A pricing strategy considers factors like competitor actions, market conditions, consumer trends, and other variable costs to account for the pricing model of the goods.
Businesses must decide on a pricing strategy before advertising products to customers. In this list, we will review the five most commonly used approaches to pricing and decide what fits your business needs.
1. Competition-based pricing
Competition based pricing utilizes competitor’s pricing data for similar products to set a base price for their own products. Rather than focusing on production costs or the value of the item, this pricing method relies heavily on market data.
Think of it in this way. You have five competitors who sell the same product as you, and you categorize them from the most high-end brand to the affordable brands. Then, you decide where you fit in.
What is the ideal situation for using competition-based pricing?
The reason companies rely on competition-based pricing is simple. It is easy, and you have complete control over your market position. Market information gathered on competitors can give more insights than just pricing, which you can implement in your brand to replicate similar results.
The disadvantages are that it is hard for companies to sustain only on competitive pricing if they are not actively adding value to customer’s lives and don’t have a quality product. Also, one of the major pitfalls is that selling solely based on a competitor’s pricing can undermine your product and cost you revenue.
Competitive pricing is a highly useful tool for retailers and small businesses, especially in eCommerce.
2. Cost-plus pricing
Cost-plus pricing is a basic strategy that works by considering the total cost of making a product and adding a markup to that to determine the price of a product. This is a good strategy in the long term. A business owner needs to first understand the costs involved in production: material, labor, warehousing, machinery, utilities and such. The markup price that is added to the top of production cost is what the company makes in profit.
Here’s how cost-plus pricing works:
Step 1: calculate the complete production cost for x units of product.
- Step 2: divide the cost by x units to get unit cost.
- Step 3: multiply unit cost by markup percentage. If unit cost is $10 and markup percentage is 20, then the profit margin is $10 X 20/100 = $2. The price of the product is $12.
It is ideal for retail companies. Based on the product offering they can charge different markups.
However, this is not ideal for software service companies, music producers, and the like because the price of the product is much higher than the product cost.
3. Dynamic pricing
The most basic way of describing dynamic pricing is that your price is not static and instead changes based on other factors. These factors can be for example segments or time.
Dynamic pricing in segments.
Companies use algorithms to derive the pricing for different groups based on statistics.
Say, you own a car rental company and your AI is specialized to hike up prices at locations with lots of pubs and bars. If this sounds highly illegal and impractical, we can assure you it is not. We are just describing Uber.
Dynamic pricing by time
This kind of pricing is often seen at sales-based companies, like car or insurance dealerships where there is a huge rush to close deals at the end of the month. This is when dealers offer cheaper prices on products to match the sales quota, as compared to the start of the month.
In the real world, we see this all the time. Amazon, Uber, flight companies – they all use dynamic marketing based on supply and demand.
4. Penetration pricing
Penetration pricing is a strategy that is used to capture market share by setting product prices at a below-market level to gain customers. Once the company gets a sizable market share, they readjust the pricing accordingly.
Here’s how penetration pricing works
Consider company X, which is a small to medium-sized soap maker and sells lavender soap bars at $10. An international company Y which has a much higher production capacity, enters the market and begins selling a similar lavender soap bar at $5. This is the prime example of penetration pricing.
The goal of Y here is to run the small-sized competitor X out of business as even if, at $5, company Y makes a very minimal profit, they are confident company X cannot match their prices. And as customers begin buying from Y, X will eventually run out of business. This extreme form of penetrative pricing is also often termed as predatory pricing.
World-renowned Walmart has been practicing this for decades and has been the bane of smaller local businesses due to their unmatchable prices.
5. Price skimming
Charging a higher price for a product when it has been newly launched, leveraging market demand, and then lowering or readjusting price based on demand at a later point is known as skimming pricing.
We see this often at the launch of celebrity product lines or new product launches from a reputed brand. Early adopters are customers who are willing to pay a much higher price for a product whether that price reflects the true value of the product or not, to have it when the demand is high, usually at the launch.
The prices of these products are then lowered to attract more price-sensitive customers. Therefore, for each customer segment, the company is charging the maximum amount by skimming off the top of these customer segments.
Whether it is Rihanna’s Fenty Beauty, Kanye’s new clothing line, or the newest Playstation, businesses use skimming pricing to leverage willing customers who are not only paying for the product but the privilege of being the first in line to be able to use that product. In a few months, the prices of these products usually go down.