Pricing strategies are difficult for any business in any particular niche. This includes the large enterprises and international corporations, with entire marketing departments and teams working on determining the best pricing strategies.

This also includes, of course, the medium and small businesses, many of whom do not have the staff or hours to dedicate to working out which pricing strategies will be best for their businesses.

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Unfortunately, many rely on intuition or quick glances at their competitors’ prices, which is then followed by setting their prices lower.

While common, it may not be the best way forward. It could lead to the devaluation of your product or your business not being able to break even because the pricing was set too low.

Today we’ll look at the most effective ways that you can set your pricing strategies to ensure competitiveness and profitability.

I. The Four Ps of the Marketing Mix

Before we begin to look at exactly what type of pricing you should employ, let’s first look at why pricing strategy is key for your small business marketing and overall success.

Pricing is a crucial aspect of your marketing mix, and one of the four ‘Ps’ that helps drive your marketing. These four are:

1. Product

Your product is for many reasons the first and most important part of your marketing mix. Your product can be a good or a service, or a combination of the two, and it in some valuable way fulfills a customer’s needs or wants.

In order to correctly set your marketing strategy, and specifically for today your pricing strategy, you need to be fully aware that you know the ins and outs of your product.

If you have that clear grasp of what your product is, how it helps people and what makes it unique, you can successfully market it.

2. Pricing

This is our focus for today and one of the biggest selling points for your product (besides the perceived value the product brings).  Your price will impact your profit margins, supply and demand, and your marketing strategy.

While the value of your product is up to your skills and understanding of what is needed in the market, the pricing strategy you employ can be calculated to positively impact these other factors.

The strategy will also affect how you handle the remaining two Ps.

3. Promotion

When you’ve set your product and your pricing strategy, you need to work to promote it.

With the increasingly digitization of society, the business and marketing spheres are adjusting appropriately. Promotion will look at those factors and work using traditional and modern promotion methods.

The most important part of your promotion, of course, is to present your product’s value and differentiate it from that of a competitor.

Promotion will include advertising, marketing on social media, search and email, public relations and a lot more.

For a more extensive look at how to small businesses can market their products, get our free ebook Small Business Marketing 101.

4. Place

Although the common saying is “the right place at the right time,” marketers tend to state it differently: “the right product, at the right price, at the right place and the right time.”

Place is also crucial to finding success with your product. If you’ve got the perfect product, price and promotion, but you put it in the wrong place, you will experience failure.

It’s necessary to determine exactly where your ideal clients are congregating, and how, in order to successfully market your product.

Nowadays, this ideal location is mostly online, but with the size of the web it is still a difficult task.

While all four Ps are important to help determine and set the success of your product, we’ll focus today only on the pricing strategies.

II. The Pitfalls of Bad Pricing

For many small business owners, an effective pricing strategy usually means finding ways to sell something cheaper than their competitors do. Unfortunately, this often ends up hurting them.

If you price your products too low, you may cause your products to appear too cheap. This can have an effect on the product being offered by just being of lower quality or value than the competitors’.

It can also harm the brand, as many people will then associate the brand as being low-quality competitors, or even worse, “knock-offs” of the better original.

Beyond that, low pricing may cause you financial ruin if it is not enough to cover costs. This is especially true if your sales volume goes down.

If you price your products too high, your customer’s perception of value for the product may end up suffering, or they may go to a competitor with a better price and value.

Of course, whether a high-priced item will survive or not depends on how elastic the product is.

If it is highly elastic, even a small increase in price will have huge effects on demand, such as coffee or airline tickets. A product with low elasticity means that price increases do not affect demand much, such as for cigarettes or gas.

Unfortunately for most business owners, products are likely to be highly elastic.

With high levels of competition, if your product is priced higher than your customers are willing to accept and that you can justify, then you will lose customers.

III. Guidelines for developing pricing

Before we dive into the many different methods businesses use to price their products, we first need to establish the steps you should take before coming to pricing strategies.

