Your business can make a product or service accessible to more customers by offering it at a lower price. However, your business cannot maximize shareholders’ value and profits without offering the product or service at a higher price. Hence, you need to implement a tiered pricing strategy that maintains a balance between increasing demand for the product or service and maximizing the shareholders’ value or profits. While analyzing different types of pricing strategies, you must consider key factors like cost of production, the organization’s revenue goals, prices of competing products, price elasticity, brand positioning, and prevailing economic trends. You can consider various types of pricing strategies to determine the best price for a product or service.
But you must remember that the pricing strategies in marketing focus on a specific aspect like production cost or competition. Your pricing strategy must combine multiple types of pricing strategies to set a price that increases both sales revenue and profit without impacting the demand for your product or services. That is why; you must consider and evaluate some of the widely used pricing strategies.
14 Types of Pricing Strategies in Marketing You Must Consider to Set the Best Price for a Product or Service
1) Competition-Based Pricing
As its name suggests, the pricing model only considers the going rate or market rate for a product or service. You can easily increase demand for the product or service based on the prices set by competitors. You have the option to set the price the same, above, or below the price set by competitors. But you should not forget that the completion-based pricing model does not consider important factors like consumer demand and cost of production.
2) Cost-Plus Pricing
The pricing strategy emphasizes on determining the price of a physical product based on its production cost. You need to add profit as a fixed percentage of the product cost. Hence, you can increase shareholders’ value by increasing the profit margin. You must not consider the pricing model while determining the prices for services and digital solutions. Also, the approach ignores key factors like competitors’ prices and consumers’ demands. Here is a quick guide on cost-plus pricing and when to use it.
3) Dynamic Pricing
The flexible pricing model focuses on changing the price of a product or service from time to time based on changing market trends and consumer demands. Many businesses these days use analytics and algorithms to determine the price of a product or service based on real-time information like current demand, competitors’ pricing, and market trends. You can use AI-driven software solutions to keep the price of a product or service dynamic according to current demand and prevailing rate.
4) Freemium Pricing
The companies providing software services and solutions often opt for freemium pricing. As its name indicates, the freemium pricing model allows customers to download and access a basic version of the product for free. But the customer needs to upgrade to avail advanced and new features of the digital product. You can leverage the pricing model to persuade the users to upgrade after gaining their trust. Also, the pricing strategy allows you to increase the price regularly by adding new features and offering more benefits.
5) High-Low Pricing
The pricing strategy focuses on driving sales of a product by offering discounts. When you adopt the high-low pricing strategy, you can set the price of the product high initially. But you have to give attractive discounts on the initial price when the demand for the product starts declining. Many retailers these days adopt a high-low pricing model to boost the sale of seasonal products and existing stock. They even organize big discount days regularly to sell the products at discounted prices.
6) Hourly Pricing
The pricing model is suitable only for professional and business services. Many lawyers, consultants, freelancers, and contractors these days charge clients at hourly rates. The clients can leverage the pricing to pay for the duration of services availed by them. However, the pricing model considers only efforts and does not consider efficiency. Many professionals have to increase the hourly price to earn more by leveraging their experience and expertise.
7) Skimming Pricing
You can adapt the skimming pricing strategy to offer innovative and fresh products to customers at higher prices. But you need to reduce the price of the product gradually as the consumer demand declines. Many companies adopt this pricing model to increase profits by offering new models of devices and gadgets at higher prices. You must remember that the pricing model often impacts the reputation of a brand adversely as the existing customers recognize the additional and fake pricing margin.
8) Penetration Pricing
Many businesses adopt the penetration pricing strategy to acquire more customers for a new product or service. They allow customers to avail the product or service initially by paying lower prices. However, businesses increase the price of the product or service as consumer demand surges. New businesses and startups often opt for the pricing model to acquire customers by beating the competition. However, established businesses avoid the penetration pricing model to prevent revenue loss in the long run.
9) Premium Pricing
Many businesses adopt this pricing strategy to set a higher price for a product or service by marketing it as luxury, premium, exclusive, rare, or high-value. They promote the product or service by targeting potential customers who are willing to pay more to boost their status without considering the actual cost of a product. However, you can leverage the pricing model to drive sales only after establishing your business as a brand that launches products or offers services that provide both value and prestige to customers. However, the new businesses cannot adopt the premium pricing strategy to persuade prospects to pay more.
