Simply put, price is the amount of money expected from a customer for a product or service. Pricing strategy, on the other hand, is a more complex term. It refers to how a business calculates its pricing and affects the profits and the taken market shares, and positioning of a product or service. We’ve created this guide to help you set up your pricing strategy right based on the type of your business to help you maximize profits.
In this article, we’ll share tips on finding the best pricing strategy for your online business. Below, you’ll find the main points to consider and the most popular types of pricing strategies. Additionally, we’ll answer the most important questions related to the topic.
Steps to Setting Up a Pricing Strategy
In this section, we’ll cover the steps for creating the perfect pricing strategy that aligns with your online business and target audience.
- Define Your Business Goals
Forget about gaining revenue in this step. Often, revenue alone isn’t the only reason you need to set up a pricing strategy. Think of what else is essential for your business. Do you wish to reach a new audience segment? Beat the competition? Change your positioning on the market?
For instance, new companies may choose a lower price to penetrate the market, then raise the price once they gain customers. A company that produces affordable products may increase its pricing to change the customer perception of the product quality. Defining your goals is crucial for any decision in your online business.
- Think About Your Product or Service
What are you selling? What’s the positioning of your product, its quality, and features? How unique is what you offer? From the customer’s point of view, the value of your product or service is the most crucial factor in their decision-making. For example, premium pricing is suitable for luxury, unique goods but certainly isn’t an option for custom printed mugs.
- Conduct Market Research
The truth is, no pricing strategy will work unless it takes into account the market a product or service is placed in. You should research your competition – their products or services, pricing, quality, advertisement model, target audience, etc. Generally, the company that offers the best value is the one that takes up the largest market share. The higher your competition, the harder it may be to charge a high price unless your product is significantly better in terms of quality. You will also need to spend a lot on marketing. On the other hand, if you offer a unique online service, you have complete freedom in setting up your pricing.
- Analyze Your Audience
You’re trying to sell something to real people. Identify who your target audience is, what they’re looking for, the most important product/service features for them, etc.
For instance, let’s say you’re providing online investment consultations. Most likely, your audience is mature and willing to spend money on education to gain profit in return. They’re looking for an expert opinion, and your knowledge is the most essential factor. Based on this brief information, you can already set pricing that’s disproportionately high to your expenses.
- Calculate Costs and Desired Profits
Every product has a production cost. This includes the manufacturing and shipping expenses of the product itself, but these aren’t the only costs you should consider. The costs of an advertisement, managing your website, or warehouse rent may affect the final price, too.
If you don’t consider non-direct expenses, you may end up with a negative profit. Thus, the best way to define the cost of your product is to add up all of your business expenses first. Then, divide the amount by the sales volume. This way, you get the cost of one unit. The next step is to define how much you wish to earn.
The easiest method to determine the necessary markup is to think of how much you need/want to earn in a certain period. Then, divide your desired earnings by the sales volume during that time. The number you get is the recommended minimum markup you should set per unit. Of course, the final markup depends on other factors mentioned above, too.
Services don’t have manufacturing costs, but you should still count towards your expenses. Service expenses include time, tools necessary for providing the service, software, cost of education, site hosting costs, etc.
Which Strategy is Best for Your Online Business?
Different types of online businesses require different pricing strategies. To find out more about popular strategies, refer to our FAQ section.
Competitive, price skimming, value, and cost-plus strategies are suitable for almost any kind of online business. Furthermore, they can be integrated into other pricing strategies. Let’s say you chose dynamic pricing for your food delivery service. Additionally, you can take into account the competitor pricing. If you sell a product and your primary pricing strategy is cost-plus-based, you may also consider the customer perception of your product value.
Some strategies are a better fit for specific types of online businesses, though. Penetration pricing, for instance, is generally considered a temporary pricing strategy mainly used by startups or for reaching new audience segments. You can’t hold your price below the market level while keeping your product or service quality high enough forever.
Dynamic pricing isn’t the best option for products, but it’s excellent for some services. Be aware, though, as customers may consider this pricing model unfair. Think of taxi services such as Uber. Their pricing depends on the time of the day and car availability.
If your service is also dependent on changing factors, dynamic pricing is a great model. But if you offer, for instance, online fitness coaching, simply implementing different payment tiers for additional services set may be a much better idea than giving an individual price to every customer.
Any pricing model can additionally be adjusted to psychological factors. A psychological pricing strategy is based on customer’s subjective perception of prices. Numerous studies have proven that certain costs have a psychological impact on consumers that may not align with reality. You likely know the marketing trick of setting prices at $0.99 instead of $1.
