July 30, 2013
A question many entrepreneurs have is how to price a product. Companies must pay special attention to their pricing in order to thrive in today’s hyper-competitive marketplace. Pricing can make or break a company, so it’s essential to devise a strong product pricing strategy. For start-ups, figuring out a pricing strategy can be even more critical. There are so many unknowns and so many unanswered questions … Why isn’t the product selling as well as anticipated? Is it the price or is the product wrong for the market?
When considering how to price products or services, there are three basic price strategy approaches:
- Cost-based pricing considers the price of the product, plus the desired profit margin that the company is seeking to earn. This is usually the least effective.
- Customer-based pricing considers the price that customers are willing to pay, with little emphasis on the cost of the product or service. This is based upon the value the customer places on the product.
- Competitor-based pricing considers the prices that competitors are charging. So the main focus is to under-cut the competitor, while simultaneously offering strong customer service.
Let’s take a moment to look at these approaches. To stay in business, the company must create something of value for the customer. How much would you be willing to pay today to solve your most critical problem? It’s probably more than just a mark-up on the manufacturing cost of the solution. With customer-based pricing, you need to know what value the customer places on the product. Cost-based pricing only considers the desired margin and not what the customers are willing to pay for it. I worked for a company that required the end product to have both a specific margin and volume requirement in order for any product development project to be funded. This limited what products could be offered. Just because you want to sell toilet paper for the price of gold, doesn’t mean your customers will pay the price. Most companies start their pricing strategy by researching how their competitors are pricing their products. The truth of pricing is it is not entirely in the hands of the company, the marketplace often sets the bounds. Cost is more easily controlled than pricing.
When selecting a product pricing strategy, it’s important to consider your target customers – their budget, their desires and their approach to shopping for your product or services.
Customer Considerations and Pricing
There are four basic types of customers:
- Poor consumers have little money. They rely on state benefits and pensions, low-paying jobs and many are un-employed or under-employed. These consumers frequent bargain bins, boot sales and discount stores. Even in wealthy western countries, this consumer group may account for up to a quarter of the population.
- Status consumers, also called fashion consumers, buy items because they’re “cool” and current. Teens fall into this group and even some poor adults may borrow or charge purchases in order to have the latest and greatest clothing, gadgets and cars.
- Experience consumers enjoy the actual experience of shopping. These consumers may frequent flea markets for the opportunity to haggle; they’re often spotted at online auctions. These shoppers shop for the sake of shopping. But not all experiential shoppers are bargain hunters; they may look to be pampered or enjoy an enhanced, interactive, or entertaining experience.
- Ethical consumers buy products and services that align with their beliefs. These consumers often seek out products that don’t test on animals, fair trade goods and eco-friendly wares.
Now that we’ve explored the various types of consumers and the three basic product pricing strategies, it’s time to look at the many different price strategies that you’ll encounter.
Odd-Ending pricing involves prices that end in odd numbers, set just below the dollar mark (e.g. $4.99 instead of $5.00). This plays upon the psychological principle whereby people associate good value with the number 9, whereas people associate higher quality with the number 0, so at a high-end shop, you’re more apt to find goods priced for $30 instead of $29.99.
Psychological pricing involves pricing in a way whereby the item appears less expensive. For instance, a DVD may be priced at $9.97 and this (often subconsciously) appeals to people who may believe that $10 is a bit too expensive. This approach appeals to bargain hunters.
Monthly pricing and large vs. small losses involves paying as you go on a monthly basis rather than spending a large sum at once. This pricing strategy makes people feel more comfortable, since they feel like they’re spending less, which is associated with greater satisfaction. Consumers are more apt to make “four easy payments of $29.99” instead of one larger lump sum.
Prestige pricing plays upon the belief that higher prices are associated with higher quality. Luxury brands utilize this strategy, which often includes using branding elements that convey a look of sophistication; this helps the customer to justify the higher price point.