1. Understand your product and distribution

As we mentioned above, you should know the ins and outs of your product. You should be able to describe your product features in your sleep. Knowing what your product is, who it is for and how it brings value is crucial here.

You should also understand how your product or service will be distributed to the customers. For web applications, this may be simple.

For example, at InvoiceBerry the customer merely has to log into our system via our website without needing to download anything. Goods may be shipped with actual ships or sent by train, truck, planes or even bicycles to be sold directly or in stores.

2. Determine customer demand

This is applicable both for businesses with existing products hoping to adjust the prices and businesses just starting out.

You need to have a good idea of what the effect of your price will be on sales by estimating how the demand will fluctuate with the price.

Existing businesses can experiment with small but significant segments of customers, if possible, and see the impact.

3. Determine product and service costs

In order to determine if you’ll make a profit from your product or service, you need to calculate the costs involved.

Your total costs should be the lower limit of what you should be charging and anything above that will be your profits.

There are two costs when it comes to your product or service.

The first is fixed costs, which will be a certain amount regardless of how much or little of your product you actually produce. Fixed costs include:

• office rent
• insurance
• equipment
• business licenses
• interest on debt (loans)
• employee salaries

There may be others depending on your business.

The second is variable costs, which will increase with each additional unit being produced. These include production labor time, materials and packaging.

4. Understand Competitor and Legal Influences

While you may be able to determine your price based on your costs, that is unfortunately not the way the market works. There are two other factors to consider.

Competitor pricing

This should be taken into account when determining your own price, but you should also continue watching competitor pricing afterwards, as your competitors may lower their prices. Check out Dealavo price competitor software to track and analyze your competitors’ moves.

At all costs, you should avoid a price war which can occur when you set your price too low. No one benefits from price wars. If you price it too high, you may attract competitors who want in on your profits.

Legal limitations

Depending on your location, there may be pricing controls that will control how high you can price your product.

You could also run afoul of price discrimination laws by charging different prices to different customers, and many other considerations you should take note of.

5. Pricing objectives

What is the purpose of your pricing? What do you hope to accomplish? Knowing your overarching goals will help you better determine which pricing strategy to utilize.

There are usually four pricing goals:

• to maximize profit: this objective hopes to improve current profits, as opposed to long-term profits.
• to maximize revenue: this objective hopes to maximize current revenue without consideration for profit margins, and the intention is usually to maximize long-term profits.
• to maximize quantity: this objective hopes to sell as many units as possible or serve as many people as possible in order to decrease long-term costs
• to have price equilibrium: this objective hopes to find a steady price in order to avoid potential price wars and have stable profits.

IV. Different Pricing Strategies and Examples

Finally, we’ll look at what kind of pricing strategies should be used for businesses at different stages and needs. These strategies are:

• New business pricing strategies
• General pricing strategies
• Promotional pricing strategies

We’ll provide examples at the end of each strategy to help you get a good idea of whether this pricing strategy will be viable for your small business.

1. New Business Pricing Strategies

New businesses may have a more difficult time in determining their pricing because they have no real data to go on. While they may know their competitors’ pricing and their own costs, they don’t have any interaction with customers to help them determine the best step forward.

With that being said, it may also offer benefits as a new brand can bring mystery and excitement. There is a lot more space to shape your branding, and a big part of that is in pricing.

There are typically two pricing objectives for new businesses or new products:  to maximize quantity sold or to maximize profits. In order to achieve that, many new businesses utilize one or many of the following.

A. Price Skimming

Price skimming is one of the most popular pricing methods for new businesses. In this strategy, the new product or service is set a price that is actually higher than its actual value.

When the product or service is rolled out, the customer is not familiar with the price and doesn’t know how to properly value it. Once the market catches up with the product or service (i.e., competitors enter), the product or service price will come down to the real market value.

This means that the profit margins will be higher in the beginning in order to get back any R&D or marketing costs.

One popular example of price skimming is Apple’s iPhone sales. When the iPhone 5s first came out, it was priced at $649 for the 16GB version. Now you can find it for $210.

