Done right, an effective pricing strategy can propel a company into the stratosphere. Done wrong, pricing can be the demise of an organization. In today’s hyper-fast, multi-channel environment, a competitive pricing strategy is more important (and harder to achieve) than ever.
Fixing an “optimum” selling price causes headaches for companies everywhere. Underestimate what your customers are willing to pay, and you leave revenue and profit on the table. Overestimate, and you risk lost sales.
One thing is certain — pricing can not be left to chance. Smart businesses are giving pricing strategies the attention and investment they deserve. Let’s take a closer look at the different pricing strategies and why they matter to your business.
What is a pricing strategy?
The definition of a pricing strategy is the process of determining the optimal pricing for a particular product or service. Simple to define but hard to do, pricing strategies aim to deliver maximum revenue and profit by considering things like the cost of goods sold (COGS), competitor pricing, market conditions, level of demand, and the type of product or service being sold.
When we think about what is meant by pricing strategy, it’s important to note that pricing is not a ‘set-and-forget’ function. A competitive pricing strategy should be systematic and agile to cope with today’s highly competitive and complex market; companies must anticipate market shifts and predict their competitors’ next moves.
Why is a pricing strategy important?
Put simply, companies that do pricing strategies well are more profitable than those that don’t. According to Deloitte, companies that actively make their pricing model a crucial part of their overall strategy typically outperform industry peers on numerous financial metrics.
Sure, a company has to cover its costs and reach its financial goals, but pricing also tells customers things about its offering, including quality and exclusivity. Getting the right pricing strategy in place at the right time is vitally important.
An ineffective pricing strategy can lead to several potential problems, including:
- Poor or unreliable margins
- Price-sensitive “commoditized” customers
- Reduced revenue and profit
- Loss of market share
- Low perceived value or quality
Who is responsible for pricing strategy?
Research shows that companies with clearly defined ownership and accountability of the pricing process are more likely to exhibit effective pricing — 30% more, to be exact. So who in an organization is in charge of pricing?
Effective price management draws on expertise across numerous functions, including sales, finance, marketing, product development, and customer service. Larger organizations might have a Pricing Department, headed up by a Pricing Manager. In other businesses, pricing models could be determined by the Managing Director, CEO, Sales and Marketing Director, Commercial Director, or collaboration of any or all of these.
7 types of pricing strategies
Companies can adopt numerous pricing models, and some may draw from more than one, depending on the circumstances. Let’s look at some of the most common pricing strategies and some examples.
1. Cost-plus pricing
Cost-plus pricing is a simple pricing strategy commonly used in retail. This pricing model adds a percentage to the cost of goods sold (COGS). Companies generate the retail price (and profit margin) by marking up the product production cost by a specific percentage. The formula for calculating cost-plus pricing considers materials, labor, and overhead costs, multiplying this by the markup amount.
Cost-plus pricing works well for businesses where value and cost of production are closely related, like groceries and hardware. It can also be applied to services with consistent costs like hours billed. This pricing model isn’t suited to companies whose products or services offer much higher value to the customer than the cost of producing them, like software. This type of business is better suited to a premium or value pricing model.
Simplicity is one of the key advantages of cost-plus pricing strategies, as companies can set prices without consumer research or the need to analyze historical data. On the other hand, it ignores external factors like perceived customer value and competitor pricing.
Cost-plus pricing example
Consumer goods, like groceries, clothing, and electronics, are likely to be priced using a cost-plus pricing strategy. Retailers and manufacturers will add a fixed percentage on top of COGS. The markup amount can vary wildly between products and industries, depending on the product’s perceived value and the market’s competitiveness.
Here’s an example of cost-plus pricing for a manufacturer of batteries:
Production cost per unit (including materials and labor): $5.00
Overheads per unit (including marketing and shipping): $3.00
Total COGS: $8.00
Markup percentage: 50%
Price per unit: $12.00 ($4.00 profit margin)
2. Penetration pricing strategy
Penetration pricing (similar to loss leader pricing) is a competitive pricing strategy that entices customers to switch from competitors by offering a lower price for a product or service. A penetration pricing strategy is often used to gain market share and brand awareness quickly when a company launches a new offering into the market.
Penetration pricing is usually applied short-term, allowing companies to snap up customers and maintain loyalty when prices go up. It can lead to an increase in both revenue and market share, but it can erode profit margins and brand equity.
Penetration pricing example
You have probably taken up an offer based on penetration pricing for a subscription like a streaming service. The provider lures you with an irresistible offer, like $10 per month for the first three months. After this introductory period, the price goes up to the standard level. The provider bets you’ll enjoy the service so much that you’ll keep subscribing once the welcome offer ends.
3. Premium pricing
Premium pricing sets prices higher than the market average to cultivate a perception of value and quality in customers’ minds. Also known as prestige pricing, a premium strategy is a psychological pricing model that can be advantageous for companies that pitch themselves as a premium or “luxury” brand because customers associate cost with quality.
A premium pricing strategy has several advantages for businesses, including higher margins and increased brand equity, but this type of pricing model can bring much higher advertising and branding costs. It is also a risky pricing strategy if companies do not ‘walk the walk’ — customers will not look favorably on brands that charge a premium price for a sub-par product.
Premium pricing example
The infamous French fashion label Chanel has produced some of the most iconic looks in modern history. While the products are made to a very high standard, the brand has built such an enviable reputation that customers mostly pay for the brand name (an eye-watering $5,500 for the seminal Chanel 2.55 handbag). To earn this status, Chanel splashes out on extravagant runway shows, glossy advertisements, and celebrity campaigns to the tune of $1.46 billion per year.