10) Project-Based Pricing
Unlike hourly pricing strategy, project-based pricing strategy makes the client pay for a project or assignment regardless of the time and effort put in by a professional. Many freelance professionals and business service providers these days adopt project-based pricing strategies to charge a flat fee for the entire project. The pricing model allows professionals to increase prices according to the complexity, value, and requirements of individual projects.
11) Value-Based Pricing
The pricing strategy considers what the customers are ready to pay for a product or service. Businesses use advanced analytics to understand the needs, expectations, and buying habits of customers based on real-time data collected from various sources. The actionable data help decision-makers to set a price that customers are ready to pay. Some businesses adopt the value-based pricing strategy to offer the same product or service to different customers at different prices. The pricing models help businesses to meet customer expectations and promote customer loyalty.
12) Bundle Pricing
You can adopt the bundle pricing model when you are offering complimentary products as a bundle. You can allow customers to buy a specific product individually or as a component of the bundle. However, the customer can save money by buying the product as a component of the bundle. The pricing strategy helps you to increase sales revenue by selling multiple products simultaneously as a bundle. Also, you can easily create a customer base for complementary products.
13) Psychological Pricing
The pricing strategy makes you target customers’ psychology while setting the price for a product or service. Businesses target the psychology of customers in a variety of ways while setting the price. Some companies make customers feel that they are availing of a deal by setting the price of a product at $9.99 instead of $10. At the same time, many businesses persuade customers to buy an expensive product by offering discounts while they place an order for a less expensive product. The real-time data collected through analytics helps you to finetune the psychological pricing strategy by changing key aspects of the pricing information – font, color, and size.
14) Geographic Pricing
The pricing strategy allows you to set multiple prices for a single product according to the targeted market or geographic location. Many multinational companies adopt the geographic pricing strategy to sell the same product at higher prices in high-income countries. They reduce the prices of the product while launching in middle-income or low-income countries. You can opt for this pricing model to make your product accessible to customers across geographic locations according to their ability to pay.
Creating a well-planned pricing strategy is as important as creating a sales or marketing strategy. While determining the price of a product or service, you can consider different types of pricing strategies. But you must remember the pricing strategies complement each other. Your pricing strategy must combine multiple pricing strategies to increase sales and profits while keeping the product accessible to more customers.
This blog was republished in May 2024.
While launching a new product, your business has the option to choose from many pricing strategies. Unlike other product pricing strategies, the price skimming strategy emphasizes maximizing revenue and profits in the short run by setting the initial price of the new product high. You have to lower prices gradually as the demand for the product declines.
According to Investopedia,
“Price skimming is a product pricing strategy by which a firm charges the highest initial price that customers will pay and then lowers it over time. As the demand of the first customers is satisfied and competition enters the market, the firm lowers the price to attract another, a more price-sensitive segment of the population.”
Multinational tech companies like Apple implement price skimming strategy successfully to generate more revenue when the demand for the tech product is extremely high. But your business should consider price skimming only when your brand is well-established, the product is unique, and the competition is limited. You must keep in mind the major advantages and disadvantages of the price skimming strategy to capture the high demand for the product.
Major Advantages of Price Skimming Strategy
Earn Profits Consistently
Many tech companies leverage price skimming to maximize profits in the short run by setting high prices. Also, the strategy helps them to earn recurring revenue and profit in the long run by selling the product to more customers at lower prices over a period of time. Hence, your business can consider price skimming to keep up profits in the long run.
Quick Return on Investment (ROI)
Tech companies incur research and development (R&D) expenditure to develop and launch unique products. Also, they promote the newly launched product aggressively to boost demand. Price skimming strategies help businesses recover the investment in R&D and promotion costs by generating higher profits in the short run. Also, the product pricing strategy helps enterprises to make R&D an ongoing process.
Target Different Customer Segments
The price skimming strategy divides your customers into two broad segments – early adopters and price sensitive. While launching the new product, your promotional and marketing campaigns can target early adopters who are willing to pay higher prices. But the price-sensitive customers can buy the same product subsequently as its price drops. Your business can adopt this product pricing strategy to target different segments of customers.
