Choosing a pricing strategy is one of the most important decisions you can make as a business leader. Get it wrong and your sales will suffer, causing consumers to question the value of your brand. Get it right and you can increase sales, reduce costs, and improve your company’s profitability.

If you’re wondering where to begin, you’re in the right place. Learn about the different kinds of pricing strategies, the benefits of choosing the right one, pricing strategy examples, and how to create an effective pricing strategy for your business.

What you’ll learn:

• What is pricing strategy?
• 5 different types of pricing strategies
• Benefits of implementing an effective pricing strategy
• How to create a pricing strategy: 5 points to consider
• Tips for setting pricing strategy from 20 years in sales

What is pricing strategy?

A pricing strategy is a method to decide what your products and services should cost. Pricing strategy is both an art and a science. It’s about understanding production costs, profit margins, and the competitive landscape, so you can make a profit and keep shareholders happy.

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5 different types of pricing strategies

When you choose the right pricing strategy for your business, you can feel confident that the prices for your products or services are competitive while ensuring profitability. In my experience, these are five of the most popular strategies:

1. Cost-plus pricing

The cost-plus pricing strategy only looks at the unit cost and ignores prices set by competitors. Also known as markup pricing, this strategy is a simple way to determine the sales price of a product. Start by adding up your production costs. Then determine your desired profit margin, or markup, to set your selling price. Here’s an example:

A former aerospace engineer sells a line of high-end boomerangs for collectors, handmade with balsa wood imported from Ecuador. Here 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 then adds a markup of 300%. The formula to set the price looks like this: Production costs ($35) x markup (300% or 3) = selling price ($105)

When to use: Government contractors are well known for using cost-plus pricing because there isn’t similar competition on the market. 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

This method looks at competitors’ pricing as a benchmark. Instead of using production costs or customer demand, companies set prices at, below, or above their competition.

Here are the different types with examples and when to use them:

• Above the competition: This method uses higher-than-competition pricing justified by additional or unique benefits customers receive, like convenience. Here’s an example: Four gas stations are all located at the same intersection. But the gas station closest to the freeway on-ramp charges $0.25 more per gallon than the other three, and 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 market rate. The business then gains a larger overall profit when customers purchase additional items. Printers are a great example of this strategy. A lower-cost printer might attract customers, but they also need to purchase paper and ink cartridges. This increases the total cost and leads to repeat purchases when ink and paper run out.
• Matching the competition: When a company sets prices equal to its competitors, the focus shifts from price to the product or service itself. This can happen in industries heavily regulated by the government, as U.S. airlines were before 1978. Before deregulation, 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 where a company initially charges a high price for its products or services and then gradually lowers the price to attract a wider audience. Companies employ this strategy when they want to recover sunk costs upfront.

Fashion companies have long used price skimming for unique specialty products in the marketplace. When an innovative new product is released, the price is initially expensive. The company is targeting a smaller pool of consumers willing to pay the high price at launch.

Once the company captures all of the buyers it can at the launch price, it begins to slowly lower the selling price over time. This strategy captures price-sensitive customers while putting pressure on other fashion retailers that enter the market.

When to use: This strategy is used when you have a buzzworthy product in your industry, with early adopters clamoring to get it first. It also helps you create an air of exclusivity; only those with certain budgets can afford your product.

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. For this to be sustainable for the business — and ultimately profitable — prices must eventually be raised.

When to use: Many software companies launch using penetration pricing to make a splash in the market, and then move to competition-based pricing after they’ve gained some brand recognition. This disruptive strategy may incur early losses for businesses that use it, but the hope is 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 — in other words, what they perceive as valuable. You can see value-based pricing in luxury products such as leather handbags, automobiles, and high-end makeup brands.

While the quality may not be measurably different from its lower-priced competitors, luxury brands use marketing to become status symbols for consumers and send the message that their products are high value. When this is successful, buyers are willing to pay a premium.

When to use: With value-based pricing, you need to build a brand focused on value — conveying unique benefits, features, and offerings of your products.

Luxury brands do this well, but the actual value of the product doesn’t always match the perceived value; their pricing is often based on how much their customers think they’re worth rather than on production costs or competition. A substantial investment in marketing, research, and PR is required for this to be a successful formula.

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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 fast market penetration. But these are just some of the big wins from pricing correctly.

Here are additional benefits 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 it worth to you for that convenience? 
• 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. 
• Building brand ambassadors: People who believe in your brand are more likely to become advocates, leading them to recommend your products or services to friends and family. They may also offer positive reviews online or tag your brand in social media posts.
• 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 in the exchange of goods and services that the market will bear.

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How to create a pricing strategy: 5 points to consider

Choosing the best pricing strategy for your business doesn’t have to be a headache. Here’s how to get started:

1. Understand your goals

Think about what you want your business to achieve. Do you want to grab customer attention quickly with an enticing new product launch? Then maybe you’d go with penetration pricing. Are you trying to build a reputation for your luxury brand? Value-based pricing might be best.

2. Analyze the competition

Make sure you understand what your competition is offering in the marketplace and how much they are charging. This will help you set your pricing because it will give you an idea of what others are willing to pay for similar products.

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

3. Research your target market

Knowing your target audience is a key step in determining your pricing strategy. Understanding who your target audience is, including their age, gender, location, likes, dislikes, and values, gives you a better shot at appealing to the right people with the right offer at the right price.

4. 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. Keep in mind that some strategies, such as penetration pricing, may be effective during a product launch but are typically not a sustainable long-term strategy.

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.

5. Test your prices, then learn and adjust

Once you’ve picked 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. And in those moments, that’s okay.

If you want to see what dollar amount works, try A/B testing your price on a product page. For example, if you’re selling a book, you could create two landing pages — one priced at $11.99 (with a low-cost add-on, perhaps) and the other at $9.99. 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 me how much most people are willing to pay.

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Tips for setting pricing strategy from 20 years in sales

As the founder of The Harris Consulting Group and with more than two decades of experience in sales, I know what the market bears and I price right in the middle. I don’t ever want to be the most expensive, because when someone turns around and asks for a discount, which everyone does, I can easily come back and say, “My price is based on what the market will bear. How would you like to proceed?”

If you want to see your business grow and flourish, you must first develop an effective pricing strategy that’s 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 the economic impact based on the pains they are experiencing in their current ways to solve their problems. This includes what they would be able to do better and faster once they implement your solution. As human beings, we are all comparison shoppers.

Understanding your production costs is also key, of course. This 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, and insurance; and manufacturing costs, services, and labor.

Invest in the right pricing strategy

Getting your pricing strategy right is critical for the health of your business, so it can be an intimidating idea to tackle. Luckily, it’s not a one-and-done motion. Pricing strategies are all about testing what the market will bear, then adjusting based on what you learn. For the health and growth of your company, investing time, money, and resources into your pricing strategy will never be a gamble — it’s an investment in your future.