B. Penetration Pricing

This is quite different from price skimming. Here the price is set quite low in order to gain market share quickly.

By the time the price raises, the hope is that the customer will be so used to the product that he or she will continue using it at full price.

This is common for subscription services or, as below, web hosting.

C. Versioning Pricing & Freemium

This type of pricing strategy is used especially for information, services or software companies. Versioning pricing involves selling the same product at different “versions.”

There is an introductory or basic version that has an attractive low price, or has no price at all. The customer is then inducted into the service or software ecology, at which time he or she is encouraged to move up to better versions with greater features for higher prices.

At InvoiceBerry, as with most SaaS (software as a service) companies, we use the freemium/versioning model.

D. Captive Product Pricing

This is often referred to as the razor-razor blade pricing technique, by which one item is cheap or given away for free but packaged with another item. The two items must work together for this technique to be effective.

For example, a razor is offered for free or heavily discounted, but it will only work with the brand razor blades which the customer will have to purchase at full price with a high profit margin to offset the discounted item.

Another popular (and still frustrating) example is the printer-ink strategy, where the printer (HP here) costs only $30 but the ink will cost $34-$36 each time.

2. General Pricing Strategies

These are standard pricing methods utilized by many small businesses to sell their products competitively and profitably.

A. Competitive Pricing

This is the most common and should be utilized in some form regardless of what pricing strategy you ultimately go with.

First, you need to make a survey of your competitors’ pricing, then calculate the average or mean. From that, you can decide to go below their base prices or stay at the same level.

This of course has to take into account your own costs. For this to be effective, your cost structure should be similar to your competitors’, or else you could be underpricing your products.

Competitive pricing is also common with franchises, such as McDonald’s and Burger King, that are able to be competitive and profitable.

B. Customer Perceived Value (CPV)

This pricing strategy requires you to do your research. You need to figure out first of all what the perceived value of your product is to the customer compared to competing products.

Customer perceived value can be calculated as:

CPV = Total Perceived Benefits – Total Perceived Costs

The CPV here would be a monetary conversion of the benefits of any product or service.

For example, if a customer buys a car, besides the usual uses of a car, the benefits can include his feeling of excitement when driving it, the adoration or envy from his friends and family, and many others.

If he believes the benefits in total equals $25,000, and the total costs to produce the car come to $14,000, the seller will have to decide which price to offer based on the CPV.

The lower the price, the higher the benefits, the higher the CPV and the higher the incentive to purchase.

The higher the price, the lower the CPV, and at too high a price the seller can price himself out of the market. Therefore, at a price of $23,000, the CPV is $2,000 and could be enough incentive for the customer to make the purchase.

You would of course also need to take into account the competition to help you determine the price.

C. Cost-plus

This pricing method uses your cost structure as a basis and then adds on the margin you would like to have for each product or service you offer.

Although this will ensure a good profit margin that you are comfortable with, it runs the risks of underselling due to lack of competitiveness in your pricing strategy.

It also provides no incentive for production and contract costs to be minimized.

For example, let’s say a business determines its costs to be the following:

• Direct materials = $15
• Direct labor = $5
• Allocated overhead = $7.50

The company chooses to apply the standard 30% markup to all products. With this, the total costs come to $27.50. With a 30% markup, the company decides to sell its product for $35.75.

D. Psychological Pricing

This strategy comes in three flavors and is based on the idea that pricing can be used to affect perceptions of quality, fair value, savings and more.

Charm pricing

This is a common pricing strategy for retailers and supermarkets. Here, the prices will normally end in ‘9’ or ’99.’

The left digit is simply reduced from a round number by one cent in order to induce customers to buy more based on the way our brain works.

Specifically, our brains see that $5.00 and $4.99 are different prices, although much more drastically than we are aware of. To our brains, $4.99 is $4.00, which is much cheaper than $5.00.

This does not work, however, if the left-most (the whole-dollar value) is the same. If the price goes from $5.50 to $5.49, there isn’t much difference for the brain.

