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Pricing Strategies and Models Explained
What’s the right price for your product or service?
What price will make you profitable and attract customers?
Not sure? Keep reading to learn the basics of pricing strategy and setting the right price.
What is a pricing strategy?
A pricing strategy is the overarching approach or plan a business uses to determine the price of its products or services.
It considers various factors such as market conditions, competition, production costs, and the perceived value to the customer. The ultimate goal of a pricing strategy is to maximize profitability, maintain or grow market share, and ensure long-term sustainability while meeting the company’s other objectives.
What is a pricing model?
A pricing model is the specific method used to set the price of a product or service. It provides a structure to implement your chosen pricing strategy.
What’s the difference?
The distinction between a pricing strategy and a pricing model lies in their scope, purpose, and application.
The pricing strategy aligns prices with business objectives, market conditions, and customer perceptions. A pricing strategy considers market entry tactics, customer psychology, brand positioning, and long-term market objectives.
The pricing model is the mathematical method you use to create a specific price. It usually involves manufacturing costs, customer demand, and competitor pricing.
Think of the strategy as the roadmap guiding where a company wants to go with its pricing and the model as the vehicle it uses to get there.
Types of pricing strategies
1. Penetration pricing
Setting an initial low price to quickly attract customers and establish a market presence. Ideal for new entrants wanting rapid market share.
Example: Streaming services offering discounted rates for the first three months.
2. Price skimming
Starting with a high price and then reducing it over time. Suitable for innovative products.
Example: New tech gadgets like smartphones often use this strategy.
3. Value-based pricing
Pricing based on the perceived value to the customer rather than production costs. Works best for unique products or services.
Example: Luxury brands like Rolex or Louis Vuitton.
4. Competitive pricing
Setting prices based on competitor rates. Ideal for industries with many competitors offering similar products.
Example: Supermarkets pricing staple goods.
5. Premium pricing
Charging a higher price to reflect a product’s premium status and quality.
Example: Brands like Apple or Tesla.
6. Economy pricing
Offering no-frills products at a low price. Common in mass markets.
Example: Budget airlines like Ryanair.
7. Bundle pricing
Grouping multiple products together at a discounted rate. Useful for increasing sales volume.
Example: Cable TV packages.
8. Price leadership
Price leadership occurs when one dominant company, usually the largest or most influential in an industry, sets the price of a product or service, and other competitors in the market follow suit.
OPEC often influences global oil prices by adjusting its production levels.
9. Preemptive pricing
Intended to drive away competition or deter others from entering the marketplace by deliberately selling at below market prices (temporarily, of course).
Amazon launching the Kindle with e-books priced below typical hardcover prices.
Types of pricing models
1. Cost-plus pricing
Calculating the cost of production and adding a fixed gross margin. Common in retail.
Example: A shirt that costs $20 to make might be sold for $40.
2. Geographic pricing
Adjusting prices based on location or region.
Example: A software product priced differently for the U.S. versus India.
3. Dynamic pricing model
Prices change based on real-time factors.
Example: Uber’s surge pricing during high demand.
Example: Software packages with Basic, Pro, and Premium tiers.
5. Freemium model
Basic services are free, with charges for advanced features.
Example: Spotify offers free music streaming but charges for an ad-free experience.
6. Subscription model
Recurring fee for product or service access.
Example: Monthly Netflix subscriptions.
7. Pay-what-you-want model
Customers choose their price. Often seen in indie industries.
Example: Some indie video games or music albums.
8. Volume-based pricing
Decreased price per unit with increased quantity.
Example: Wholesale retailers like Costco.
9. License pricing model
One-time fee for product usage over a period.
Example: Microsoft Office’s one-time purchase option.
10. High-low pricing model
Products have a higher standard price but are frequently discounted.
Example: Department stores having frequent sales.
How to choose your pricing strategy
Selecting a pricing strategy comes down to cost, goals, and customer perception. Here’s how:
1. Set business objectives
Define clear goals, such as maximizing profit, penetrating the market, establishing a premium brand image, or achieving specific revenue targets. Your pricing should align with these objectives.
2. Understand your costs
Consider both direct costs (like raw materials and labor) and expenses (such as rent and marketing). Factor in variable costs that change with production volume and expenses that remain constant. Determine the break-even point to identify the minimum price needed to cover all expenses.
3. Analyze the competition
Research competitor prices and understand their value propositions. Identify their market positioning, whether premium or budget and observe any historical pricing trends or changes to gauge market reactions.
4. Know your audience
Understand your target audience’s demographics and what they value in a product. Gauge their price sensitivity and gather feedback on pricing preferences to ensure your price resonates with them.
5. Test and adjust
Before a broad rollout, test the new pricing on a segment of your audience. Refine your pricing based on customer input.
More on pricing products and services
Check out our other startup pricing resources to turn your pricing strategy into profitable steps for your business.