A little history...
For centuries, goods were sold through auctions and barter systems based on the type of the product and their demand in the market. Products that were in high demand but were low in supply were sold through auctions, these include seasonal unique items, art, etc. And barter systems for more commonly traded goods, where the price of an item was negotiated between an individual buyer and seller.
The pricing system was replaced by the concept of fixed pricing (Posted prices) around the mid-19th century, though there is some discrepancy as to who exactly invented it. But it was sometime between 1845 - 1861, that along with the industrial revolution at its peak, having fixed prices became a necessity to increase the efficiency of the selling process.
However, efficiency doesn’t always guarantee the highest profits, Profits are maximized when each customer is charged according to their Willingness to Pay. And it took us more than a century to realize that the concept used by our forefathers is the best one but it needs to be more efficient.
With the help of technology, in the 1980s came the reshaped version of the barter system as Dynamic pricing. It was pioneered by the airline and tourism industries. In recent times, online retailers have also adopted dynamic pricing, with giants like Amazon leading the way.
Are you leaving money on the table?
Traditional ways of setting product pricing involve a lot of intuition (your own or your competitors'), and some mix of cost price + margin (that you think the customer is willing to pay for the value you add). And sometimes it does work! - but is that all the money or are you leaving some on the table?
Putting in the time and effort required to get your product pricing right and optimizing your pricing strategy, you’ll end with significantly more revenue than your competitors who treat pricing more passively.
Pricing of a product is not just the monetary value generated by it but an indication of multiple factors like how much you value your brand, your product, and your customers to your potential customers.
“If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business - Warren Buffet
It is one of the first things that can convert your potential customer to a customer or make them close the browser window altogether. As such, it is worth putting effort into setting the appropriate value. Let us look at some of the standard ways of doing it -
Pricing strategies
There are different pricing strategies to choose from based on what works best for your business, some of the common ones are
Cost-plus Pricing
Competitive Pricing
Value-based Pricing
Penetration Pricing
Price skimming
Dynamic Pricing
Pricing strategies are more efficient growth levers than acquisition strategies. It is the untapped growth potential of your business, it can be up to 7x more powerful than acquisitions.
Among Fortune 500 companies, fewer than 5% have functions dedicated to price optimization.
If the price is too low, the product is passed over since cheaply priced is associated with cheaply made. Similarly, if the price is higher than the amount the customer is willing to pay, it won’t result in a conversion.
Let’s look at each of the strategies mentioned above, and their pros and cons.
Cost-plus pricing
It is the simplest and age-old method of determining the price of a product which embodies the basic idea behind doing business. The price of a product is set by evaluating all variable costs incurred by the company for its production and adding a profit margin on top.
This method involves very little market research, and takes neither your customers’ willingness to pay nor the competitors’ strategies into consideration.
Pros
It covers the full cost of creating the product and also ensures a positive rate of return. And by creating a buffer in profit margin, companies can account for uncalculated costs and fluctuations in demand.
It is helpful when there is little to no data regarding the customer’s willingness to pay and when there aren’t any competitors in the market.
It allows you to push forward at least a starting price to work from as the customer and market develop.
Cons
It is inefficient as the guaranteed rate of return can make stakeholders become passive towards pricing.
It doesn’t adapt to the fluctuations in the market and changes in the customer, which results in losing out on hefty profits.
It doesn't take the customers' willingness to pay into consideration. As customers care more about how much value you’re providing rather than how much something costs you to make. Oblivious to market and staggers innovation.
Competitor based pricing
Competitor-based pricing is a strategy that looks at your competitors’ pricing structure as the core benchmark for building your own pricing structure. The prices are anchored with general trends in the market and are aligned with customers’ expectations of what they’ll pay for your product or service.
It is built on research, first step is to find out who your competitors are, that closely match your own brand’s profile. Next, look into their pricing, the way it’s packaged, the tiers they used, and the features they differentiated on.
This will gain you an understanding of what customers expect in the market, so now you can align your prices accordingly. The price you choose will inform how customers perceive your brand.
Higher-than-average price: to signal luxury and exclusivity to potential customers.
