If only pricing was a simple as its definition. However, there’s a lot that goes into the process.
Pricing strategies take into account many of your business factors, like revenue goals, marketing objectives, target audience, brand positioning, and product attributes. They’re also influenced by external factors like consumer demand, competitor pricing, and overall market and economic trends.
It’s not uncommon for entrepreneurs and business owners to skim over pricing. They often look at the cost of their products (COGS), consider their competitor’s rates, and tweak their own selling price by a few dollars. While your COGS and competitors are important (as you’ll see in the various models below), they shouldn’t be at the center of your pricing strategy.
The best pricing strategy maximizes your profit and revenue.
Before we talk about pricing strategies, let’s review an important pricing concept that will apply regardless of what strategies you use.
Price elasticity of demand is used to determine how a change in price affects consumer demand. If consumers still purchase a product despite a price increase (such as cigarettes and fuel) that product is considered inelastic. On the other hand, elastic products suffer from pricing fluctuations (such as cable TV and movie tickets).
You can calculate price elasticity using the formula: % Change in Quantity / % Change in Price = Price Elasticity of Demand.
The concept of price elasticity helps you understand if your product or service is sensitive to price fluctuations. Ideally, you want your product to be inelastic — so that demand remains stable if prices do fluctuate.
Now, let’s cover some common pricing strategies.
It’s important to note that these aren’t necessarily standalone strategies. Many can and should be combined when setting prices for your products and services.
Types of Pricing Strategies
- Competition-Based Pricing
- Cost-Plus Pricing
- Dynamic Pricing
- Freemium Pricing
- High-Low Pricing
- Hourly Pricing
- Skimming Pricing
- Penetration Pricing
- Premium Pricing
- Project-Based Pricing
- Value-Based Pricing
Competition-Based Pricing Strategy
Competition-based pricing is also known as competitive pricing or competitor-based pricing. This pricing strategy focuses on the existing market rate (or going rate) for a company’s product or service; it doesn’t take into account the cost of their product or consumer demand.
Instead, a competition-based pricing strategy uses the competitors’ prices as a benchmark. Businesses who compete in a highly saturated space may choose this strategy since a slight price difference may be the deciding factor for customers.
With competition-based pricing, you can price your products slightly below your competition, the same as your competition, or slightly above your competition. For example, if you sold marketing automation software, and your competitors’ prices ranged from $19.99 per month to $39.99 per month, you’d choose a price between those two numbers.
Whichever price you choose, competitive pricing is one way to stay on top of the competition and keep your pricing dynamic.
Cost-Plus Pricing Strategy
A cost-plus pricing strategy focuses solely on the cost of producing your product or service, or your COGS. It’s also known as markup pricing since businesses who use this strategy “mark up” their products based on how much they’d like to profit.
To apply the cost-plus method, add a fixed percentage to your product production cost. For example, let’s say you sold shoes. The shoes cost $25 to make, and you want to make a $25 profit on each sale. You’d set a price of $50, which is a markup of 100%.
Cost-plus pricing is typically used by retailers who sell physical products. This strategy isn’t the best fit for service-based or SaaS companies as their products typically offer far greater value than the cost to create them.
Dynamic pricing is also known as surge pricing, demand pricing, or time-based pricing. It’s a flexible pricing strategy where prices fluctuate based on market and customer demand.
Hotels, airlines, event venues, and utility companies use dynamic pricing by applying algorithms that consider competitor pricing, demand, and other factors. These algorithms allow companies to shift prices to match when and what the customer is willing to pay at the exact moment they’re ready to make a purchase.
A combination of the words “free” and “premium,” freemium pricing is when companies offer a basic version of their product hoping that users will eventually pay to upgrade or access more features. Unlike cost-plus, freemium is a pricing strategy commonly used by SaaS and other software companies. They choose this strategy because free trials and limited memberships offer a “peek” into a software’s full functionality — and also build trust with a potential customer before purchase.
