In the dynamic world of business, implementing a robust pricing strategy is often the secret weapon that determines a company’s success or failure. As competition intensifies, understanding and adopting the best practices in pricing is essential in staying ahead of the curve, acquiring customers, and, ultimately, driving profitability.
This article provides a pricing strategy guide with 10 best practices or elements that every pricing strategy should have to succeed.
What is a pricing strategy?
A pricing strategy is a comprehensive plan that businesses develop to determine the price of their products or services. It incorporates various factors such as production cost, market conditions, competition, customer behavior, and business objectives.
Why is it important to have a competitive pricing strategy?
The importance of a pricing strategy cannot be overstated. A good pricing strategy serves as the bridge that connects the company’s financial goals with the reality of the market. It not only impacts the company’s bottom line but also influences customers’ perceptions of value, affordability, and quality. It’s a key determinant of market positioning and a major player in competitive differentiation.
10 best practices or elements to incorporate in your pricing strategy with case studies and examples
1. Competitor price monitoring
Competitive pricing continues to be one of the most influential factors driving customers’ behavior (Figure 1). This is why understanding your competitors’ pricing approach is crucial. With competitor price monitoring, you can gain insights into their pricing methods and adapt or innovate your strategy accordingly. This tool can help execute a competitor-based pricing strategy.
For instance, in the ride-sharing industry, Uber and Lyft1 often monitor each other’s pricing. When Uber cuts its prices, Lyft tends to follow suit to maintain its competitive edge, reflecting a reactive pricing strategy.
Learn more about price monitoring tools with this guide.
Figure 1. Most important factors that influence customer decisions
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- Monitor consumer sentiment toward your brand
2. Customer-centric pricing
Positioning your customers at the heart of your pricing strategy ensures you meet their needs and expectations, thus fostering customer loyalty. Understanding your customers’ willingness to pay, their perceived value of your product, and their sensitivity to price changes are vital elements of this strategy.
for instance, a company selling high-end smart home systems learns from market research that customers value the energy-saving feature most. Instead of basing their price on production costs or competitors’ rates, they price their product on the potential energy savings it offers. They calculate an average customer can save $1,200 annually on energy bills, or $12,000 over the system’s 10-year lifespan.
Therefore, they price their system at $6,000, even if it’s higher than competitors. Customers see this as reasonable due to the $12,000 long-term savings.
Hence, the company successfully implements a customer-centric pricing strategy, ensuring customers feel they’re getting good value and enabling the company to maintain a higher price point.
3. Skimming or premium pricing strategy
A skimming or premium pricing strategy is a method where a business initially sets high prices for its product or service, particularly when it’s novel, superior, or exclusive in its market. The idea is to ‘skim’ the top layer of the market — consumers who are willing to pay more for the perceived value, exclusivity, or innovative aspects of the product.
A skimming pricing strategy has several potential benefits:
3.1. Maximizing profits
The high initial price set allows the business to maximize profits from early adopters who are less price-sensitive and more willing to pay for innovation or exclusivity.
3.2. Brand positioning
The high price can position the product and the brand as high-quality or luxurious in the eyes of consumers, which can enhance the brand’s overall perception and potentially allow for premium pricing of other products in the brand’s portfolio.
3.3. Cost recovery
If the product involves significant research and development costs, a premium pricing strategy can help to recover these costs more quickly.
3.4. Market segmentation
In a skimming pricing strategy, as the price gradually decreases over time, the product becomes accessible to more price-sensitive segments of the market, expanding the customer base.
Apple2 is a prime example of a skimming pricing strategy. They’ve mastered the art of pricing their products based on customer-perceived value. Even though their products tend to be pricier than their competitors, customers perceive their products as high-quality and innovative, justifying the premium price.
4. Cost-based pricing
This is one of the most basic and common pricing strategies. In cost-based pricing, the final price is determined by adding a markup or profit to the cost of production. This strategy ensures all costs are covered, making it a viable strategy for businesses that aim to maintain steady profit margins.
An example of cost-based pricing is seen in the restaurant industry, where dishes are typically priced by considering the cost of ingredients, labor, overheads, and then adding a markup for profit.
