How to choose a pricing strategy for your business

It’s no secret that small businesses play a vital role in the Australian economy. However, revenue for small businesses can be scarce.

While various factors can affect a business’s revenue potential, one of the most important factors is its pricing strategy.

To get this right, it’s critical to use financial reporting and insights to guide your decisions. You also need a good understanding of the many different pricing strategies that you can choose from for your products and/or services. We look at 12 common pricing strategies in detail below.

What is a pricing strategy and why is it important?

In short, a pricing strategy refers to all of the various methods that small businesses use when setting prices for their goods and/or services. It’s an all-encompassing term that can account for things like:

• Market conditions
• Actions that competitors take
• Account segments
• Trade margins
• Input costs
• Consumers’ ability to pay
• Production and distribution costs
• Variable costs

Pricing strategies are useful for numerous reasons, though those reasons can vary from company to company. Choosing the right price for a product or service will allow you to maximise profit margins if that’s what you want to do. Contrary to popular belief, pricing strategies aren’t always about profit margins. For instance, you may opt to set the cost of a good or service at a low price to maintain your hold on the market share and prevent competitors from encroaching on your territory.

In these cases, you may be willing to sacrifice profit margins in order to focus on competitive pricing. But you must be careful when engaging in an action like this. Although it could be useful for your business, it also could end up crippling your company. A good rule of thumb to remember when pricing products is that your customers won’t purchase your product or service if you price it too high, but your business won’t be able to cover expenses if you price it too low.

Twelve different pricing strategies for your small business to consider

As we’ve just identified, project management and strategic, actionable decisions go into setting the price of a product. Here are 12 different pricing strategies that you should consider as a small business owner.

1. Pricing for market penetration

As a small business owner, you’re likely looking for ways to enter the market so that your product and/or service becomes more well-known. Penetration pricing aims to attract buyers by offering lower prices on goods and services than competitors.

For instance, imagine a competitor sells a product for $100. You decide to sell the product for $97, even if it means you’re going to take a loss on the sale. Penetration pricing strategies draw attention away from other businesses and can help increase brand awareness and loyalty, which can then lead to long-term contracts.

Penetration pricing can also be risky because it can result in an initial loss of income for the business. Over time, however, the increase in awareness can drive profits and help small businesses stand out from the crowd. In the long run, after penetrating a market, business owners can increase prices to better reflect the state of the product’s or service’s position within the market.

Penetration pricing is one of several competitive pricing strategies available. Another is dynamic pricing, which we look at in more detail below.

2. Economy pricing

This pricing strategy is a “no-frills” approach that involves minimising marketing and production expenses as much as possible. Used by a wide range of businesses, including generic food suppliers and discount retailers, economy pricing aims to attract the most price-conscious consumers. Because of the lower cost of expenses, companies can set a lower sales price and still turn a slight profit.

While economy pricing is incredibly useful for large companies like Kmart and Target, the technique can be dangerous for small businesses. Because small businesses lack the sales volume of larger companies, they may find it challenging to cut production costs. Additionally, as a young company, they may not have enough brand awareness to forgo custom branding.

3. Pricing at a premium

With premium pricing, businesses set costs higher because they have a unique product or brand that no one can compete with. You should consider using this strategy if you have a considerable competitive advantage and know that you can charge a higher price without being undercut by a product of similar quality.

Because customers need to perceive products and/or services as being worth the higher price tag, a business has to work hard to create a perception of value. Along with creating a high-quality product and/or service, owners should ensure that the product’s or service’s packaging, the store’s decor and the marketing strategy associated with the product and service all combine to support the premium price.

An example of premium pricing is seen in the luxury car industry. Companies like Tesla can get away with higher prices because they’re offering products, like autonomous cars, that are unique compared to anything else on the market.

4. Price skimming

Designed to help businesses maximise sales on new products and services, price skimming involves setting rates high during the initial phase of a product. The company then lowers prices gradually as competitor goods appear on the market. An example of this is seen with the introduction of new technology, like an 8K TV, when currently only 4K TVs and HDTVs exist on the market.

One of the benefits of price skimming is that it allows businesses to maximise profits on early adopters before dropping prices to attract more price-sensitive consumers. Not only does price skimming help a small business recoup its development costs, it also creates an illusion of quality and exclusivity when you first introduce your product or service to the marketplace. It’s one of several dynamic pricing strategies available, which we look at in more detail below.

5. Psychological pricing

Psychological pricing refers to techniques that marketers use to encourage customers to respond based on emotional impulses rather than logical ones.

For example, setting the price of a watch at $199 is proven to attract more consumers than setting it at $200, even though the actual difference here is quite small. One explanation for this trend is that consumers tend to put more attention on the first number on a price tag than the last. The goal of psychology pricing is to increase demand by creating an illusion of enhanced value for the consumer.

6. Bundle pricing

With bundle pricing, small businesses sell multiple products for a lower rate than consumers would face if they purchased each item individually. A useful example of this occurs at your local fast food restaurant where it’s cheaper to buy a meal than it is to buy each item individually.

Not only is bundling goods an effective way to reduce inventory, it can also increase the value perception in the eyes of your customers. Customers feel as though they’re receiving more value for money. Many small businesses choose to implement this strategy at the end of a product’s life cycle, especially if the product is slow selling.