Make Early Adopters Promote the Product
The early adopters help your business to improve both quality and experience by acting as testers. Their feedback and suggestions will help you to improve and update the product consistently. At the same time, early adopters help tech companies to increase the demand for the product in the long run through word-of-mouth promotion. Your company can further use customer reviews and testimonials as a powerful marketing tool while offering the product to price-sensitive customers.
Position the Product as a Premium Brand
According to Entrepreneur.com,
“Price sends a psychological message related to value: things that cost more are assumed to be of higher value. Things that cost less are assumed to be of lower value.”
Your business can position and promote the newly-launched product as a premium brand simply by increasing the initial price. Unlike other product pricing strategies, price skimming emphasizes setting the initial product price high. Hence, you can create a higher-end brand image without running expensive marketing campaigns.
Analyze Market Behaviour
After implementing the price skimming strategy, you can monitor and compare the changes in the demand of the product as the follow-up prices drop. You can further analyze the market behavior elaborately by dividing the customer base into multiple segments and timing price reduction. Hence, you can easily identify the price that maximizes the demand for the product. The demand analysis will be of great help to your business while determining the prices of other products in the future.
Manage and Control Inventory Efficiently
Often businesses have to produce a certain number of units to recover production costs. But demand for and popularity of the new product may not remain intact due to a variety of reasons. Price skimming strategy helps your business to manage and control inventory efficiently by driving sales by reducing product prices. You can reduce the warehouse inventory levels simply by reducing the product price.
Important Disadvantages of Price Skimming Strategy
Not Suitable for Crowded Markets
Tech companies leverage price skimming strategy successfully by making product innovation an ongoing process. They invest in R&D to develop unique products that can be sold at higher prices. But you cannot leverage price skimming if customers have the option to choose from similar products offered by many companies. Your business should consider a price skimming strategy when the competition is limited and demand for the product is inelastic.
Higher Profit Only in the Short Run
As mentioned earlier, the price skimming strategy increases profits by leveraging product innovation and limited competition. The demand for your product will decrease gradually as competitors offer similar products at lower prices. Hence, you cannot increase revenue and profits in long run among heavy competition.
Must Meet High Customer Expectations
The customers always expect flawless quality and an excellent experience when they pay a higher price for a new product. Many customers will start posting negative reviews and comments when your product does not meet their high expectations. Hence, the price skimming strategy will impact both your brand and product adversely in case the customer expectations are not met.
Can’t Reduce Price Significantly
The effectiveness of a price skimming strategy directly depends on your follow-up pricing strategy. You cannot beat the competition by decreasing the price of the product drastically. A huge drop in the product price will make early buyers feel like being cheated and deceived by your company. Hence, you have to decrease the follow-up prices gradually to sustain customer loyalty despite an increase in competition.
Your business can increase both revenue and profit in the short run by implementing a price skimming strategy. But you must remember that price skimming, like other product pricing strategies, has its pros and cons. Hence, you must understand the advantages and disadvantages of the price skimming strategy to boosts the initial demand for your product.
While determining the price of a product, the decision-makers evaluate the pros and cons of several pricing strategies. Some decision-makers opt for the penetration pricing strategy to create demand and acquire a market share of offering the product or service at a lower price. At the same time, some decision-makers opt for premium pricing/prestige pricing/image pricing strategy to drive sales by offering higher prices for a product or service than the competitors.
What is Premium Pricing Strategy?
Unlike other pricing strategies, the premium pricing strategy emphasizes on setting the price of a product or service higher than the competitors. The higher price will boost the demand for the product or service by targeting the customers who expect superior quality and experience. Hence, the premium pricing strategy emphasizes on creating and boosting the demand for a product by creating the perceptions of higher-quality and superior experience.
According to EconomicsHelp.org,
“Premium pricing is a marketing tool to set higher prices for certain goods in the hope that the higher price will give the impression the good is of a higher quality. Premium pricing may be applied to similar goods, where there is a slight increase in quality.”
Have Companies and Brands Implemented Premium Pricing Strategy Successfully?
