As you coordinate a pricing model for your company, you will typically consider three major pricing methods: cost-plus, value-based, and competition-based. In some sectors, you may even consider using dynamic, “freemium,” or other less-common price-setting strategies to boost your business’s profitability.
Marketing and sales experts agree that implementing tools from different strategies is best when pricing products. Cost-plus pricing, for example, can be an excellent way to determine if your business is headed for losses. Likewise, competitor-based prices can be useful in highly saturated markets.
This guide will review five strategies for incorporating different pricing methods into your business plan. To set a fair price, you will need to examine your finances, customers’ perceptions, your competition, and your business’s individual needs. These tips will help you get the most out of the many ways to set prices as a retailer.
Use Cost-Plus Formulas to Check your Profitability
In cost-plus pricing, you determine the production costs of a product and then add your desired profit margin to set your price. This simple price-setting method is popular among businesses that do not have the resources to collect troves of marketing data. However, its limited scope can undermine companies that do not pay attention to their customers and competition. Because the cost-plus method limits your ability to account for external factors, it is not frequently used as the sole price-setting method for a business.
Instead, analysts recommend incorporating cost-plus formulas as a check on the profitability of your business. This can be done by calculating your expenses per unit, such as production and labor costs, and subtracting them from the price of a product. You can then use the remaining number to calculate a percentage, which is your profit margin. If your profit margin on a given item is negative, then you will need to rethink your pricing strategy. Cost-plus pricing is therefore a useful tool to ensure the financial health of your store.
Cost-plus calculations should also be used if you wish to substantially lower an item’s price. Suppose customer feedback indicates that a pair of headphones you sell is overpriced. To see how much you would lose in a price reduction, you can subtract your production costs from the new price, which will determine your new profit margin. The cost-plus formula is therefore useful to determine whether you can meet consumer demands without skimming too much off of your revenue.
Understand how Customers Perceive your Value
Many marketing experts recommend incorporating value-based pricing in any sales strategy. In value-based price setting, you research how customers perceive your worth and use that information to set an item price. You can then continue to leverage that data to add features or services that increase the perceived value of your products.
This strategy incorporates market research into price setting, making it a profitable activity for any business. Even if you use other methods to set your final price, the data that you collect during this process can help you improve customer service, brand perception, and product quality. Furthermore, understanding what your clients value will help you hone your sales and marketing tactics, improving your profits without raising prices.
Value-based pricing is especially useful in service and SaaS businesses. Most services cost far less to produce than they are actually worth, so cost-plus pricing can become redundant. Therefore, a service business needs to carefully examine what a customer will actually pay for their time. For a basic example, suppose a person offered their neighbor’s kid $30 to mow a lawn. The kid then charges other neighbors $30 because that is the perceived value of lawnmowing in their neighborhood. The business has no overhead cost, so the kid had to use the neighbor’s offer to determine the value of their time. Service- and SaaS-based businesses therefore uniquely benefit from value-based approaches.
Keep Prices Competitive
Competitor-based pricing is a method that bases product prices on those of your competition. Some businesses use this method to undercut markets to boost sales. Premium brands also check their competition to keep their prices high to maintain exclusivity. Most marketing experts do not recommend using competitive pricing on its own. Instead, it should be a key element in your larger strategic plan.
Keeping track of your competition is a core sales tactic, so it’s only natural that you should include some elements of competitive pricing in your overall business plan. Running regular comparisons between your business and your competitors is a solid long-term business strategy. You can use information from competitors to find new ways to increase profitability and to check your pricing strategy for errors. If your prices are substantially lower or higher than your competition, then you may want to revisit them.
Competition-based pricing can also be useful to attain short-term strategic goals. One strategy, called penetration pricing, uses competitive pricing to undercut a saturated market. This approach is often used by new brands or established brands seeking to enter a new market. Similarly, retailers might set sale or clearance prices lower than competitors to clear inventory to make room for new product.
Consider Less-Common Pricing Strategies
In some cases, you may benefit from incorporating lesser-known pricing strategies in specific sectors. Travel, entertainment, and transportation companies often use dynamic pricing to take advantage of high-demand times. Airline companies, for example, charge more per passenger during the holidays than during regular seasons. Industries that experience fluctuating demand benefit from this method because increased profits during busy periods float them through low seasons.
Price skimming is another method that involves setting prices high to attract the wealthiest share of the market. This strategy can be effective for luxury retailers seeking to create an exclusive product. However, to be successful, your brand must be well-known, and your product quality must warrant its price.
Online gaming, streaming, and other digital services have benefitted from a new pricing model known as “freemium” pricing. With this approach, your base product is free for consumers to access. However, to gain access to additional features in benefits, your customers will need to pay a monthly subscription or series of small fees. This is a classic bait-and-switch tactic that captures customers’ attention with a free version that entices them to upgrade.
Know your Business
As you develop your pricing strategy, you must always be aware of your business’s industry and resources. These internal factors will help you determine the method that you should use to price your good. Your industry determines your competition and the price structures that are acceptable to consumers. A dynamic strategy, for example, is typical for travel companies, but it would not work at a grocery store. Your resources will also influence pricing methodology. A value-based strategy involves heavy market research, which is not always doable for small businesses. Likewise, undercutting the market with competitive pricing may be impossible if your margins are already slim. You should therefore incorporate the elements of pricing strategies in ways that make sense for your company.
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