5. Price benchmarking
Price benchmarking refers to the process of comparing your product or service prices against those of competitors or market averages. This practice allows a business to understand where it stands in the marketplace, assess the relative value it provides, and strategize accordingly.
Here are a few ways price benchmarking can help your business:
5.1. Identifying gaps
By comparing prices with those of competitors, a company can identify where it may be underpricing or overpricing its products or services. This knowledge can inform adjustments to maximize profitability without risking customer satisfaction.
5.2. Understanding market dynamics
Price benchmarking helps understand broader market trends and consumer preferences. If competitors are able to command higher prices for similar offerings, it may signal higher demand, superior quality, better branding, or more value-added services.
5.3. Improving negotiation position
Knowing the prevailing market prices can improve a company’s bargaining position with customers and suppliers. Businesses can justify their pricing or negotiate better deals based on market trends.
5.4. Influencing pricing strategy
A company can make informed decisions about its pricing strategy, whether it’s cost-plus pricing, value-based pricing, or penetration pricing, based on insights gathered from benchmarking.
6. dynamic pricing strategy
Dynamic pricing involves adjusting prices in response to market demand, competition, and other external factors. This pricing strategy is particularly useful for industries where demand fluctuates, and customer decision is price-based, such as airlines, hospitality, or e-commerce.
A real-world example of a dynamic pricing strategy can be found in Amazon. The e-commerce giant changes prices millions of times a day based on algorithms that consider factors like demand, inventory, and competitor prices.
McKinsey offers dynamic pricing modules that can be applied on different product categories and market responses (Figure 2).
Figure 2. Dynamic pricing modules
7. Psychological pricing
This pricing method plays with customers’ perception of prices. Strategies like charm pricing ($9.99 instead of $10.00), price anchoring (placing a higher-priced item next to an item with a lower-price to make it seem cheaper), and prestige pricing (pricing products high to denote exclusivity and quality) fall under this approach.
Swedish furniture retailer IKEA3 often uses charm pricing, positioning its products as affordable without significantly affecting its profit margin.
8. Value-based pricing
Value-based pricing is determined by the perceived price or value of a product or service to the consumer rather than the actual cost of production or market rate. In other words, the price is based on what the customer believes. This strategy works best for products or services that provide unique value to customers, have little competition, or are targeted towards a niche market.
9. Penetration pricing
This pricing strategy involves setting an initially lower price, usually lower than the intended established price of a product or service, to attract customers. Penetration pricing aims to increase sales volume or market share rather than maximize profit in the short term.
Here is how it can be used:
9.1. Launching a new product
When a company launches a new product, they may employ a penetration pricing strategy. The initial low price helps draw customers away from competitors and towards the new product. This tactic can be especially effective when introducing innovative or technologically advanced products.
9.2. Entering a new market
If a company enters a new market (especially if there are already established competitors), a penetration pricing strategy can help attract customers who may already be loyal to another brand. The aim is to entice them to try the new product because of the lower price.
9.3. Gaining market share
Over time, as customer awareness increases and the product gains market acceptance, the firm may gradually increase the price. The idea is that consumers will continue to buy the product because of their positive initial experiences with it, even though the price has gone up.
10. Pricing strategy evaluation and adaptation
Finally, a good pricing strategy is not set in stone. It should be regularly evaluated and adapted based on market trends, customer feedback, and business performance. This flexible approach allows businesses to stay relevant and competitive in a rapidly evolving market.
Netflix4 provides a good case study here. Over the years, the streaming service has altered its pricing multiple times, introducing new plans and revising existing ones in response to market trends, user behavior, and competition.
Further reading
If you need help finding a vendor or have any questions, feel free to contact us:
References
- McArdle. Megan (2019). Uber and Lyft are locked in a price war. There are only two ways out. Washington Post. Accessed: 08/June/2023
- Business Insider (2021). Slicing the Apple: An analysis of Apple’s pricing strategy. The St Andrews Economist. Accessed: 08/June/2023
- SKOBAYA (2016). Secret behind IKEA’s pricing strategy. Deakin Business School. Accessed: 13/June/2023
- Maknouni, Saba (2023). Netflix International Pricing Strategy. Global Marketing. Accessed: 13/June/2023
