In a world driven by value, product pricing is nothing less than essential to a company’s success. Unfortunately, it’s also a catch 22: charge less, and you’ll be short on profits, but charge more, and the customers will leave.
It's not all that simple though. Take Apple, for instance. Their pricing strategy allows them not only to stay competitive, but also to target specific, high-spending audiences while staying within the reach of a mass market at the same time. UBS analyst Steven Milunovich defines this approach as “mainstream luxury
” – it is a clever twist on premium pricing that we’ll talk more about later, and a good example of how effective a right strategy can be.
What It Means in Strategic Terms
Pricing depends on many different factors – your average costs, the product’s attributes, customer’s perception of value, their current demand and ability to pay, marketing objectives, market landscape, economic trends, opportunity assessment, and competitor’s prices are just some of the variables that pricing strategies take into account.
But, what strategic pricing essentially comes down to is profitability. More often than not, the business’s ultimate goal is to make money, which means that the newly set prices should be in perfect alignment with customers’ demands and their ability to pay on the one side, and competitors’ price tags on the other. Finding middle grounds between these two benchmarks is a good way to start.
How to Set Your Prices: Methods and Process
There’s plenty of ways to identify your price range, but don’t make the mistake thinking that you can do it by focusing on a single pricing factor. Let’s say you choose to charge solely against your competition: it may earn you some leverage on the market, but what if your competitor’s prices were wrong in the first place?
That said, a smart pricing strategy is the one that takes all factors into account. It’s never based on a single calculating method, but presents a combination of various ways for arriving at your optimal price. Here’s a rundown of the most frequently used ones, along with a framework for employing them together.
Step 1: Defining Objectives
First of all, you need to define your objectives and identify your priorities. While making more profit is the ultimate goal, there is more than one way to get there.
That’s why your choice directly depends on the growth strategy you’re going with. For instance, if you’re planning to maximize your share and re-penetrate an existing market with an existing product, lower prices might help you achieve your goal. In case you’ve set your mind on market expansion, a penetration strategy is once again the best move. But, if you’re going with product expansion and have something truly unique to offer, then premium pricing is certainly worth considering.
Step 2: Research
You’ve probably done some research before you’ve landed on the most opportune growth strategy, but now you have to reassess and calculate that data once more. The factors to start with are costs, customers, competitors, and positioning – once all four are researched and identified, the right pricing model for your business goals should become obvious enough.
1. Calculating Costs
Though “costing out a price” is usually defined as a separate calculating method – it takes into account your costs and your desired profit, then totals these into a price - it’s really nothing but a foundation for developing the right strategy.
There’s no point in charging nothing more than you spend, which means that every single pricing model is based upon the cost plus percentage calculation. That’s exactly what being profitable implies, after all: selling the product at a price that is higher than the amount it costs you to make and provide it.
How to calculate this amount? Consider every cent you spend on making and delivering the product, starting with direct costs (the price of raw materials and labour) and concluding with indirect costs (everything from phone bills, bank charges, electricity and storage, to packaging, marketing and delivery).
2. Knowing the Customer
This is where things get slightly complicated. Everything depends on how much the customer is prepared to pay for the product you offer, but there’s a number of psychological factors that you cannot afford to ignore. Simply put, if you don’t target the audience well, you’ll end up with a bad price and no buyers.
]Let’s take a look at how different customers perceive low prices. Being affordable to all, your product will attract low-income buyers, but it may backfire with mid-income and high-end consumers. Since the price reflects the value, there will always be those who’d rather skip your product because the fact that it is inexpensive makes it look “cheap”.
That’s why customer research may just be the most important part of the equation. Along with all other parameters you use for audience targeting, consider the type of buyer that your ideal persona is. Are your customers price-sensitive and spend money solely on what they can afford, or are they convenience-centered and don’t mind spending a little more on nice packaging and home delivery? They might be quality-driven and status-conscious and have no problem with splurging on elite products. Whatever the case, you need to know.
3. Studying the Market
There are three ways you can go with competitive pricing – lower your prices, make them higher, or copy the entire model from your closest competitor. We’ve already talked about what happens when your product is too inexpensive, and a third option hardly gives you any shot at acquiring the competitive edge. This leaves us with prices that are higher than your competitor’s, so that’s what we’ll explore.
