Let’s be honest, the primary objective of sales is to make money for your business. But sales without smart pricing is risky at best, and costly at worst. In my time coaching businesses in industries from wholesale, manufacturing and trades to professional services, I’ve seen it all. As I learned early on in my career, ‘anyone can sell a dollar for fifty cents’. This truth has stuck with me ever since.
Creating the right price for your product or service is about so much more than making money.
Taking the time to get your pricing right is a powerful yet under-utilised growth lever. But many businesses that are looking to grow set their pricing without much thought. This crucial mistake sees them leave money on the table from the beginning.
There is a fine line between working for free and being greedy but when the price is right, you create a strong foundation for your business. As a business coach, I’ve seen many businesses race to the bottom with cheap pricing. When you price yourself too low, you run the risk of not generating the revenue needed to cover expenses. Conversely, when you price too high, your prospective customers may look elsewhere in search of better value.
Whatever your business goals, a smart pricing strategy reflects your business identity and ensures that your business can keep growing sustainably. In this guide to pricing strategies, I explain pricing strategies every business should know about. I also explain the right strategy for the stage of growth your business is in.
What are pricing strategies?
Pricing strategies refer to the methodology a business uses to set prices for their products/services. Some of the more common pricing strategies include:
- Cost-plus pricing – Take the cost of creating your product and add a certain percentage to it. Many trade-based businesses running in Australia use this strategy.
- Value-based pricing – Set your prices according to what your prospective customers think your product is worth. Think HelloFresh – the world’s largest meal kit provider.
- Competitive pricing – Set your prices based on what the competition is charging. Think Netflix vs Amazon Prime vs Disney+.
- Dynamic pricing – Change your prices to match the current demand for the item. Think Uber surge pricing from Melbourne Airport at 5.30pm on a Friday.
- Bundle Pricing – Sell products and services at a package price that is lower than the price of buying all the items individually. Think Telstra vs Optus vs iiNet telephone/internet bundling.
- Price skimming – Set your prices as high as the market will possibly tolerate and then lower them over time. Think ‘First to market’ offerings like Salesforce.
- Penetration pricing – Set your prices by offering rates that are much lower than the competition. Think ‘Dollar Shave Club’ or ‘Dinnerly’ (the budget offering from Marley Spoon).
The most frequently used pricing models are: cost-plus, value-based, competitive, bundle and dynamic pricing. The other models that are used less often are price skimming and penetration pricing.
Do not compete on price alone
Competing on price alone obscures the value of your offering. It encourages customers to see your product or service as a commodity – something easily bought off the shelf from any seller. I coach my business clients to understand that there will always be larger competitors with lower operating costs that may enter your segment and destroy any business attempting to compete using a low-price strategy.
The businesses I coach avoid this risk by doing some basic analysis. I advise my business coaching clients to research the market and analyse the highest price the market will bear. We look at the whole value of what competitors are offering, so we can see where our offering sits in comparison. For more advanced businesses, I coach them to analyse how much the demand of a product/service changes when the price changes and all other factors remain unchanged.
The purpose of this research is to take the pulse of the market and to identify the opportunities and the landmines for pricing strategies.
Avoiding a Price War
A price war is when competitors continually lower their prices to undercut one another to gain business/market share, this almost never works out in a favour of small business however the following steps should be followed to mitigate the chances.
- Build brand recognition of your business and build in a resilience to price changes.
- Find/add in unique value/offerings which your business can advertise to stand out in the marketplace.
- Evaluating your competitors can identify their weaknesses. You can increase the perceived value of your own products by offering an alternative to competitor products not focussing on price.
- Provide products/services that are exclusive to your business to ensure further protection from falling prices.
- Price matching forces consumers to make informed purchase decisions rather than purchase items based on the lowest price.
- Competing businesses lose their profit margins when they offer more for the same price and therefore can avoid this by reviewing their products/services for appropriateness and re-branding when necessary.
- Often price wars are started due to misreading competitors’ actions or intentions. The result is often a downward spiral in prices that ruins profitability. Critically evaluate your competitors’ actions before reacting.
- Businesses can also respond by developing multiple strategies like renegotiating contracts to reduce lock-in periods where customers are contractually bound.
