The Ultimate Guide to Product Pricing

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When it comes to growing business, pricing is often neglected. People focus largely on user acquisition, partnership, and customer experience, but few know that pricing is a key driver for growth as well.

Pricing is the reflection of your business, it provides customer information on your brand value, cost structure, bargaining power, etc. After all, we live in a world driven by value. Good pricing will not only gain the trust of your customer but also increase your profit.

Read on to learn about the importance of pricing, and how to choose the pricing model that’s best for your business.

Outline
1. Why is pricing so important
2. How to choose your pricing strategy
3. Top pricing strategies
4. Find your best pricing strategy

Why is pricing so important

Pricing is the act of placing value on a business product or service. Setting the right prices for your products defines the success of your business.

According to the Harvard Business Review, a 1% increase in volume yield a 3.3% increase in operating profit. However, a 1% increase in price increases operating profit by 11.1%.

Although price and demand are largely correlated, the process of setting prices is not that simple. Lowering prices may not always increase your sales, sometimes it reduces sales and harms your brand. Similarly, a high price sends no message about product quality without proper branding.

Ultimately, every small-business owner must find and develop the right pricing strategy for their particular goals. The key is to understand what’s the unique advantage you have in your business and what affects your production process.

How to choose your pricing strategy

To have a perfect pricing strategy, you need to have a great understanding of your business.

The following questions may help you have a clear thought about how your business operates.

1. What is your cost
2. What is the current business environment
3. How is your bargaining power
4. What is the customer behavior
5. What is your expense
6. What is your incentive structure internally
7. What is your product line
8. What is your brand value
9. What is the level of competition
10. What is your commercial objective

What is your cost

What is the overall cost to bring your product to the market? Dig into every process in your business, and add up the cost to have the cost of goods sold of your product.

If you are selling directly to the customer, then the answer is quite straightforward.

If you have multiple distribution models or there are many players involved, spend time figuring out these things.

• Commission
• Terms
• Production time
• Transaction cost
• Refund/ return rate
• Inventory
• Shipping
• Tax

What is the current business environment

In the business environment when the inflation rate is high, it would be harmful to businesses if they don’t adjust prices accordingly.

Furthermore, price in the effect of supply shocks, such as no carrier for shipping during COVID-19, will ensure your long-term business stability.

Think about these factors that will affect your business.

• Inflation
• Exchange rate
• Fulfillment situation
• Geo-politics
• Policy

How is your bargaining power

Are you a great negotiator with your supplier? If you have great control of your supply chain, then lower prices to improve customer happiness might be a good strategy.

For example, Walmart uses the advantage of terms to provide the best price for their customer.

What is the customer behavior

Are your customers aware enough of the above-mentioned changes in business?

For example, customers are not happy when they are charged for shipping. However, after COVID-19, they are more accepting to pay for shipping since they know what’s going on in the supply chain.

Thinking about how your customer will react to price changes may help you find your best pricing strategy.

What is your expense

Are you spending lots of money on customer acquisition? Are you spending a lot on administrating process?

If your sales are mostly driven by advertisement, it will be brilliant to increase your Average Order Value (AOV) by implementing different pricing strategies such as bundling.

Moreover, you may take into account the potential policy change of your distribution platform (Apple’s privacy policy impact Facebook ads).

What is your incentive structure internally

Is there any incentive program related to your product price?

If your sales compensations are linked to product price, think about how to adjust prices without impacting the morale of your best salesman.

What is your product line

Is there more than one product in your business?

Make sure not to make your products compete with each other when you change your price.

For example, Apple once reduced the price of its flagship iPhone. After observing the decline of sales in iPhone SE, they decide to bring back the original price.

What is your brand value

If you are a prestigious brand like Chanel or Hermès, then lowering prices to increase sales might harm your brand.

Coca-cola once make the cola price related to the CPI level of each city, and it turned out to be a huge disaster.

Think about how you position your brand and you won’t make mistakes the same mistake.

What is the level of competition

Are you in a fierce market where people are playing price war?

Factoring in the level of competition can help you protect your business.

Airline companies can hardly reduce their price due to their cost. But making the seat bigger or providing better meals can also improve the competition.

What is your commercial objective

Are you in the stage of acquiring customers?

For some Saas companies, it might be great to acquire customers with lower prices and onboard users fastly. They might be profitable afterward due to the stickiness of their product. Amazon uses the cash flow from sales to build its fulfillment center and create huge advantages in years.

Think about what’s the goal for your business in the short-term and long-term, then choose a suitable pricing strategy.

Top pricing strategies

Once you’ve answered the above questions, you’ll want to find a pricing strategy. Here are some common strategies to get you started.

1. Value-based Pricing
2. Cost-plus Pricing
3. Competitive Pricing
4. Price Skimming
5. Penetration Pricing (Discount Pricing)
6. Loss Leader Pricing
7. Bundle Pricing
8. Anchor Pricing
9. Dynamic Pricing
10. Seasonal Pricing
11. Economy Pricing

Value-based Pricing

Value-based pricing means setting a price based on how much the customer believes a product or service is worth.

It is the most ideal pricing strategy for companies if they can clearly communicate their value to customers. An excellent example is the lensball.