With freemium, a company’s prices must be a function of the perceived value of their products. For example, companies who offer a free version of their software can’t ask users to pay $100 to transition to the paid version. Prices must present a low barrier to entry and grow incrementally as customers are offered more features and benefits.
High-Low Pricing Strategy
A high-low pricing strategy is when a company initially sells a product at a high price but lowers that price when the product drops in novelty or relevance. Discounts, clearance sections, and year-end sales are examples of high-low pricing in action.
High-low pricing is commonly used by retail firms who sell seasonal or constantly-changing items, such as clothing, decor, and furniture.
What makes a high/low pricing strategy appealing to sellers? Consumers enjoy anticipating sales and discounts, hence why Black Friday and other universal discount days are so popular.
Hourly Pricing Strategy
Hourly pricing, also known as rate-based pricing, is commonly used by consultants, freelancers, contractors, and other individuals or laborers who provide business services. Hourly pricing is essentially trading time for money. Some clients are hesitant to honor this pricing strategy as it can reward labor instead of efficiency.
Skimming Pricing Strategy
A skimming pricing strategy is when companies charge the highest possible price for a new product and then lower the price over time as the product becomes less and less popular. Skimming is different than high-low pricing in that prices are lowered gradually over time.
Technology products, such as DVD players, video game consoles, and smartphones, are typically priced using this strategy as they become less relevant over time. A skimming pricing strategy helps recover sunk costs and sell products well beyond their novelty, but the strategy can also annoy consumers who bought at full price and attract competitors who recognize the “fake” pricing margin as prices are lowered.
Contrasted with skimming pricing, a penetration pricing strategy is when companies enter the market with an extremely low price, effectively drawing attention (and revenue) away from higher-priced competitors. Penetration pricing isn’t sustainable in the long run, however, and is typically applied for a short time.
This pricing method works best for brand new businesses looking for customers or for businesses who are breaking into an existing, competitive market. The strategy is all about disruption and temporary loss … and hoping that your initial customers stick around as you eventually raise prices.
(Another tangential strategy is loss leader pricing, where retailers attract customers with intentionally low-priced items in hopes that they’ll buy other, higher-priced products, too. This is precisely how stores like Target get you — and me.)
Also known as premium pricing and luxury pricing, a prestige pricing strategy is when companies price their products high to present the image that their products are high-value, luxury, or premium. Prestige pricing focuses on the perceived value of a product rather than the actual value or production cost.
Prestige pricing is a direct function of brand awareness and brand perception. Brands who apply this pricing method are known for providing value and status through their products — which is why they’re priced higher than other competitors. Fashion and technology are often priced using this strategy because they can be marketed as luxurious, exclusive, and rare.
Project-Based Pricing Strategy
A project-based pricing strategy is the opposite of hourly pricing — this approach charges a flat fee per project instead of a direct exchange of money for time. It is also used by consultants, freelancers, contractors, and other individuals or laborers who provide business services.
Project-based pricing may be estimated based on the value of the project deliverables. Those who choose this pricing strategy may also create a flat fee from the estimated time of the project.
Value-Based Pricing Strategy
A value-based pricing strategy is when companies price their products or services based on what the customer is willing to pay. Even if they can charge more for a product, they decide to set their prices based on customer interest and data.
If used accurately, value-based pricing can boost your customer sentiment and loyalty. It can also help you prioritize your customers in other facets of your business, like marketing and service. On the flip side, value-based pricing requires you to constantly be in tune with your various customer profiles and buyer personas and possibly vary your prices where your customers vary.
Like we said above, these strategies aren’t necessarily meant to stand alone. We encourage you to mix and match these methods as needed.
Now, let’s discuss how to apply these strategies to different businesses and industries.
Not every pricing strategy is applicable to every business. Some strategies are better suited for physical products whereas others work best for SaaS companies.
Product Pricing Strategy
Unlike digital products or services, physical products incur hard costs (like shipping, production, and storage) that can influence pricing. A product pricing strategy should consider these costs and set a price that maximizes profit, supports research and development, and stands up against competitors.
