Pricing strategies are an important step for all manufacturing and retail companies. Setting prices that appeal to your customers and make a profit can be tricky, but choosing an effective pricing strategy can help you find the balance. In this article, we discuss what a pricing strategy is, eight common types of pricing strategies and how to choose one.
What is a pricing strategy?
A pricing strategy refers to the method companies use to decide which price to set for its products. A good pricing strategy involves setting prices that suit the value of products while also turning a profit.
A company’s goal when it comes to pricing strategies is usually to set unit prices that appeal to customers and are higher than the product’s production cost. When choosing a pricing strategy, companies have to consider a number of important factors, including the quality of their products, the manufacturing costs and the market demand.
Types of pricing strategies
The pricing strategy that is best for a company depends on its individual strategic goals. Here is an overview of eight common pricing strategies, with examples of each:
1. Competitive pricing strategy
A company with a competitive pricing strategy chooses its prices by looking at the current market rate or going rate of a certain product. A competitive pricing strategy uses other company’s prices as a standard. If a company exists in a highly saturated market with many direct competitors, a competitive pricing strategy can help the company appeal to customers who are primarily concerned with finding the lowest price.
Example competitive pricing strategy: A company that sells cell phone accessories sets intentionally low prices to help its products stand out in that market.
2. Cost-plus pricing strategy
A cost-plus pricing strategy focuses on the cost of producing individual items. It is commonly called the “markup” strategy because companies who use it often mark up product prices in order to make a specific profit. Price markups are usually expressed as percentages. This type of strategy usually works best with physical products, since it is easy for the company to calculate production costs.
Example cost-plus pricing strategy: A clothing company produces dresses that cost $20 to manufacture, and sells them at a 100% markup for $40. The company makes a $20 profit on each dress.
3. Freemium strategy
This strategy, a combination of the concepts “free” and “premium,” has become increasingly common. Companies that use this strategy offer a limited version of their product or service for free in hopes that users will then decide to start paying for access to the “full” version with more advanced features. Unlike the cost-plus strategy, this method is typically used by digital services and software companies.
Example freemium strategy: A software company offers a free trial of its product to the public, which entices more users to become paying customers.
4. Dynamic pricing strategy
A dynamic pricing strategy allows prices to rise and fall depending on the current market and the level of demand. Companies that use dynamic pricing strategies must have the flexibility to be able to adjust prices to maximize peak demand periods.
Example dynamic pricing strategy: An airline raises ticket prices during the holiday season when the highest number of customers are buying airfare. This strategy enables the company to maximize profits while also allowing savvy customers to take advantage of low price periods.
5. High-low pricing strategy
Companies that use high-low pricing strategies initially sell items for high prices which are then lowered dramatically when demand slows or when the product’s appeal lessens. You will see evidence of this strategy in discounts, clearance racks and “everything must go” sales. This strategy is useful for retail companies or brands that sell seasonal products, such as holiday decorations or outdoor furniture.
Example high-low pricing strategy: A home goods store sells Halloween decorations for high prices during September and October, and then sells any remaining inventory for 80% off in November.
6. Price skimming strategy
Price skimming is an effective pricing strategy when companies target customers that are already interested in their products. The strategy is to set your prices high in the beginning to maximize short-term profits. You make fewer sales at first, but they are more profitable. The price is then steadily reduced over time to attract other customers.
Skimming leaves an opportunity for competitors to undercut your prices and try to attract your customers. Therefore, a high-quality product is essential to maintain your value-oriented customers’ interest.
Example price skimming strategy: A car manufacturer releases an eight-cylinder luxurious SUV with various innovative features that no other car currently on the market offers. The starting price for this model is at the highest point. A year later, the car company releases another model resembling the high-end one. It has only six cylinders and a lower price.
7. Penetration pricing strategy
A penetration strategy is a marketing tactic that professionals use to introduce new products or enter a new market. When using a penetration pricing strategy, the company offers lower prices for their products when they first start. The prices depend on how many competitors there are in the market, how similar their products are and how they price their products.
By demonstrating the value of their product at a low price, marketing professionals aim to retain their customers even after they’ve increased the prices for each product. This is important because it allows the company to increase their consumer base and profits.
Example penetration pricing strategy: A movie company is trying to enter the video streaming market. The company advertises a free trial for its subscription plan, with a price that’s half their competitor’s for three months following the free trial. After trying out the service for the lower price, it’s easier for customers to stay with the new streaming company if the quality of the service is acceptable.
8. Promotional pricing strategy
Companies often use promotional pricing, or discounts, to attract customers and increase their brand exposure. Promotional pricing employs one-time discounts, sales over time and limited-time offers to encourage customers to make purchases.
Types of promotional pricing include loyalty programs, flash sales, buy one, get one free deals, seasonal sale and percentage sales.
Example promotional pricing strategy: A small-town boutique rewards its customers for their patronage by offering member-only rewards, discounts and private sale preview events. This increases their customers’ perceived value of what the boutique offers and they are more likely to talk about it with their friends.
How to choose a pricing strategy
Choosing a pricing strategy involves considering a number of important factors, like production costs, market value and customer demand. Follow these tips to choose an effective marketing strategy:
Know your customers: The first step in choosing a pricing strategy is to anticipate the needs and wants of your customer base. If you know what they are looking for and what they can afford, you will be able to supply appealing products at a price they are willing to pay. One way to find out more about your customer base is to issue a customer survey that asks questions like: “What do you like about this product?” “Would you recommend this product?” and “Is this product’s value equal to its price?”
Know your products: The next step is to understand the unique value of your product. To do this, companies must dedicate time and effort to market research. This involves comparing a product to similar products already on the market, considering competing prices and conducting surveys to determine the best target demographic. Knowing the value of their products will help producers to choose pricing strategies that guarantee a profit.
Consider your industry: The best pricing strategy for each company varies greatly by industry. When choosing a pricing strategy, you will need to look at other companies in the same industry that are selling similar products. Odds are, they are using a particular pricing strategy because it lends itself to their product or their business model. If you can learn by observing the successes and mistakes of others, you will greatly increase your chances of success.