Complete Guide to Pricing Strategies: Types, Benefits, and Examples

Complete Guide to Pricing Strategies: Types, Benefits, and Examples

The price you decide on will ultimately determine the sales revenue and profitability of your company.

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Choosing between pricing strategies is one of the most important decisions you can make as a business leader. If you get it wrong, your sales can suffer, and you may even cause consumers to question the value of your brand. But when you get it right, you can increase your sales, reduce your costs, and improve your company's profitability.

If you're wondering where to begin, you're in the right place. Learn about the different types of pricing strategies, how to choose the right one, get some pricing strategy examples, and determine how to create an effective pricing strategy for your business.

What you'll learn:

• What is a pricing strategy?
• 5 main types of pricing strategies
• Benefits of implementing an effective pricing strategy
• Best practices for choosing the right pricing strategy
• How to choose the right pricing strategy for your business
• Tips for creating a pricing strategy

What is a pricing strategy?

Your pricing strategy is the baseline you use to determine what to charge for your products and services. There are several different options to explore, but before you can decide which pricing strategy to use, you must first understand your production costs and calculate the lowest price at which you'd at least break even. Then you can consider your desired profit margins and what's realistic given the competitive landscape. Considerations should include how your product or service compares with your competitors' in terms of quality, features and price. By doing your research before you jump in, you can create a strategy that attracts the right customers, makes a profit, and keeps shareholders happy.

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5 main types of pricing strategies

Choosing the right pricing strategy for your business means striking the balance between making sure the prices for your products or services are competitive and maximizing both short-term and long-term profitability. Five of the most popular strategies are cost-plus pricing, competitive pricing, price skimming, penetration pricing, and value-based pricing. Let's cover what goes into each pricing strategy and explore some examples.

1. Cost-plus pricing

Also known as markup pricing, the cost-plus pricing strategy is a simple, straightforward way to determine the price of a product. It's mainly based on the cost to produce each unit, without much emphasis on the prices set by competitors. To set your price using the cost-plus pricing strategy, start by adding up your production costs. Then determine your desired profit margin (or markup) and add that to the production cost. That sets your selling price.

Here's an example:

A former aerospace engineer sells a line of high-end boomerangs for collectors. He makes them by hand with balsa wood imported from Ecuador. Below are the costs to produce one boomerang:

• Material: $5
• Labor (based on industry averages): $20
• Overhead (for manufacturing space and utilities): $10

The total cost to produce a single boomerang is $35. The engineer decides to add a markup of 300%. The formula to set the price for his boomerangs looks like this:

Production costs ($35) + Production costs ($35) x markup (300% or 3.00) = selling price ($140)

When to use: Government contractors are well-known for using cost-plus pricing because the market doesn't have competitors. Retailers, such as supermarkets and department stores, also use the strategy because it's a relatively simple formula and provides a consistent rate of return.

2. Competitive pricing

Competitive or competition-based pricing uses competitors' pricing as a benchmark. Instead of starting with production costs or customer demand, companies look at competitors' pricing data and set their own prices at, below, or above the industry average depending on their unique selling proposition and their business goals. Those that offer a similar product and want to quickly grow their market share will likely set a comparatively low price. On the other hand, a company that's bringing a premium product with unique features to market may set a higher price.

Here are more scenarios:

• Above the competition: This method uses higher-than-competition pricing that's justified to customers by additional or unique benefits, such as convenience. Let's say four gas stations are all located in the same area. The gas station that has the easiest access and is closest to the freeway on-ramp charges $0.15 more per gallon than the other three, but customers seem happy to pay the higher price for the convenience.
• Below the competition: Also known as the loss leader strategy, this pricing scheme deliberately sets an item's price point below the average market rate. Businesses that use this version of competitive pricing often seek to gain a larger overall profit by encouraging customers to purchase additional items. Printers are a great example of this strategy. A lower-cost printer might attract customers, knowing that those same customers will also need to purchase paper and ink cartridges. This both increases the total initial sale while also leading to repeat purchases when ink and paper run out.
• Matching the competition: When a company sets prices equal to its competitors, the focus can shift from the price point to the product or service itself. This often happens in industries that are heavily regulated by the government. For example, before deregulation in 1978, U.S. airlines differentiated themselves from the competition by offering perks such as free champagne or gourmet meals.

3. Price skimming

Price skimming is a strategy in which a company initially charges a high price for its products or services when it first enters the market. Doing so can signal superior quality while creating an exclusive experience for early customers willing to pay a premium. Companies employ this strategy when they want to quickly recover development costs and have a buzzworthy product with enough customers clamoring to get it-even at a high price point. Over time, though, the company gradually lowers its product's price to attract a larger customer base.

