumption-based pricing model where customers are charged based on the actual computing and storage resources they use. This approach has been particularly attractive to data-intensive businesses and has enabled the business to scale its cost-efficiency.
Adobe’s Subscription-based Pricing
Adobe transitioned from a one-time purchase model to a subscription-based pricing strategy with its Creative Cloud suite. This shift has provided Adobe with more predictable revenue streams and allowed customers to access the latest software updates continuously.
IBM’s Watson Model
IBM uses an outcome-based pricing model for its Watson AI platform. Clients are charged based on the measurable business outcomes and value generated by Watson’s insights rather than a fixed fee for the technology itself. This approach aligns IBM’s success with its clients’ success.
Rolls-Royce’s “Power by the Hour”
Rolls-Royce pioneered this model in the aerospace industry. Instead of selling aircraft engines outright, they charge airlines based on the number of hours the engine is in flight. This model incentivizes Rolls-Royce to produce reliable, efficient engines while providing airlines with predictable costs.
Philips Healthcare’s “Pay-per-Scan” Model
For some of its medical imaging equipment, Philips offers a usage-based pricing model where healthcare providers pay per scan rather than purchasing the equipment outright. This reduces upfront costs for hospitals and aligns Philips’ revenue with the equipment’s actual use.
Michelin’s Fleet Solutions
Michelin offers a tire management service for commercial fleets where customers pay per kilometer driven rather than purchasing tires outright. This model includes maintenance and replacement, shifting the focus from selling products to providing a comprehensive service.
HPE GreenLake
Hewlett Packard Enterprise’s GreenLake offers a consumption-based IT model, where customers pay only for the computing resources they use. This flexible approach allows businesses to scale their IT infrastructure up or down as needed without significant upfront investments.
Summary and Key Takeaways:
Developing a strong pricing strategy is critical for the success of any business. With so many different pricing models to choose from, it can be overwhelming to decide which one is best for your specific product or service. By understanding the various types of pricing strategies and the best practices for implementing them, businesses can set themselves up for success and achieve their desired revenue goals.
- Understand the various types of pricing strategies at play, including cost-plus pricing, value-based pricing, competitor-based pricing and more.
- Consider internal and external factors like product value, differentiation, competition, and market demand, when setting prices.
- Use data and analytics to inform pricing decisions and adjust pricing strategies over time.
- Communicate pricing changes transparently and effectively to customers.
- Regularly evaluate and adjust your pricing strategy to ensure it remains effective and aligned with your business goals.
If you’d like to learn more about how to optimize your pricing with Vendavo solutions, get in touch with our team.