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How much should I charge for my product or service? A common question many businesses struggle with at one point or another. Revenue is the lifeline of any business; it is the total value of all goods and services sold in a certain period. Since goods and services are sold either on a credit or cash basis, revenue is recognised when all benefits and risks of ownership are transferred from the seller to the buyer.
In this article, we discuss some pricing strategies a business can consider when deciding the selling price for its goods or services.
Cost-Plus Pricing
Cost-plus pricing charges a percentage surcharge to the cost of the product, and cost(s) here include both fixed and variable costs. The main advantage of this pricing method is that it guarantees a profit per sale, and to ensure this remains the case, there must be discipline in managing expenses against revenues. On the other hand, the main limitation of cost-plus pricing is that it does not consider the demand for the product or service.
Penetration (Market Share) Pricing
Market penetration pricing requires a business to charge a lower price than its competitors, even if it means forfeiting short-term profit for long-term gains in the form of market share. It is a good strategy for repeat purchase products, including those with a tying arrangement, like printers with proprietary inks. It is also great for products that require network effects; the product value increases as more people use it, e.g., social media apps. Penetration pricing is not recommended for one-off purchases or luxury products, as it would impact consumers' perceptions.
Sequential Skimming Pricing
This strategy is the direct opposite of penetration pricing. Here, prices are set high and subsequently reduced as new competitors enter the market. It is best for new and novel products and allows the pioneer to maximise profits over time. A skimming pricing strategy helps attract early adopters and segments customers by price sensitivity. A great case study for this strategy is Apple, which introduces new devices at high prices and then sells them at lower prices to price-sensitive customers when a more recent version is released.
Value-Based Pricing
Here, customer value determines price, and it can take different forms, such as use value (functional benefits), exchange value (how much people are willing to pay), reference value (the price of the best alternative), and differentiation value (difference between the product's use and the next alternative).
Neutral Market (Competitor Based) Pricing
To maintain market share in a competitive market, a business could lower prices in reaction to price cuts from a competitor, or it could provide more value to customers for the same price. If the customer has a disincentive to switch to the competitor, then it is easier to keep market share. For example, an Apple Music user who has invested time building their playlists would hesitate to migrate to another service.
Dynamic Pricing
Dynamic pricing is a sophisticated strategy commonly used by airline businesses. It is the practice of charging prices in real-time response to shifts in supply and demand. Have you ever wondered why your flight tickets get more expensive as the travel date gets closer? Airlines leverage dynamic pricing strategies like yield management to determine prices.
Consumers are prone to various biases regarding price and value; this impacts their buying decisions, and businesses can leverage these perceptions to design more attractive product offers in line with their pricing decisions. Some popular strategic offerings include;
Tiered Pricing (Versioning) - Creating different versions of a product/service could help shape customers' perception of utility. The difference must be noticeable and something the user considers valuable. As the Good-Better-Best Strategy suggests, it is better to offer three (3) or more versions of a product to cater for users with extreme aversion; they tend to avoid the most expensive option (too expensive) or the cheapest option (low quality), so they go for the safest option in the middle. This “safe” option should be the product/ service that gives the business the most margins, as it is expected to be the best-seller.
Bundling - Because versioning requires time and money, businesses can leverage bundling to increase revenue from customers willing to spend more. Bundling can come in the form of price bundling (combining a set of products for a relatively cheaper price), feature bundling (combining multiple functions in one product), pure bundling (making a complimentary product compulsory), or mixed bundling (allowing consumers to buy the products separately or in a set). The leverage effect here is to place the most preferred item in the bundle at the forefront; this helps elevate the perceived utility.
Subscription Pricing - This is still widely used in both online and physical products, and the main advantage of subscription pricing is that it maximises customer lifetime value. Subscription pricing groups multiple transactions into one payment. For example, a monthly buying decision can be “Yes” or “No”, but a slightly discounted annual subscription reduces the uncertainty in revenue and helps increase customer retention. It also helps the business with cash flow because upfront payments are worth more, more money is earned per transaction, and marketing and transaction costs per customer are lower.
Price Promotions (Discounts) - Businesses leverage temporary promotional discounts to increase demand, gain additional revenue, and acquire new customers who wouldn't otherwise buy the product. The advantage of price promotions is that new customers increase long-term revenue, and loyal existing customers purchase even more. On the other hand, discounts can hurt businesses if not managed properly. Customers may stockpile during discounts, competitors may also deploy a discount strategy, and if they are too frequent, they become less effective because buyers can easily anticipate them and pass on offers.
Business goals determine pricing strategies, and whatever they are, the ultimate goal of a pricing strategy is to maximise long-term profit. A pricing strategy must exploit the business's competitive advantage over others and steer away from its weaknesses.
Do you need guidance in finding the right price for your product or service? Schedule a FREE consultation with our expert(s)and take your product offering to the next level!
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