Such a difference in the price asks for a justifiable differentiating point
. If you offer the same product as your competitors do but choose to charge more, then you need to include something different and extra – higher quality, more convenient packaging, free delivery, and an exceptional after-sale service are some of the options to think about.
Besides, it’s not a raw product that determines the price, but the total value of what you can offer and provide. Though competition research is necessary, this goes to show that it isn’t so much about charging against existing prices, as much as it is about discovering an opportunity that your competitors have failed to seize.
While some companies strategize around product differentiation, others place more focus on market positioning, also called value proposition: “an effort to influence consumer perception of a brand or product relative to the perception of competing brands or products”.
Apple is a nice example of market positioning done right, which is exactly what makes them the giant and unwavering brand that they are. Since this approach allows you to define your unique place on the market and make your business brandable, positioning is particularly effective in competitive niches.
It’s that game-changing difference in how customers perceive a premium priced MacBook ($1200) and a budget priced Yoga 700 ($600), and the difference in how they’ll perceive your product against your competitor’s. In order to determine this, you’ll need to take a long, mindful look into market dynamics, and identify all factors that influence customer’s demands, needs, and expectations.
Step 3: Choosing the Right Strategy
Now that you know how much you need to spend, who your customers are, how your competition charges for their products, and what is your place on the market, review as many ready-made pricing strategies as you possibly can. As long as you base the decision on your business objectives and research, you can hardly go wrong.
These are just some of the popular pricing strategies that provenly work, and one of them can certainly help you achieve your specific goals.
1. Premium Pricing
Premium pricing is one of those strategies that allow you to set your prices higher than your competitors’. Profit-wise, it’s definitely the most advantageous one, but it does come with a number of requirements that you have to meet.
For starters, the value you provide should be impossible to match, and there should be no substitutes for the product or real competition to battle against. In any other case, your target audience will have to be prepared to pay more for what usually costs less, either because they are convenience-centered or because they are status-conscious.
2. Economy Pricing
While premium pricing goes up, economy pricing positions you at the lower side of the market. It is a strategy that works well with products with decreased production costs, and those that need no marketing or additional promotions. Food in grocery stores is a textbook example of this approach.
3. Penetration Pricing
If you’re launching a new project or entering a new market, and your buyers are mostly price-sensitive, then penetration pricing is a great pick. It means that your prices will be lower at the beginning, thus attracting a substantial customer base, and then gradually increase after a certain amount of time.
4. Skimming Strategy
The skimming strategy is suitable only for those products that are so new and original that there are still no competitive substitutes on the market. Be they high-end (expensive jewelry) or simply unique (a never-before-seen software solution), they got a chance for making a lot of profit even with high prices. Since the product itself is your differentiating point, you can feel free to sell it at a higher cost. Once the copycats arrive – and you can bet they will – you can gradually lower the price and make the product affordable for low-end buyers, too.
5. Complementary Pricing
The definition of complementary pricing is a bit complicated, but it’s nothing that cannot be illustrated with a simple example. This strategy allows you to sell one product at a price so low that it doesn’t necessarily make any profit whatsoever – say, shaving razors – but then offer a complimentary one that covers the costs and breaks you even – razor blades. Since the first product can be used without the second only for a certain amount of time, its main purpose is to create a continuous demand.
Step 4: Launching New Prices & Monitoring Results
We’ve said before that choosing a pricing strategy in accordance with business objectives and market research is almost infallible, but that still doesn’t mean that you shouldn’t test your new price after the launch.
While monitoring results, you should be able to detect a favorable difference between the old and the newly established model. Start with measuring your conversion rate – if there’s any upsurge, it means that the new price is already attracting new customers.
Pay attention to their behavior as well, and focus on early signs of expansion, contraction, or churn. They’ll tell you everything you need to know about the effectiveness of a chosen strategy, and whether or not you need to alter the price or try a different model altogether.
Product pricing is not something to be taken lightly. In between being the key driver for sales and presenting a huge strategic challenge, the “right price” requires an excessive amount of planning and research. Ideally, it’s a factor that attracts exactly those customers that your business targets, while still making your profitable enough to skim some cream and move forward.