It’s no secret that small businesses play a vital role in the US economy. However, revenue for small businesses can be scarce.
For instance, small businesses that do not have any employees average just $44,000 a year in annual revenue with two-thirds of these companies earning less than $25,000 per year. While various factors can affect a business’s revenue potential, one of the most important factors is the pricing strategy that its owners and team members utilize.
Once you have a firm understanding of what a pricing strategy is, you can start reviewing the various approaches and choose the best one for your product.
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 to price their goods 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 will allow you to maximize 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 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 if you price it too high, but your business won’t be able to cover expenses if you price it too low.
10 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 ten 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 becomes more well-known. Penetration strategies aim 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 position within the market.
2. Economy pricing
This pricing strategy is a “no-frills” approach that involves minimizing 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 Walmart 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 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, owners should ensure that the product’s packaging, the store’s decor, and the marketing strategy associated with the product 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 more unique than anything else on the market.
4. Price skimming
Designed to help businesses maximize 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 maximize 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 to the marketplace.
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 bang for their buck. 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 performance clothing. You may choose to set a higher price point for winter clothes in your cold-climate retail stores than you do in your warm-climate stores. You know people are more likely to buy the clothes in the winter environments, so you set a higher price to take advantage of demand.
8. Promotional pricing
Promotional pricing 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 an extended holiday, like Memorial Day Weekend. By offering these deals as short-term offers, business owners can generate buzz and excitement about a product. Promotional pricing also incentivizes 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 an excellent “value” for the good or service. The approach recognizes that customers don’t care how much a product costs a company to make, so long as the consumer feels they’re getting an 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.
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.