How do you know when the price is right?

When you consider that 30% of the thousands of pricing decisions made each year fail to deliver the optimal price, it’s not an overstatement to say that determining effective pricing can determine your business’ success.(1) It’s imperative to get pricing right, or as close to right as possible.

If you price your items too high, you’ll price out many consumers and lose market positioning. Too low and you’ll struggle to turn a profit and could potentially risk losing money. To get to that “just right” Goldilocks moment, business leaders have to incorporate a little bit of math and a little bit of magic.

At the end of the day, the perfect formula will be up to you — but we can get you started! We’ll take you through the different strategies you can put to the test, and explain how keeping a customer-centric mindset can bring that magical “human” aspect into every decision you make.

Six pricing strategies to know

Before you forge ahead with your own pricing strategy, it’s important to understand what’s out there. Here are some of the most common pricing strategies that may be right for your business.

• Cost-plus/mark-up pricing: This is arguably the easiest way to figure out the price of a product. Simply add a fixed percentage on top of the material, labor, shipping, and marketing cost for one unit of product (unit cost). One thing to note is that this pricing strategy does not take into consideration external factors like consumer demand.
• Competitive pricing: This method looks at a competitors’ pricing and uses that as a benchmark to determine your slightly lower prices. The competitive method can be highly effective in winning customers if the product you’re selling is very similar to others and price is your only differentiator. It is, however, more challenging for small businesses to maintain this strategy. You’ll have to sell a larger volume than your competitors to take care of those profit margins.
• Value-based pricing: Value-based pricing is consumer-focused. In this method, retailers base their pricing on the perceived value of the product (rather than on material costs of production). This pricing is handy in industries that sell luxury goods, for example, where collecting or possessing an item comes with intangible benefits for the customer. There’s no exact formula for this one, but companies can gather feedback through surveys to understand how much customers say their items or services are worth.
• Penetration pricing: This approach focuses on releasing a lower-priced product to gather up as much market share as possible. Then, a company may elect to increase the price over time. This often works with subscription services offering an introductory rate, but the method also works for grocers. As an example, recently Kroger has been aggressively cutting prices on organic food. The brand’s Chief Operating Officer Mike Ellis says Kroger is “trying to make sure that [customers] can get a good quality product at a price that’s comparable to the non-organic brands and in some cases actually the same price.”(2) Kroger also uses its unique position as one of the nation’s largest retailers to its advantage, negotiating with suppliers and running its own manufacturing to keep overhead costs low.
• Price skimming: This is the opposite of penetration pricing. Price skimming is when a company slowly reduces the cost of a product over time. This may sound counterintuitive, but it can work for the right brand. First, a business charges the highest initial price that customers will pay. Then, as the demand of the first customers is satisfied, the company lowers the price to attract a secondary, more price-conscious audience. This method works to bring in high short-term dollars from loyal customers, and is most effective for brands with a coveted name and image. It’s employed by Apple, for example, whose pricey product releases always draw impressive sales.(3)
• Keystone pricing: Like cost-plus pricing, keystone pricing is another simple mark-up system. In this method, the mark-up is equal to the cost of the item you are selling without overhead or selling costs, which means you’re essentially selling the product for double what you paid for it. This sounds like overpricing, but remember how expensive things like shipping, storing, and other supply chain services can be. One watch-out: this method does not factor in competition. If your competitor is offering a lower price for the same product, you’ll likely need to adjust your strategy.

Determining the right strategy for your business

There are a lot of factors that go into choosing the strategy that works for you, but ultimately yours should take your target audience, how much they are willing to spend, and competitors into account. It’s totally okay (and encouraged!) to test and learn, or change course as demand and market conditions shift.

Before you decide on your approach you should also make sure you have a full view of the costs involved with bringing your product to market. Of course there’s the unit cost, but don’t forget about production, packaging, shipping, marketing—the list goes on. Once you’re sure your direction is cost effective, make sure it also aligns with your business goals and value proposition before hitting go.

Consider customer-centricity

While some of the strategies listed above do not include external factors, value-based pricing in particular can teach us a few “valuable” lessons (we had to). Namely it is always important to keep those customer perceptions and sentiments top of mind. No matter which strategy you employ, continuous assessment of your customer base will help you better understand your target audience and anticipate needs that might alter your pricing.

Get the price right

Getting the price right takes trial and error, but it’s well worth the effort. Setting an effective pricing strategy can help you increase profits and market share, improve customer satisfaction, and your overall omnichannel experience.

Now that you have a better understanding of the different directions your business can take, you can make more informed decisions and get those registers beeping (or clicking). P.S. To make the checkout process even more seamless, consider offering Zip to your customers.

Footnotes

1. McKinsey

2. The Motley Fool

3. Forbes