How To Choose the Right Pricing Strategy for Your Business
Define your business goals
Your business goals are a massive determinant on your pricing strategy. Goals like ‘Increase market share from 32% to 40%’ or ‘Provide employment opportunities for females over 40 or disaffected youth’ will affect how pinpointed your strategy has to be.
Research the market
Data driven market research is an important step in planning your pricing strategy. Deep dive into your market specifically to know what products/services are out there already, what makes your competitors’ products/services good or bad and why yours is a better solution than those ones. Whether yours is a premium product or a low-cost alternative, competitor pricing will help guide your decision making.
Segment customers and analyse them
You are more likely to see a Carlton Draught ad than Baby Bunting ad while watching AFL or NRL. Just like sports broadcasters know their audience, you too must learn about your target market. Define how your product improves your customer’s lives (or creates value for your customers) and use that to come up with your brand positioning.
Watch your competitors
Establish your top three competitors and then learn how they price their products/services.
One of the cheapest and easiest ways I coach my business clients to get some research is by a simple Google search for your product/service in your area. I also advise my clients to ask their prospective customers where they are currently buying from. You can also ask your suppliers who else purchases from them.
Find out whether your competitors make more by bundling multiple products or services together or structure their business with multiple price points to purchase at. You might not price exactly like they do, but you can see examples of what works (and what does not work!) in your industry.
The Rule of Three
Studies have found that giving a customer only 2 price options to choose from will automatically find the customer going for the cheapest option. However, as you would have seen in most restaurants, giving customers a range of 3 price options will generally see them purchase something middle of the range as nobody wants to be seen as cheap.
In trade-based business however, carefully wording your options will play a powerful part in your customer’s choice. Nobody wants “good” or “budget”; most will want “better” or “upgraded”, and you will also find some customers interested in “best” or “premium”!
Create your pricing strategy plan
As I have established, there are many pricing strategies to choose from and you also have the option of mixing and matching.
To get some money coming in, I often coach my clients with newer businesses to use penetration pricing to help their business get a foothold and draw attention away from the competition.
Then once a customer base has been established, we start to move those prices up to competitive pricing (to meet the market).
Then add on bundle pricing to make customers feel like they are getting extra value. Similar to bars bundling discounted food with premium beers or painting companies that do the painting in the first instance with trailing 5 – 10 year maintenance contracts.
Then, move to value-based pricing once you have established your reputation or you are offering additional services and have differentiated yourself from the competition.
If you create market research habits early on in your journey as a business manager, you will have greater foresight when setting prices for your products or services. When I’m mentoring business owners on pricing, I coach them to have the ability to adjust pricing when necessary.
Research will help you avoid taking a problematically low price-position in the market and will provide valuable insights into how your future customers will spend their money – according to the Australian Bureau of Statistics, 13% of businesses ‘changed product/service options and 11% of businesses ‘increased product/service pricing’.
(Read more about it here: https://www.abs.gov.au/statistics/economy/business-indicators/business-conditions-and-sentiments/may-2021)
A smart pricing strategy during uncertain times can become a competitive advantage. By knowing what value your business delivers to its customers, it can price more confidently and not panic into slashing prices when it does not necessarily need to.
So, what is the right price for your product/service?
The right price for your product or service is the price that maximises your revenue AND keeps customers coming back. And that really depends on the type of business you are running.
A winning pricing strategy portrays value, convinces customers to buy and gives your customers confidence in your product or service. There is a reason why people relate cheaply priced products/services with cheaply made ones. Higher priced brands often give the perception that they are of higher value but if that price is more than your customer is willing to pay, it would not matter. A price too low will seem cheap and erode confidence in your offer. The ideal price is the sweet spot that convinces your customers in the value of your offer.
I advise my business coaching clients that value-based pricing is almost always the pick of the bunch. The value-based pricing model it is truly customer-centric and encourages narrowing down your customer base to segments and finding the sweet spot of those target segments you want to work in.
Companies that can differentiate and offer unique or highly valuable features in their products/services are better positioned to take advantage of the value pricing model than companies that chiefly sell commoditised items or sell on price.