One experiment by the University of Chicago and MIT tested this on women’s clothing. They set the prices at $34, $39 and $44. Even though it goes against logic, the best-selling item was priced at $39, even though it wasn’t the least expensive option.

Prestige pricing

Charm pricing is effective for some products and services, but not for all.

Some products such as luxury goods are better sold by doing the exact opposite, which is where prestige pricing comes in. Here, the price is raised to a rounded number, for example going from $99 to $100.

According to a 2015 study, rounded numbers encourage customers to make decisions based on their feelings that the purchase “feels right” rather than on some more calculated opinion.

The study authors discovered that, for higher-priced goods at least, people were more willing to buy champagne at $40 rather than at $39.71.

Premium pricing

This strategy is based on the idea that higher prices can convince the customer that the product or service has high value.

There are many psychological aspects involved in this persuasion, including the exclusivity the price offers. The availability of the product or service should also be limited which improves its exclusivity.

For example, if Dolce & Gabbana are sold at Walmart, that will decrease its perception of quality and negatively impact its pricing.

It is important to state, however, that the brand should usually be strong for premium pricing to be effective.

Apple is again appropriate as it has a strong brand and can offer its products at premium prices.

3. Promotional pricing strategies

This section will be especially important for those businesses that are not particularly new and want to get a boost in their sales.

As we said above, instead of just giving away as many discounts as possible, you should also have a method to your pricing. Let’s look at some of the most common promotional pricing strategies.

A. BOGOF (Buy One Get One Free)

This is one of the most popular promotional methods to use and it’s easy to see why. Instead of giving away something for free, you are instead incentivizing people to buy a product in the first place.

When they buy one item, they can get the same item for free, or another item of equal or lesser value. There are variations on this model, including a BOGOHO (buy one, get one half off) or many others.

Food and clothing stores use the BOGOF pricing strategy often.

B. Loss Leader Pricing

This pricing strategy is based on, essentially, sacrificing one item in order to get a sale on another. Here, the business offers up an item below market value in order to incentivize the customer to go ahead and purchase another popular item.

This is used a lot in retail in order to get traffic away from their competitors. It is also used by ecommerce businesses and especially magazines, where the first few copies are free.

C. Close-out pricing

This is a common strategy in retail and other businesses where the business is offering significant discounts on goods that are in overstocked or will be obsolete.

It is also used when businesses are going out of business.

The purpose of close out pricing is to get some cash from the sales of these goods before the costs to store or dispose of them cause cash flow problems.

D. Membership (loyalty) pricing

Here, you can offer special pricing to those customers that you see as most valuable. The most common form is to use a loyalty program where points are awarded at various stages of the customer’s journey.

The further up the customer gets in repeat sales, the more points the customer receives. This, along with the other psychological aspects of loyalty programs, helps incentivize the customer even further.

They then receive lower prices, special discounts, rewards, gifts or others.

E. Bundle Pricing

Bundle pricing is when you encourage people to buy things in bundles or packages by offering discounts. In this strategy, businesses will often bundle goods that are discontinued, overstocked or being phased out with popular items to help boost sales and avoid liquidation pricing.

Businesses also use it to introduce new products by pairing it with old, popular products or other complementary products for lower prices. This can help to boost sales overall or to improve brand identity for the new product.

For example, the Xbox One S is a newer Microsoft gaming product, and therefore they bundle it with the necessary complementary products. Buying them separately will be much more expensive:

• Xbox One S = about $240
• Xbox wireless controller = $25
• Battlefield 1 = about $40
• 1 month EA Access = $5
• Total price: $310

With the bundle price, that’s a total savings of $52.

V. Small Business Pricing Strategies

There are many pricing strategies here that can be employed. The most important aspect when it comes, of course, is the preparation.

• Do you understand the market well enough?
• Do you understand your product or service well enough, including all associated costs?
• Do you understand your ideal customer well enough?
• Have you checked your competitors’ pricing?

If you can answer a strong yes to these questions, only then should your next step be to decide on the best pricing strategies for your small business.

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