However, not everyone can apply this strategy. Some requirements include:

1. Strong brand
2. In-demand product
3. Unique marketing strategies
4. Trust with customers
5. Great reputation and testimonials

This strategy is common in products that increase customers’ self-image. For example, Gucci and LV in the luxury industry, Avatar.ai in Saas, and NFT.

Pros:

• High profit margin
• Flexible to set

Cons:

• Hard to sustain without a strong brand
• No referring price point
• Perceive value is subjective

Cost-plus Pricing

Cost-plus pricing, also known as markup pricing, is the most simple way to determine the price of a product. To get the price, you add a fixed percentage (markup) on top of your product costs.

It’s mostly common in the retail industry, especially in physical products.

For example, if the costs of selling an e-bike are:

• Manufacture cost: $300
• Labor cost: $100
• Marketing cost: $200
• Shipping cost: $50

If you require a markup of 50%, then the price of the e-bike will be:

Cost ($650) x Markup (1+ 50%) = Selling price ($975)

Pros:

• Straightforward to calculate the price
• Easy to maintain profit margin

Cons:

• Ignore competition and brand value
• Less flexible

Competitive Pricing

Competitive pricing means pricing your products based on competitors’ prices. This strategy is used when the price is the only factor that drives customers to buy.

If you have an advantage in supply chain management and operation, this strategy might be for you.

Pros:

• Effective for companies that have abundant capital or supply chain advantage

Cons:

• Not sustainable for small companies
• Usually result in low profit margins

Price Skimming

Price skimming means when an e-commerce business charges the highest initial price that customers will pay, then lowers it over time.

The goal is to drive more revenue while demand is high and competition is low.

Apple uses this pricing model to cover the costs of developing a new product and continue to build the cellphone network, like the iPhone series.

Skimming is useful when:

1. The market is in the initial stage with fewer competitors.
2. High profit margin won’t impact profitability that much after lowering price
3. The high price send message of being exclusive and high quality.

Pros:

• Great for prestigious brands to cook a huge product launch

Cons:

• Not suitable for crowded markets
• Require higher profit margin

Penetration Pricing (Discount Pricing)

Penetration pricing means giving customer discount prices for penetrating the market. The main purpose of this strategy is to drive traffic.

The strategy is suitable for brands with high customer loyalty, new companies that are entering the market, or special events.

Sass company often offers a really low price to onboard users and increases the price after users are used to their product.

Pros:

• Effective for getting customers or removing inventory

Cons:

• The product might be perceived as low quality
• Discounts might not be as effective if implemented too often

Loss Leader Pricing

Loss leader pricing is a marketing strategy that prices products lower than the cost to produce them in order to attract new customers or to sell additional products to customers.

Companies typically use loss leader pricing when they are entering new markets or attempting to increase market share. Furthermore, companies that have additional revenue streams on top of the product they sell might also use this strategy.

For example, Sony sells Playstation at a price that incurs losses in order to sell video games in the future.

Pros:

• Effective for increasing AOV

Cons:

• Costly to implement

Bundle Pricing

Bundle pricing is a strategy that combines similar or complementary products together and sells at a discount.

The purpose of bundle selling is to increase AOV. This strategy is suitable for companies that spend a lot on customer acquisition.

Pros:

• Increase AOV

Cons:

• Reduce profit margin

Anchor Pricing

Anchor pricing refers to the practice of establishing a price point that customers can refer to when making decisions.

For Saas companies, the strategy can be used to charge customers with different plans. Customers will tend to purchase the plan in the middle due to the anchoring effect.

E-commerce stores often use this strategy by labeling high compare-at-price next to the sales price.

Pros:

• Increase profit

Cons:

• Not useful for an unrealistic anchoring point

Dynamic Pricing

Dynamic pricing is the strategy that changes prices based on demand.

Amazon is known for using this strategy to promote its in-house brand.

This strategy relied on large data for making decisions. If implemented well, it can create a great customer experience.

Pros:

• Improve customer experience

Cons:

• Required massive amount of data
• Not suitable for subscription products

Seasonal Pricing

Seasonal pricing refers to adjusting product prices based on market demand. What’s different from Dynamic Pricing is the frequency of changing prices.

For seasonal pricing, the market demand changes are more predictable and less frequent.

For example, it’s traditional for e-commerce brands to have discounts in BFCM (Black Friday & Cyber Monday). Seasonal pricing can also be applied when there are seasonal supply fluctuations.

Pros:

• Stabilize revenue across months
• Increase revenue based on market demand

Cons:

• Discount is not effective for an inflated price (Raise the price and discount)

Economy Pricing

Economy pricing refers to charging a price that is close to production cost.

It is often used by commodity businesses that have huge volumes. The business model relies on selling a lot of products to new customers on a consistent basis.

Pros:

• Easy to implement

Cons:

• Typically has a lower margin

Find your best pricing strategy

Pricing is more art than science, and there’s never a black-and-white approach to setting an effective pricing strategy. Entrepreneurs have to do their homework and make decisions in systematic ways.

Now that you’re equipped with knowledge for doing your own research. If you are a Shopify merchant and are looking for a tool to test your price, ABConvert is for you. Apply the knowledge in this article and create price tests in seconds.

I hope this article is helpful for you and wish you all the best in your business journey.