Small business owners should keep in mind that the profits they earn on the higher-value items must make up for the losses they take on the lower-value product. They should also consider how much they’ll save in overhead and storage space by pushing out older products.

7. Geographical pricing

If you expand your business across state or international lines, you’ll need to consider geographical pricing. Geographical pricing involves setting a price point based on the location where it’s sold. Factors for the changes in prices include things like taxes, tariffs, shipping costs and location-specific rent.

Another factor in geographical pricing could be basic supply and demand. For instance, imagine you sell sports clothing; you may choose to set a higher price point for winter clothes in your cold-climate retail shops than you do in your warm-climate shops. You know people are more likely to buy the clothes in the winter environments, so you set a higher price to take advantage of the demand.

8. Promotional pricing

Promotional pricing is another competitive pricing strategy. It involves offering discounts on a particular product. For instance, you can provide your customers with vouchers or coupons that entitle them to a certain percentage off the good or service. You could also entertain a “Buy One Get One” campaign, tacking on an additional product as an add-on.

Promotional pricing campaigns can be short-term efforts. For instance, you may run a promotional pricing strategy over a long weekend like Labour Day. By offering these deals as short-term offers, business owners can generate buzz and excitement about a product. Promotional pricing also incentivises customers to act now before it’s too late. This pricing strategy plays to a consumer’s fear of missing out.

9. Value pricing

If you notice that sales are declining because of external factors, you may want to consider a value pricing strategy. Value pricing occurs when external factors, like a sharp increase in competition or a recession, force the small business to provide value to its customers to maintain sales.

This pricing strategy works because customers feel as though they are receiving excellent “value” for the good or service. The approach recognises that customers don’t care how much a product costs a company to make, so long as the consumer feels they’re getting excellent value by purchasing it.

This pricing strategy could cut into the bottom line, but businesses may find it beneficial to receive “some” profit rather than no profit. An example of value pricing is seen in the fashion industry. A company may produce a product line of high-end dresses that they sell for $1,000. They then make umbrellas that they sell for $100.

The umbrellas may cost more than the dresses to make. However, the dresses are set at a higher price point because customers feel as though they are receiving much better value for the product. Would you pay $1,000 for an umbrella? Probably not. Thus, external factors like customer perceptions force the value pricing strategy.

10. Captive pricing

If you have a product that customers will continually renew or update, you’ll want to consider a captive pricing strategy. A perfect example of a captive pricing strategy is seen with a company like Dollar Shave Club. With Dollar Shave Club, customers make a one-time purchase for a razor. Then, every month, they purchase new razor blades to replace the existing one on the head of the razor.

Because the customer purchased a DSC razor handle, he or she has no choice but to buy blades from the company as well. Thus, the company holds customers “captive” until they decide to break away and buy a razor handle from another company. Businesses can increase prices so long as the cost of the secondary product does not exceed the cost that customers would pay to leave for a competitor.

Like penetration and promotional pricing, captive pricing is a type of competitive pricing strategy.

11. Dynamic pricing

Dynamic pricing is when you charge different prices depending on who is buying your product or service or when they buy it. It’s a flexible pricing strategy that takes many factors into account—particularly changes in supply and demand.

You might have heard dynamic pricing referred to as demand pricing, surge pricing or time-based pricing. There are even different types of dynamic pricing, including price discrimination or variable pricing, price skimming (discussed in more detail above) and yield management.

A good example of dynamic pricing comes from the airline industry. If you’ve ever noticed how much flight prices can change depending on when you book, you’ve experienced dynamic pricing firsthand. While dynamic pricing is relatively common in ecommerce and the transport industry, it doesn’t work for every type of business. The greatest risks can come when variable prices are applied to products or services that are typically bought by price-sensitive customers. This is also known as price elasticity—when small changes in price have a large impact on demand.

12. Competitive pricing

Competitive pricing is when your prices either match or beat those of similar products that are sold by competitors. Often this simply means selling your products or services at a better price, but you could choose to offer better payment terms instead.

As we’ve seen above, competitive pricing strategies include penetration pricing, promotional pricing and captive pricing. The secret to knowing which of these could work best for your business comes from data. Gather as much information as possible about your market and what your competition is doing.

What is the most effective pricing strategy?

The most important factors influencing your pricing strategy are rooted in your financial data. First and foremost, you need to know what it costs to produce your products or provide your services. You need to continuously monitor these costs so you can quickly react to changes and maintain long-term profitability.

External conditions are often just as important as your cost of production. Know your market, your competition and your customers. Emerging trends, supply chain threats and even shifting perceptions of your brand can all force you to rapidly change your pricing strategy. Finally, consider your longer term revenue goals. If you are selling premium goods or services and want to drive up demand, think carefully about whether discounts could do more harm than good by damaging the perceived value of your product/service. If you are going for market penetration with a loss leader, how long can you sustain this before cash flow becomes too stretched?

Keep track of business revenues.

Once you determine the right pricing strategy, your profit margins could increase. You’ll want to make sure you’re using reliable accounting software to keep track of relevant data. QuickBooks makes it easy for you to monitor relevant sales data and manage cash flow in one place. This data allows you to continually evaluate your pricing method so that you can make price changes in real time, grow your business and improve your customer success.