Many multinational tech and non-tech enterprises have been increasing revenue and profits by implementing a premium pricing strategy successfully.
For instance, Apple has been increasing its global revenue consistently by offering different models of iPhone and iPad at a higher price than leading Android device manufacturers.
According to the Hindustan Times,
“The Bill of Materials for iPhone 12 comes to $373, while the prices of iPhone 12 models start from $699.”
Similarly, many oil marketing companies offer premium unleaded petrol at a higher price than the price of regular unleaded petrol. Many consumers buy premium unleaded petrol at a higher price with the expectations to keep the engine clean and deliver the higher speed. Also, popular designer brands and luxury brands offer designer clothes at a higher price with the intention to make the clothes appear luxury goods.
What are the Major Advantages of Premium Pricing Strategy?
Generate More Revenue and Profits
When a company set a higher price for a product or service, it can generate more revenue. Also, the increase in the selling price will help the business to obtain higher profits. A business can further leverage the pricing strategy to increase the profit margin without increasing the number of units sold.
Improve Brand Value
As mentioned earlier, the business has to create the perception of superior quality and experience while adopting image pricing strategy. The premium price-tag will help the business to improve both brand value and perception. The improved brand value makes it easier for businesses to offer new products and services at higher prices in future.
Restrict Entry Barriers for Competitors
Many companies have already acquired market share by adopting a premium pricing strategy. The competitors often find it difficult to launch equivalent products that deliver superior quality or experience. Hence, the premium pricing strategy helps businesses to restrict entry barriers for competitors.
What are the Important Disadvantages of Premium Pricing Strategy?
Overreliance of Unique Selling Price (USP)
Many consumers evaluate the product or service elaborately despite willing to pay a higher price. A business can convince the potential customers to purchase only when the higher price tag justifies the product’s USP. The businesses must create a competitive edge before persuading customers to pay a premium.
Difficult to Create a Mass Market
A business cannot create a mass market for a product by adopting the prestige pricing strategy. The pricing strategy will create demand and acquire market share over a period of time. Also, the higher price-tag will not boost the sale of a product or service in the mass market. This shortcoming will create opportunities for competitors to sell alternative products in the mass market.
Huge Marketing and Advertisement Cost
The leading brands and large companies leverage the premium pricing strategy by promoting and advertising their products or services aggressively. The expensive ad campaigns help them to create the perception the product is of superior-quality or delivering a superior experience. Small businesses often lack the budget to spend millions of dollars on marketing and advertisement every year.
When Should Businesses Consider Adopting Premium Pricing Strategy?
Unlike other pricing strategies, the premium pricing strategy relies on two important factors – the company’s reputation and consumer’s perception. The consumers will pay more to avail of a product or service only when it has a competitive edge. A business can generate more revenue by adopting a premium pricing strategy only when it is offering a unique product/service, or its product/ service has a competitive advantage.
But businesses often find it challenging to increase demand for and boost sales of a new product or service while offering it at a higher price. Often companies adopt a premium pricing strategy only after creating demand, establishing brand loyalty, and developing a strong customer base. Also, they promote the product or service aggressively by telling compelling brand stories to convince customers to buy the product or service by paying a premium.
Like other pricing strategies, premium pricing strategy or prestige pricing strategy has its own pros and cons. While adopting a premium pricing strategy, the decision-makers must conduct elaborate market research to check if the consumers are ready to pay a premium. Also, they must make the product or service warrant a higher price by enhancing the competitive edge.
Before launching a new product or service, the businesses use a variety of pricing strategies and methods to determine its selling price. Some pricing strategies focus on recovering the cost of production, while others help businesses to generate more revenue and profits. Unlike other pricing strategies, penetration pricing strategy helps businesses to penetrate a new product or service into the competitive market.
What is Penetration Pricing?
While adopting the penetration strategy, businesses offer a new product or service to the customers at a lower price during the initial release period. The low price makes a larger number of customers avail of the product or service. At the same time, many customers switch from competitors to the new product r service to save money.
According to Investopedia,
“Penetration pricing is a marketing strategy used by businesses to attract customers to a new product or service by offering a lower price during its initial offering. The lower price helps a new product or service penetrating the market and attracting customers away from competitors.”