👉🏼 We recommend these pricing strategies when pricing physical products: cost-plus pricing, competitive pricing, prestige pricing, and value-based pricing.
Digital Product Pricing Strategy
Digital products, like software, online courses, and digital books, require a different approach to pricing because there’s no tangible offering or unit economics (production cost) involved. Instead, prices should reflect your brand, industry, and overall value of your product.
👉🏼 We recommend using these pricing strategies when pricing digital products: competition-based pricing, freemium pricing, and value-based pricing.
Restaurant Pricing Strategy
Restaurant pricing is unique in that physical costs, overhead costs, and service costs are all involved. You must also consider your customer base, overall market trends for your location and cuisine, and the cost of food — as all of these can fluctuate.
👉🏼 We recommend using these pricing strategies when pricing at restaurants: cost-plus pricing, premium pricing, and value-based pricing.
Event Pricing Strategy
Events can’t be accurately measured by production cost (not unlike the digital products we discussed above). Instead, event value is determined by the cost of marketing and organizing the event as well as the speakers, entertainers networking, and overall experience — and the ticket prices should reflect these factors.
👉🏼 We recommend using these pricing strategies when pricing live events: competition-based pricing, dynamic pricing, and value-based pricing.
Services Pricing Strategy
Business services can be hard to price due to their intangibility and lack of direct production cost. Much of the service value comes from the service provider’s ability to deliver and the assumed caliber of their work. Freelancers and contractors, in particular, must adhere to a services pricing strategy.
👉🏼 We recommend using these pricing strategies when pricing services: hourly pricing, project-based pricing, and value-based pricing.
Pricing models can be hard to visualize. Below, we’ve pulled together a few examples of pricing strategies as they’ve been applied to everyday situations or businesses.
Dynamic Pricing: Chicago Cubs
I live in Chicago five blocks away from Wrigley Field, and my friends and I love going to Cubs games. Finding tickets is always interesting, though, because every time we check prices, they’ve fluctuated a bit from the last time. Purchasing tickets six weeks in advance is always a different process than purchasing them six days prior — and even more so at the gate.
This is an example of dynamic pricing — pricing that varies based on market and customer demand. Prices for Cubs games are always more expensive on holidays, too, when more people are visiting the city and are likely to go to a game.
Another prime example of dynamic pricing is INBOUND, for which tickets get more expensive as the event nears.
Freemium Pricing: HubSpot
Moreover, within those marketing tools, HubSpot provides limited access to specific features. This type of pricing strategy allows customers to acquaint themselves with HubSpot and for HubSpot to establish trust with customers before asking them to pay for additional access.
Penetration Pricing: Netflix
Netflix is a classic example of penetration pricing: entering the market at a low price (anyone remember when it was $7.99?) and increasing prices over time. Since I joined a couple of years ago, I’ve seen a few price increase notices come through my own inbox.
Despite their increases, Netflix continues to retain — and gain — customers. Sure, Netflix only increases their subscription fee by $1 or $2 each time, but they do so consistently. Who knows what the fees will be in five or ten years?
Premium Pricing: AWAY
Does luggage need to be almost $500? I’d say no, especially since I recently purchased a two-piece Samsonite set for one-third the cost. However, AWAY has still been very successful even though they charge a high price for their luggage.
This is because when you purchase AWAY, you’re purchasing an experience. The amazing branding and image AWAY portrays for customers make the value of the luggage match the purchase price.
Pricing is a Process
Thinking about everything that goes into pricing can make your head spin: competitors, production costs, customer demand, industry needs, profit margins … the list is endless. Thankfully, you don’t have to master all of these factors at once.
Simply sit down, calculate some numbers (like your COGS and profit goals), and figure out what’s most important for your business. Start with what you need, and this will help you pinpoint the right kind of pricing strategy to use.
More than anything, though, remember pricing is an iterative process. It’s highly unlikely that you’ll set the right prices right away — it might take a couple of tries (and lots of research), and that’s OK.
Originally published May 28, 2019 7:30:00 AM, updated September 19 2019