Many suppliers also artificially create a low supply of some luxury goods to increases the demand in turn. You may use similar tricks in addition to your primary pricing strategy or make psychological pricing the main objective.
This section will answer some of the most common questions about setting up a pricing strategy.
Why Is a Pricing Strategy Important?
Pricing isn’t only about profit, although it’s the main objective of most businesses. Price creates the first impression and helps to position your product or service on the market. A pricing strategy should take into account your desired positioning along with the expenses and customer value perception.
For instance, a company may set an extremely high price on a product if they want to take up the luxury product niche. From the customer’s perspective, if they see a product priced unreasonably low, they may think it’s according to quality.
Of course, strategic pricing can maximize your profits. If you select the price at random without considering all factors that affect it, you may have difficulty finding customers or covering expenses. It’s also crucial to keep up with the competition.
What are Examples of Pricing Strategies?
Different pricing strategies have their pros and cons and maybe better suited for specific online businesses. Here are the five most popular pricing strategies.
- Competitive Pricing Strategy
This strategy merely considers the market data rather than production costs or the value of the product. Let’s say you have five competitors. First, you categorize your competitor’s pricing from high-end to affordable. Then, you decide where your product lies on the quality scale and set your pricing accordingly to competitor pricing.
- Cost-Plus Pricing
This is a classic pricing strategy that is based on production costs and desired profit margins. If you wish to earn a 20% markup for every piece of your product, you should first determine the production costs of X units. Then, divide the total cost by the number of units, and multiply by the markup percentage. This way, you get the price of one unit.
- Dynamic Pricing
The name says it all – that’s pricing that changes depending on certain factors, such as time or the complexity of work. It’s better suitable for services than products.
- Penetration Pricing
It may be hard to attract a new audience for startups. For this reason, some use a penetration pricing strategy to set a price significantly below the market average. Once the customer base is gained, the company can increase the price.
- Price Skimming
This strategy is all about readjusting the price until you find the balance. When a product is just launched, the price may be higher than average on the market. Then, the price lowers depending on the market demand and competitor pricing.
What Is Value-Based Pricing?
Value-based pricing strategy isn’t the same thing as cost-plus pricing. You may think that value-based pricing is based on production costs and profit margin calculation from the name. Although value-based pricing may take that into account, the main objective of this strategy is the customer perception of a product or service value. The final price may be significantly lower or higher than the calculated cost-plus value.
Companies selling products with the higher competition may have trouble gaining customers if they set the desired markup at 200%. Customers have a wide choice range, so they consider such a product worthless. In this case, the company should adjust its pricing to fit customer-perceived value. On the opposite, some unique services may charge a high price even if the production costs equal zero as long as customers think that the service is worth the money. In a sense, all successful pricing strategies are value-based. Without considering the customer perception of value, you won’t gain many customers and maximize your profit.
What is an E-Commerce Pricing Strategy?
E-commerce pricing strategy is a general term for the pricing of online stores. It’s not only about the pricing of the product being sold by your e-commerce business. When setting up a pricing strategy, you should also think of the cost of managing an e-commerce site and of other nuances of online store pricing. For instance, in physical stores, you don’t have to care about the shipping pricing. But in e-commerce, may play an essential role in customer decision-making and your final profit. Such factors as free returns or profits from site ads may also affect the final product price in an e-store.
To create a perfect e-commerce pricing strategy, you should count the product cost based not only on production expenses but also on shipping costs, site management, and other related expenses. Sometimes, e-commerce pricing may be lower than that of physical stores, as there are no rent expenses involved.
What Should You Consider When Setting Your Pricing Strategy?
The first thing you should think about is your business goal. Pricing strategy isn’t always about maximizing profit. Your goal may be to gain a larger market share or to reposition your product on the market, for example.
Then, you should calculate the production and other related costs, both fixed and variable. If you’re selling a service with o production costs, consider the employee wages and time spent on delivering the service, the costs of managing your online business site, and so on.
The third point to think through is your target audience. Analyze their average income, value perception of your product or service, and their needs and wants.
Your positioning on the market is also crucial. Consider whether you’re selling a high-end, luxury product or the most affordable option on the market. Your positioning may not correlate with your production expenses as long as it matches the customer perception of a product value.
A thorough pricing strategy is crucial for the success of your online business. It may skyrocket your profits and help you reach the right audience, but a lack of it may lead to the collapse of your company. Remember that your pricing affects how customers perceive your product or service. Keep track of your marketing efforts and adjust your pricing strategy according to your goals and customer needs.