4. Dynamic pricing
As the name suggests, a dynamic pricing strategy is not fixed — it automatically adjusts prices based on numerous human and market-based factors. Dynamic pricing relies on complex data sets and advanced technology platforms like Flintfox, to automatically generate the “optimum” real-time price.
Typically used for e-commerce, dynamic pricing considers the availability of a product or service like rideshare surge pricing, customer behavior, the level of consumer demand, and the time remaining before the service is rendered.
Flintfox’s Pricing Engine can work on thousands of complex, channel-specific calculations to deliver 5,000 prices per second. Because technology can make split-second calculations about customer behavior and market conditions, dynamic pricing strategies can greatly increase revenue and profits. Dynamic pricing can be difficult for companies to implement without the right pricing platform. If not handled properly, it can also be a source of confusion for customers.
Dynamic pricing example
If you’ve booked an airline ticket, you will be familiar with dynamic pricing. The aviation industry is well known for its dynamic prices, which are calculated based on the number of seats remaining on a flight, the class of a seat, and the amount of time remaining before a flight departs. The fewer seats there are, the closer the departure date, the more expensive the ticket will be.
5. Price skimming strategy
Price skimming is typically employed when a new product or service enters a low-competitive market environment. A company will initially set the highest possible price the market will tolerate, allowing them to generate maximum revenue from early adopters with limited choices. As new players enter the market, they gradually lower prices over time to capture more price-sensitive customers and increase demand. The term ‘skimming’ comes from how companies skim the top layer of consumers, followed by subsequent layers.
A price skimming strategy can be very effective for a short period while a new product or service enters the market. It allows the company to set a high perception of value and quality in consumers’ minds and quickly establish itself as the “original” and the best.
Like all pricing strategies, price skimming has limitations. There must be an existing cohort of customers willing and able to pay premium prices, and they will only do so when no viable alternatives exist. Once the market becomes more competitive, brands must shift to more flexible pricing models.
Price skimming example
Electric vehicles are a great example of a price skimming strategy. With a hefty $100,000 price tag, the first Tesla model EV released in 2008, the Roadster, was unaffordable for most people. In 2021, the average electric vehicle (EV) price was $53,467. As technology advanced, production costs fell, and more competitors entered the market, including Nissan, Volkswagen, and Chevy, demand for EVs has grown at historical levels (72% year on year between 2020 and 2021).
6. Promotional pricing
Many companies temporarily reduce the price of products and services to attract more customers and drive short-term sales volume — known as promotional pricing. Promotional pricing is a psychological pricing model that gives customers the impression of scarcity and generates a sense of FOMO around missing out on a good deal.
Promotional pricing effectively drives revenue and market share in the short term. This pricing strategy works best when customers are not staunchly loyal to a particular brand; it can persuade customers to switch from a competitor’s product to their own, hoping that those customers will stay after prices return to normal. When overused, promotional pricing can damage profit margins, injure a brand’s reputation and drag the average market value down.
Example of promotional pricing
Look no further than your local supermarket aisles for hundreds of examples of promotional pricing. From laundry powder to tinned tomatoes, offers like Buy One Get One Free (BOGOF), and percentage-off discounts entice customers to try a different product where the stakes of switching are lower.
7. Value-based pricing
When companies set a price for their products or services based on perceived value rather than the cost of producing them or their historical price, they are using a value-based pricing strategy. This pricing strategy works well in specific situations, like a product perceived as high-end or luxurious, where there is an emotional and meaningful connection to the product, like a famous artwork, and when there is a sense of scarcity.
Value-based pricing strategies can be effective for some companies, but they don’t come without challenges. While other pricing strategies are relatively scientific, value-based pricing involves an element of guesswork. It can be challenging to determine what customers are willing to pay for a particular product or service, so gauging demand is very important.
Value-based pricing example
Companies traditionally use value-based pricing for limited edition products. Every time Kylie Jenner’s makeup brand, Kyle Cosmetics, launches a new product, customers receive an alert to sign up for “first access”, while a countdown timer creates a sense of urgency. Once the product goes live, it sells out within minutes. Creating this kind of hype around a product relies heavily on cultivating FOMO in customers’ minds and drawing on Kylie’s celebrity gravitas.
What’s the best pricing strategy?
There is no one-size-fits-all pricing strategy. The most effective pricing strategy for a business depends on many factors, including the product or service being sold, the business model, market demand, the industry norms, how price-sensitive customers are, and the product lifecycle stage.
Price skimming may be the best pricing strategy for a company launching an innovative new product, like a new B2B software with little or no competition. However, once competitors enter the market and consumers have more choice, they must move with the market to maintain and grow market share.
FMCG companies may work mainly with a cost-plus pricing strategy — marking up the cost of goods to create a margin. Still, they will likely also use promotional pricing throughout the year to remain competitive and claim market share from competitors.
Regardless of which pricing strategy a company employs today, it must be ready and willing to adopt a flexible pricing strategy in the future as the commercial landscape evolves.
How to create a winning pricing strategy
In today’s world, companies often work across multiple geographies, markets, sales channels, and currencies. Whether it’s an international airline, a food manufacturer, or a global clothing brand, wrangling the variables and vast swathes of data can seem impossible.
Innovative businesses are investing in intelligent pricing platforms that do away with hundreds of spreadsheets and make hyper-speed calculations to positively impact the bottom line.
Flintfox helps companies take control of their pricing by managing huge volumes of data in one simple platform. Bring your pricing, promotions, and rebates into one system, streamline your reporting and analytics and grow your profits easily.
Find out more about how Flintfox can supercharge your business today.