Your business should adopt a penetration pricing strategy to create demand for a new product or service in a short amount of time. In addition to making more customers aware of your product or service, the pricing strategy will make customer switch from competitors. But you must remember that penetration pricing, like other pricing strategies, has its own advantages and disadvantages.
What are the Major Advantages of Penetration Pricing Strategy?
Make Customers Aware and Interested
Unlike other pricing strategies, penetration pricing is effective in making more customers aware of the new product and driving the sale of the new product. The lower price will make customers switch from competitors and promote the product or service through word of mouth.
Beat Competition
Often businesses find it challenging to promote and sale a new product or service by beating the competition. Penetration pricing strategy helps businesses to create demand for and drive the sale of the new product by beating the competition. The lower price of the product will make many customers buy the new product as well as switch from competitors.
Promote Brand Loyalty
While launching a new product or service, businesses have to invest huge resources to create a popular brand and promote brand loyalty. They can adopt a penetration pricing strategy to make more customers buy the new product. The surge in sales helps businesses to promote brand loyalty by offering superior quality, value, or experience.
Curtail Production Cost
A business can easily boost the sale of a product or service by adopting penetration pricing. The surge in demand and sale of the product will help the business to curtail overheads by scaling up production. The economies of scale help businesses to avoid increasing the price of the product or service after the initial launch period.
Acquire Market Share
A business can easily disrupt the marketplace by offering products or services at a lower price. The competitors will need some time to reduce the price of their products. Hence, a business can easily acquire and increase market share by offering products or services initially at a lower price.
What are the Important Disadvantages of Penetration Pricing Strategy?
Difficult to Meet Customer Expectations
Penetration pricing strategy makes businesses to increase the price of the product or service after the initial launch period. The increase in price will affect the sale of the product directly. The customers will expect your business to offer the product or service at the same price. Also, the increase in price will make many customers switch to competitors.
Negative Brand Perception
According to Entrepreneur.com,
“Whether customers perceive a product as “cheap” or “affordable” is crucial to its success in the marketplace. But if companies think they lack control of this perception, well, they are simply wrong.”
Often customers associate the lower price of a product or service to poor quality. Hence, businesses cannot drive the sale of luxury or premium items by adopting a penetration pricing strategy.
Chances of Starting a Price War
There were many instances when a price war was started as a company reduced the price of a product or service in a competitive marketplace. There are always chances that your competitors will offer the product as a price lower than yours. Hence, a business must prepare itself to fight a price war while adopting a penetration pricing method.
When Should a Business Adopt Penetration Pricing Strategy?
While adopting the penetration pricing method, you must evaluate the pros and cons of this pricing strategy. In addition to boosting the sale of the product or service during the initial launch period, your business must keep in place a strategy to sustain the demand and sale in the long run. That is why; you must consider a slew of factors while adopting a penetration pricing model.
- The demand for and sale of a product is directly driven by its price
- Your business can curtail production cost by achieving economies of scale
- The product will be produced and launched in a mass-market where there is adequate demand
- Your business is ready to face competition and fight price wars after launching a new product
- When there is product standardization instead of product differentiation
Penetration pricing strategy helps your business to boost the sale of a new product or service during the initial release period. The lower price helps the product or service penetrate the competitive market. But there are always chances that the customers will switch to a competitor as the price of the product or service increases after the initial release period. You must consider integrating penetration pricing with other pricing strategies to drive sales and promote brand loyalty in the longer run.
While determining the price of a product or service, you can consider several types of pricing strategies. Some pricing strategies help you to increase the demand for the product or service, while others make it easier for you to generate more profit. Unlike other pricing strategies, cost-plus pricing or markup pricing helps you to generate profit as a fixed percentage on the cost of production of a unit of product.
Wikipedia defines cost-plus pricing or markup pricing as “a pricing strategy in which the selling price is determined by adding a specific markup to a product’s unit cost.”
Three Important Steps in Cost-Plus Pricing Strategy
Cost-plus pricing is one of the simple and straightforward pricing strategies. You can use a cost-plus pricing model to set the selling price of a product in three simple steps.
Step 1: Determine the production cost per unit.
You have to start by determining the cost of production by adding materials, labour, direct expenses, and overheads. You can divide the total cost of production by the total units of the product to determine production cost per unit.