Price skimming example:

Tech companies have long used price skimming when introducing unique products to the marketplace. When an entirely new or innovative product is released, the initial price can be quite expensive. That's because the company is often the only one offering this new product or innovative features. They first target a smaller pool of customers willing to pay for earlier access. Once the company captures all the buyers it can at its launch price, however, it begins to lower the selling price over time. Doing so captures more price-sensitive customers while putting pressure on other sellers that inevitably begin to enter the market with similar products.

4. Penetration pricing

In contrast to price skimming, penetration pricing is when a business enters the market with a product or service offered at an exceptionally low price. This strategy initially draws attention and attracts hordes of cut-rate customers. However, for this to be sustainable (and ultimately profitable), prices must eventually go up after gaining market share. The hope is that customers will like the product or service enough to stay loyal after the price increases. If not, the company must find a way to produce the product at a lower cost than its competitors.

Penetration pricing example:

Many internet or cell service providers use penetration pricing. They make a splash with low prices, but after gobbling up market share and earning more brand recognition, they move to competition-based pricing. Businesses that use this disruptive strategy may incur early losses, but they wager that the customers initially attracted by a bargain will stay loyal once the price creeps up.

5. Value-based pricing

With this strategy, companies set a price based on what customers are willing to pay for their products or services thanks to their perception of its value. With value-based pricing, you need to build a brand focused on value conveyed by unique benefits, features, and offerings. To successfully use this pricing strategy, brands must invest more significantly in marketing, research, and PR.

Value-based pricing example:

You often see value-based pricing for luxury products such as brand-name leather handbags, upscale automobiles, and high-end makeup brands. These luxury brands use marketing to send the message that their products have a high value. Over time, they come to represent status symbols to consumers. When this is successful, buyers are willing to pay a premium.

While luxury brands can charge more for their products, it doesn't necessarily mean the actual quality of their products matches the perceived value customers get from attaching themselves to the brand. In fact, the production cost and the product quality may not be measurably different from lower-priced competitors. Customers simply think they're worth more.

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Benefits of implementing an effective pricing strategy

If you choose the right pricing strategy, it can mean the successful launch of your product and faster market penetration. But these are just some of the big wins from pricing correctly.

Here are additional advantages of choosing the right pricing strategy:

• Conveying the value of your brand: The perception consumers have of your brand will help determine how much of their current pain they are willing to tolerate in relation to the relief your product or service offers them. Think about when you use a delivery service instead of going out and buying something yourself; how much is the convenience worth to you?
• Adding new customers: Expanding your customer base can increase sales, which leads to increased profits.
• Increasing the value of current customers: It's a lot easier to upsell or cross-sell a current customer a new feature or service than it is to find new customers. Pay close attention to your pricing with your best customers to encourage additional sales.
• Improving sales: When products or services are priced well, you'll see an uptick in sales. This is where research into your target audience can pay off.

If your pricing strategy falls short of supporting your business goals, you might attract the wrong kind of customers, leading to mistrust and diminishing the perceived value of your brand. That's why it's vital to find a fair, reasonable price that the market will bear.r.

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Best practices for choosing the right pricing strategy

Choosing the right pricing strategy for your business requires understanding both internal business goals and external market factors. This process doesn't have to be a headache. Follow these best practices and ask the right questions along the way to select the best pricing strategy for your situation.

Understand your goals

Think about your company's overall business strategy. Then consider how various pricing strategies can help achieve long-term organizational goals both in the short- and long-term. A company seeking high margins, for instance, might prefer value-based or skimming strategies, whereas one focused on growth might lean toward penetration or competitive pricing.

Guiding questions:

• What are our company's long-term goals?
• Do we have any short-term strategies for reaching those goals?
• How many competitors offer what we do?
• Do we want to maximize profit, grow market share, or focus on brand reputation?
• Do we need to quickly grab customer attention with an enticing product launch?
• Are we trying to build a reputation for our luxury brand?

Analyze the competition

Make sure you understand what your competition is offering in the marketplace - and how much they are charging. This will give you an idea of what current customers are willing to pay for similar products.

If you notice outliers - those charging much higher or lower than most - check them out. Try to understand how they justify their prices. All research is good research when it comes to understanding the marketplace.

Guiding questions:

• Is our product or service clearly differentiated? How?
• How many competitors are in the market?
• How do the top three competitors sell their product and justify their pricing?
• In launching our product, will we be a market leader, challenger, or new entrant?

Research your target market

Knowing your target audience is a key step in determining the right pricing strategy. When you understand your target audience - who your ideal customers are (including their age, gender, and location) and what they value (including their preferences, likes, and dislikes) - you gain a better shot at appealing to the right people with the right offer at the right price.

Guiding questions:

• What would they sacrifice for a lower cost?
• Who are we targeting and why?
• What do they value?
• What do they prioritize when choosing a product or service?
• How sensitive are they to price?
• What would they pay more for?

Weigh the pros and cons of each pricing approach

To determine which strategy is right for your business, look at the different pricing approaches and consider their benefits and drawbacks. Once you understand which ones best line up with your business goals, measure them against your target market.