Lower-than-average price: to undercut the competition and increase acquisition
Matched price: in line with the competitors
Pros
It is easy to calculate and understand.
It has low risk as the pricing is within the standard range of what customers expect to pay for the product.
It fluctuates according to the market and there is no need for any guesswork or complex statistical calculations.
Cons
It detaches the value your service provides with the price it demands, often making us undervalue it.
It has a limited scope of flexibility as you’ll only be limiting yourself to the knowledge and practice of your competitors rather than taking advantage of the uniqueness of your product or service.
The customer is completely removed from the equation which makes it tough to anticipate their shopping behavior.
Competitor pricing is an excellent way to understand the current market and general customer expectations of pricing. Including this as a part of a well-rounded pricing strategy aids in the success of SaaS and subscription companies.
In the above chart, companies A, B, and C have opted for competitor-based pricing whereas Company D went with their own value as the basis for their pricing strategy.
Value-based pricing
With value-based pricing, you set the price of your product based on what customers think your product is worth. It can be called “customer-based pricing”
Instead of basing it on your company’s requirements or on your competitors’ pricing, it gives an outward look by basing it on the customer’s willingness to pay.
Pros
If you have shown there is high willingness to pay than your current pricing or what your competitors are offering among your customers, then you can start at a higher price point.
If the non-customers show a lower willingness to pay, you can adjust your pricing in exchange for higher conversion
By continually upgrading your product i.e adding more value to it, you can adjust prices accordingly.
By continuous engagement with your customers and being attentive to their needs will build rapport that will increase retention, and in turn, your ability to price differently for the loyal and non-loyal customer base.
Cons
The whole process of adopting and sticking with this strategy will require time and resources.
Building the basis for quantifying your buyer personas is time-consuming which is why many companies opt for cost-plus and competitive pricing.
Using the customer feedback information to build and evolve your product is a continual process.
Penetration pricing
Penetration pricing is an acquisition strategy for companies that are entering an already established market with a new product or service. Offering a better deal than the existing market price helps to increase the foothold in highly competitive markets.
Pricing your product lower than what customers expect to pay will increase awareness and attract new customers easily. Once you have grown your customer base, you can start increasing the price to capitalize on the customer’s willingness to pay.
Pros
Using this strategy makes it easier to enter new markets with established competitors.
It is a fast way to build your customer base.
Cons
Increasing the pricing, later on, is the most difficult aspect of this strategy, as customers who are acquired by cheaper offerings are likely to jump ship when the prices increase.
This strategy is only successful if you start building strong customer relationships and having high customer retention, which is a tricky thing by itself.
The work required to gain back the lost revenue from lower prices takes a lot of time and effort.
Dynamic Pricing
Dynamic pricing and Price optimization are often used interchangeably in the business world but they represent different concepts.
Dynamic pricing is a particular pricing strategy where the price of products is altered dynamically based on multiple factors, whereas price optimization techniques focus on finding the best price that maximizes a defined cost function and can use any kind of pricing strategy to reach its goals. Combining both of them is often the go-to option for many scenarios.
To determine the optimum price of the product, there are a lot of factors that need to be accounted for, like competition, demand, inventory information, season and weather, customers’ past transaction data, etc.
Machine learning can help businesses with every aspect of the pricing journey from deciding on the price segment of a new product to dynamically alter the prices of existing products, by effective use of available data. Machine learning models can continuously integrate new information and detect emerging trends or new demands.
Van Westendorp's Price Sensitivity Meter is one of the other tools one can use to pick the right price for specific products when you are exploring the market for the first time.
Conclusion
As there is no one size fits all, there isn't a single strategy that will always work. You have to choose and decide what strategy suits your current business standing and its future goals.
If you are looking for ease and are content with a fixed positive rate of return then the cost-plus strategy is the one for you. If you want to go increase your customer base initially and can compromise on revenue, then penetration pricing will do wonders.
However, if you want to gain the most out of your strategy and at the same time, keep the customers happy, then relying on modern techniques integrated with value-based pricing is the path to walk on!
We at supl.ai have equipped organizations with the best strategies that suit their business goals, using the latest tools and techniques. We are good at helping you ethically take that extra money left on the table!
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