Step 2: Determine the profit margin or markup.
You need to determine the amount of profit you want to earn by selling a single unit of the product. Often businesses calculate the profit margin as a percentage of the production cost per unit.
Step 3: Determine the Product’s Selling Price.
Finally, you have to determine the selling price of each unit of the product by adding the production cost per unit with the profit margin or markup.
Cost-Plus Pricing Formula and Example
The cost-based pricing strategy enables you to determine the selling price of a product using the simple formula: Cost per Unit ((1 + the Markup Amount). We can describe the formula more clearly using the following example.
Let’s assume your business has to incur Rs 1000 as material cost, Rs 800 as labour cost, and Rs 200 as overheads cost to produce a single unit. Also, your business wants to set the markup or profit margin at 50%.
Material Cost: Rs 1000
Labour Cost: Rs 800
Overheads Cost: Rs 200
Cost per Unit Rs 2000
Markup: 50% or .50
Selling Price: Rs 2000 (1+.50) = Rs 2000 * 1.5 = Rs 3000
Your business can earn a 50% profit by selling a single unit of the product at Rs 3000.
Strategic Advances of Cost-Plus Pricing Strategy
One of the Simplest Pricing Strategies
Some pricing strategies require you to consider a variety of factors while determining the selling price of a product. But the cost-plus pricing strategy requires you to determine the cost of production accurately. You can determine the selling price of a product simply by determining the cost of production and profit margin.
Justifies Increase in Selling Price
Sometimes buyers complain about a sudden or unexpected rise in the selling price of a product. Cost-plus pricing strategy makes it easier for your business to justify the increase in the selling price of a product due to the increase in the production cost. Also, your business can cover the rise in production cost by increasing the product’s selling price from time to time.
Ensures Consistent Rate of Return
Unlike other pricing strategies, cost-plus pricing focuses on the cost of production fully. Also, it allows your business to determine the markup as a percentage of the production cost. Hence, your business can get a consistent rate of return in the long run by adopting markup pricing strategy.
Major Drawbacks of Cost-Plus Pricing Strategy
Ignores Prices Set by Competitors
The cost-plus pricing strategy focuses only on the cost of production. It ignores the price set by competitors for similar products. Hence, your business may set the selling price of the product too high with the aim to increase profit. But the higher price will make it difficult for your business to increase the sale of the product.
Relies on Estimated Sales Figures
The pricing strategy assumes that all units of the product will be sold out. The demand for and sale of a product is influenced by a slew of factors. Hence, there are always chances that your business may not recover the cost of production fully by overestimating the sales figures. Also, your business may not generate more profit by setting a lower profit margin based on the overestimated sales figure.
Does not Emphasize on Reducing Production Cost
Most businesses these days explore ways to reduce production cost to beat the competition and boost demand. But cost-plus pricing strategy enables businesses to increase profit margin despite a rise in production cost. Hence, the pricing strategy will not encourage your managers to improve operational efficiency and curtail manufacturing overheads.
Suitability of Cost-Plus Pricing Strategy
Many retailers these days set selling price of different products using a cost-plus pricing model. The retail products differ from each other in terms of production cost. Hence, the retailers set different rates of markup on the production cost of a specific product. The pricing strategy further allows retailers to apply different markup percentages of various products.
Also, many companies impress customers by keeping the pricing strategy transparent. They adopt the cost-plus pricing model to convince that they are applying a lower markup percentage than the competitors. The transparency helps businesses to implement a strategy to popularize their brands and promote customer loyalty.
But your business cannot determine the price of a customized software solution or software-as-a-service (SaaS) product by adopting the pricing model. Because your software solution will help businesses to get higher returns by boosting operational efficiency and curtailing cost. It is always advisable to avoid markup pricing model to determine the price of digital products and solutions.
Your business can opt for cost-plus pricing strategy to get a consistent rate of return on the cost of production. But you must remember that markup pricing, like other pricing strategies, has its own advantages and shortcomings. Your business cannot use the pricing strategy to generate revenue and boost sales of all types of product. It is always important to keep in mind the pros and cons of cost-plus pricing while comparing various pricing strategies.