If customers prioritize quality and innovation, for instance, then value-based pricing may be appropriate. If your customers are more price-sensitive, then penetration pricing or cost-plus may work better. Keep in mind that some strategies, such as penetration pricing, may be effective during a product launch but are typically not sustainable for long-term profitability. If you choose to enter the market with this type of pricing, you'll need to consider what you'll shift to once the initial product launch period stops drawing in new customers.

Guiding questions:

• Is the pricing strategy sustainable for long-term profitability, or will we need to adjust it?
• What are our long-term business goals?
• What is our short-term business strategy?
• Which pricing strategy's benefits align with our short-term objectives?
• Which pricing strategy will work with our target audience?
• Which pricing strategy lines up best with our current situation based on our product, the current market landscape, and our target customers?

Get buy-in from your key stakeholders

Pricing strategies shouldn't be chosen in a silo, nor should they be left static. It takes the right team to successfully move through the above five steps. Involve the right people and agree on a plan for how often to test, evaluate, and discuss your pricing strategy.

Who should weigh in on pricing strategy? Your stakeholders may include:

• High-level business leaders who can communicate high-level goals and short-term strategies
• Market research and marketing professionals who can study and share intel on the competitive landscape
• Sales leaders who can offer first-hand insights on ideal customers in your target market
• Financial leaders who can offer guidance on the profitability and sustainability of various strategies

This pricing team should understand which players are ultimately responsible for ongoing pricing maintenance. It's also wise to:

1. Create a reporting plan with clear expectations on how often the full team gets updates.
2. Agree on a timeline for when to evaluate and adjust pricing or test other strategies.

Test your prices, then learn and adjust

Once you've chosen your pricing strategy, keep in mind that it's not set in stone. If sales are slow or there are shifts in the market, you may need to adjust your prices to compensate. Think of this as an opportunity to test and tweak the true value of your product. And if you are an early-stage start-up, expect that in the first year or two you may make deals you would never make again as you gain traction. In those moments, that's OK.

If you want to see which dollar amount works, try A/B testing your price on an online product page. For example, if you're selling a book, you could create two landing pages - one with the book priced at $11.99 and the other offering it at $9.99 (with a low-cost add-on, perhaps). Then, you can measure which price attracts the most buyers to inform your strategy. With an equal number of people visiting each page, how many convert? The page with the most conversions tells you how much most people are willing to pay.

Guiding questions:

• Are there add-on features or cross-selling offers we can feature?
• Have we tapped out the current market?
• Should we target other customers with varying price sensitivity?
• How are our competitors responding?
• What do our margins look like and are they sustainable in the long term?

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How to choose the right pricing strategy for your business

Now that you know the basics about each pricing strategy, use the table below to determine which one may work best for your company. Consider your place in the market, your ideal customers, and how your company can avoid common risks.

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Tips for creating a pricing strategy

If you want to see your business grow and flourish, you must first develop an effective pricing strategy appropriate for your goals. Hitting the right price won't just attract customers; it will also convey the value of your brand. If the price is right, your customers will feel like your products or services meet their expectations. And the price you decide on will ultimately determine the sales revenue and profitability of your company.

When creating a pricing strategy, the first thing I encourage people to do is to understand their production costs. Doing so will help you set a price that allows you to not only break even, but also eventually turn a profit. When you create your pricing strategy, consider things such as:

• Overhead: How much you pay in rent, salaries, insurance, manufacturing costs, services, and labor.
• Customer segments: What do they value? How much are they willing to pay for it?

Long-term profitability: Is this your pricing strategy sustainable? If it's not in the short term, how and when can you make price adjustments or offer add-on purchases that will build in profitability? Perhaps you need to build in a plan for upselling or cross-selling higher value products.

No matter what, align your pricing plan with your overall business strategy, considering your long-term goals and how pricing can help you get there. Are you looking to access profit, grow market share, or create a certain brand reputation? Choose a pricing strategy that supports those goals.

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Invest in the right pricing strategy

Getting your pricing strategy right is critical for the health of your business, but that doesn't mean it has to be an intimidating task to tackle. Luckily, it's not a one-and-done motion. Pricing strategies are all about testing what the market will bear, then making adjustments based on what you learn. Putting the time, money, and resources into your pricing strategy is an investment in the future of your business.

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Janeen Marquardt, MBA, PMP is a distinguished Salesforce architect and strategist with over 15 years of experience in delivering complex business transformation solutions. Janeen is actively involved in the Salesforce community. She serves as a Group Leader in the Salesforce ecosystem, contributing... Read More to knowledge sharing and professional development initiatives. Additionally, she is recognized as a Founding Member of the Slack Small Biz Community, showcasing her commitment to fostering connections within the broader Salesforce platform. She is a mentor, a Clicked coach, and a Credential Ambassador.