How to Choose a Pricing Strategy for your Small Business
A pricing strategy is a model that a business uses to value its goods and services. It is a part of marketing and sales strategy, and greatly influences the performance and success of a business’s products in the market.
Having a proper pricing strategy is the difference between increasing market share and slowly losing it. However, how do you choose a pricing strategy? And which different pricing strategies exist?
Different Types of Pricing
Let’s first start with the different types of pricing a product. Businesses adapt their pricing strategy depending on the goals that they want to achieve. So let’s have a look at some of the most common pricing strategies that small business owners use.
Skimming Pricing Strategy
Under this strategy, businesses set a high initial price for their goods, requiring fewer sales to break even. Skimming is commonly used to recover the cost of research and development that goes into creating a new product. Price skimming is very prevalent in the electronics industry, and a great example to look at would be the initial cost of mobile phones when they were first launched.
Mobile phones were sold at very high prices, and as new (often Asian) players entered the market and offered lower-cost phones, the prices went down. This strategy is highly targeted at the early adopters who usually have a low price sensitivity. Skimming pricing is time-limited and is used in conjunction with other pricing techniques such as penetration pricing.
Penetration Pricing Strategy
Penetration pricing is widely used by businesses when launching new products in the market to gain market share. The price is normally expected to increase over time. If you are entering a new market, this strategy is a great way to gain consumer attention. Theoretically, the low price of goods causes a higher demand in the market for your product. This is a vital pricing strategy that every small business owner should have in their playbook when breaking ground in a new market.
Freemium Pricing Strategy
Freemium is a pricing model where a part of a product or service is offered free of charge to consumers. This method is typically used in pricing Software as a Service (SaaS) products, games, and web services. The base product goes for free, but consumers are required to pay to gain access to more advanced features.
Fun fact: Freemium is a portmanteau, combining ‘free’ pricing and ‘premium’ pricing.
Psychological Pricing Strategy
Psychological pricing is a strategy that positively impacts a buyer’s purchase decision. For instance, a price for a commodity is set at $99 instead of $100. The consumer perceives the $99 price as ‘less’ than the $100, prompting them to buy the item.
According to behavioral economics, human beings are irrational and think more emotionally than logically. There isn’t a rational explanation for setting a price at $2.99 instead of $3.00, but it works. Irrational pricing appeals to the buyer’s emotional impulses and is an asset that small business owners can leverage.
Economy Pricing Strategy
Lastly, under economy pricing, businesses usually have relatively low advertising costs and marketing overhead, which allows them to charge meager prices for their products. Economy pricing enables small businesses to target mass markets and garner a high market share.
How to Choose the Best Pricing Strategy for Your Business
Having gone through the common types of pricing strategies that small businesses often employ, the next thing is to choose a strategy that suits your business and products. Market dynamics play out differently for individual enterprises, hence the need to have a model you can use to select the best strategy.
Here are five simple steps to determine the best pricing strategy for your business.
Determine What’s Important to You
Identifying and setting clear-cut goals for your business is the first step to choosing the right pricing strategy. What is more important for your business right now? Is it the value that your product delivers to the customer, the margin on each product, or the sales volume? And why is this important? Do you want to enter a new market, capture market share from your competitors, or simply increase your revenue?
The pricing strategy that you choose must align with the goal you want to achieve. For instance, if higher sales volume is the primary goal, you might want to go with economy or value pricing, which will help you sell more of your products at lower prices. This pricing strategy is prevalent for products with a short lifespan. Alternatively, if a higher profit margin is your primary business goal, then cost-plus pricing is the way to go. This strategy will ensure that you recover all your production costs plus a markup.
Determine Which Strategies Fit Best
Different price strategies are differently suited to various businesses. The underlying principle behind this is that business products are different, and so are consumers. What works in an American market might not work in a European market. Consequently, what works in one product line might not work in another product line.
If you operate in the luxury goods market, your pricing should match with the quality you’re offering, which means that premium pricing strategy is the best way to go. If you are in the fast goods industry, your pricing strategy should allow your products to move quickly to avoid wastage and expiry.
Different factors that play out to determine pricing strategy fit include:
- Your target market.
- Your consumer’s ability to spend.
- Your consumer’s sensitivity to price.
- The type of commodity you offer.
- Governmental controls.
Identify Your Strengths and Weaknesses
What is your unique selling point? The value you offer to your customers in the market will help you set your business apart. If you operate in an emerging industry, customers will be more willing to try out your product, and the correct pricing strategy will be essential.
In a mature industry, added value and consumer-friendly prices play a crucial role in increasing market share. This is because consumers and already existing businesses have solid relationships.
On the flipside, evaluating your weakness against your competitors is also helpful. For instance, you may have a low production capacity compared to your competitors; hence your volume may be lower. This means that you have to be very sensitive to your pricing. If you set a low price, you may attract a significant market share and not be able to meet your orders.
Try Out and Experiment With a Limited Set of Customers
Test out different pricing strategies extensively to arrive at an optimal model for your business. You can test different strategies using geographical and demographic differentiators. For instance, you can set different prices for the international market or different states to see how it plays out.
You can also combine different pricing strategies to come up with a pricing mix that serves your intended goals. For example, you can mix promotional pricing with version pricing. This will help you capture price-sensitive customers during the promotional period and introduce them to your regular pricing once their offer is over.
Implement What Works
The rule of thumb under this step is to repeat what gives you the results you’re seeking. After testing the different pricing strategies in the market, stick to what gives you the intended results. This will help you develop a consistent price for your products. Consistent pricing will make your customers happy and keep your business running.
However, don’t be afraid to shake things up a bit even after developing a consistent price. You may need to match up your prices to competitors in the future or change your prices due to changes in the economy.
Right Pricing Strategy for Your Business Is the Key to Success
Developing the right pricing strategy is essential to do well in your market. Your pricing strategy underscores the most significant potential for your business to either soar or to go down. Always remember that the right price is one that not only keeps your customers happy but also keeps your business on its feet. Learning to walk the fine line in pricing your products is not easy, and you may not get it right on the first try. But these five steps will bring you a long way. So take enough time, experiment, and don’t give up. With this mindset, you’ll surely find the right way to price your products.
Hey there! I’m Jochem, a tall Dutch freelancer, and entrepreneur. I founded Enter Network, an international community for entrepreneurs. I love talking to entrepreneurs — from small family-owned businesses to the next Amazon, and on my blog jochemgerritsen.com, I do exactly that! I write about entrepreneurship, running a business, and a variety of other topics relevant for company founders. In addition, I send out Unrestricted, a biweekly newsletter specifically made for curious entrepreneurs who want to learn and grow — both as a person and with their business.