Anchor pricing involves establishing a price point that customers utilize as a reference or “anchor” point for future purchases. The consumer typically views the highest priced variant as the “anchor.” Therefore, store brands price their items about 15% lower than the most expensive item.
Quantity suggestive pricing involves selling multiples for an appealing price, like 2 for $5 or 5 for $5. This encourages the consumer to spend more than they would otherwise purchase.
Stuffing the bundle is a product pricing strategy conveys a greater value by including “extras” or bonuses. Items sold on television are notorious for using this method – “But wait! When you buy one rake, you’ll get a second rake free! And we’ll toss in a free pair of gardening gloves!” In the early years of the automotive industry, car manufacturers had the option of dropping their prices as they realized efficiency of manufacturing volumes, or maintaining their process by adding more features and options. They chose the latter strategy. Another more subtle form is absorbing more of the total solution. If a product is a portion of the total solution needed by the customer, consider adding features that solve more or all of the problem.
Bargain pricing strategy uses banners and signs to indicate how much the consumer will save when they make a purchase of an item that’s discounted or during a sale.
Penetration pricing strategy uses an “introductory” price to pull in customers; once they’re hooked, the price can be raised. The “introductory offer” makes consumers more apt to buy because they feel like they’re getting a deal, but they must act now in order to save. This product pricing strategy is often used to launch a new product.
Price skimming involves using a high price initially and over time, the price can be lowered. This is often used in cases where it’s a new product niche and there are no competitors. “Early adopter” consumers are most apt to purchase just so they can have the newest, coolest items.
Dynamic pricing involves selling the same item at different prices to different consumer groups. This method is usually utilized online. The hotel niche is an example of an area where this strategy is often utilized. On average, a hotel room is priced 22 different ways. Dynamic pricing also has a geographical component, whereby the price is tailored to the precise economy of a region.
Loss leader pricing strategy is a short-term pricing strategy whereby you sell an item at below cost in order to pull in new customers. It’s often paired with up-sells.
Price matching involves matching a competitor’s price and taking a slight cut in profit in order to close the sale.
Placement pricing involves competition among suppliers, who price products in a competitive manner in order to get their items displayed in the shop’s prime real estate, such as at eye-level, on end caps or near the checkout.
Image pricing involves selling the same item (branded in two unique ways) at two different price points, so you appeal to a broader range of customers.
Time pricing involves altering the price according to when a product is purchased or when a service is rendered. Primetime pricing is more expensive, whereas off-peak pricing is less expensive.
Product line pricing involves selling similar items and/or accessories at several price points to appeal to a broader range of consumers.
Optional feature pricing involves selling a bare bones base model, then you perform an up-sell to include add-ons, upgrades and accessories for an additional fee.
Membership pricing involves charging an initial up-front fee, paired with discounts on future purchases. BJ’s Wholesale Club and Costco are examples of retailers that use this pricing strategy.
Discount pricing is another common strategy. There are quantity discounts whereby you purchase more than you normally would to get a better price; there are new customer discounts; cash discounts are used when you spend cash instead of using credit or check; promotional discounts; and rebate discounts, where only a portion of the consumers will actually return the rebate form within the required timeframe.
Two of the biggest obstacles to a customer making a purchasing decision is price and time. Companies combat a customer’s tendency to procraste with limited offers, either time limited or quantity limited. Pricing is a sticky subject and is often best determined through experimenting with several different schemes. For start-ups, a radically different pricing scheme from the industry norm may be needed to gain traction in the market. Start-ups should consider “borrowing” strategies from other industry. Consider the transition from perpetual licensing schemes for software to term licensing, or buying a car to long-term leases on cars,
Finding the right product pricing strategy requires identifying your objectives as a company, your target audience and the pricing methods that will resonate with that target audience. But the above-mentioned approaches will serve as a nice starting point for anyone who’s looking for guidance on how to price products or services.
Filed under: Business Models