How Should You Price Your Products?
So, you’re starting a business, you’ve got a million and one things to do, you reach the stage where you need to decide on your pricing structure and your first thought is ‘Who cares, just sell it for whatever, as long as it sells’. After all, selling your product is more important than how much you’re selling it for right?
Well, not quite. Unfortunately, your pricing structure isn’t something you can quickly gloss over. Customers are extremely responsive to prices, so you need to take the time to establish a clear and justified pricing strategy to ensure you’re maximising your sales.
Value Positioning and Margins
The two core foundations of any strong pricing strategy are value positioning and margins. These are crucial as they represent the two sides of pricing to represent middle ground (or equilibrium as economists call it). Your value positioning is all about the customer, who buys a product based on the value they expect to get from it. They’ll rarely buy a product that they don’t expect to receive at least the same value as it’s price. Bonus points, if they expect to gain more value than the advertised price.
For you, that means you have to have a strong understanding of what your customers value and how well you deliver value compared to your competitors.
On the other side of the pricing coin, are your profit margins. You probably know all about profit margins already. It’s simply the price minus the production and sales costs. Also keep in mind, your profit margin generally doesn’t factor in the businesses fixed costs; that generally gets deducted out of your profit margin.
For you, that means you have to accurately calculate your total sales and production costs on a per unit basis. You then need to set a target margin in order to calculate the prices necessary to earn your target profit.
Let’s start at the top shall we. Going with a premium pricing strategy, where you set your price higher than your competitors, means that you think your product has the best-darn-value-proposition-of-all-time. And that’s completely fine, as long as you have the evidence to back it up. Have you conducted usability testing and surveyed your target customers to see whether they think your product is head and shoulders above the rest?
To make premium pricing work, you need to put a lot of work into your value perception. Not only does the product have to be high-quality, you need to ensure your marketing, packaging and store outfit all make the customer scream ‘this is worth it’. Otherwise, you’ll have a tough time justifying the hefty price tag.
Market Penetration Pricing
On the other end of the spectrum, you’ve got your market penetration pricing. The sole focus of this strategy is not profits, but market share, which is the percentage of your target market that buys your product rather than a competitor’s. By setting your prices below your competitors and even at a level that results in the business losing money, allows you to quickly gulp up market share. The theory is that once you’ve got the market share you’re after, you can bump up the prices to help turn a profit. And if your customers are satisfied and the new price is still around the average market price, you’ll be able to maintain most of that market share.
The most obvious examples are the businesses that employ people to stand around in public places and hand out discount cards, such as UberEats and Deliveroo. The tactic is to get you hooked on the service with an early discount and when you come back as a satisfied customer, you’ll be paying the full price.
Just above that, you’ve got your economy pricing. The name of the game here is volume; you set your price to have quite a small profit market and appeal to the price-conscious customers. You minimise your costs wherever possible and provide the no-frills alternative in the market. It can be quite difficult for a small business to survive with this method, but for the large corporation, it can be lucrative. Think Kmart and the Iconic; margins aren’t high, but volumes sure are.
In a similar way, bundle pricing works to boost volume while reducing the profit margin of each sale. It’s quite a simple technique; you sell multiple items together at a lower price. As a result, you sell a higher quantity, but make less on each individual product. That could be a restaurant offering a free or discounted dessert with every main meal purchase or a buy-one-get-one-half-price deal with shoes.
This strategy is often most effective when a business has old inventory they’d like to sell. It works particularly well if the business has a line of complementary products, such as shoes and socks.
If you’re entering a new market with few competitors, you could adopt a price skimming strategy. The strategy relies on there being few alternatives to your product, so that you can set prices a little bit higher and skim some off the top. In essence, you’re acting as a short-term monopoly. But of course, you’ll inevitably get undercut and have to lower your prices when more competitors enter the market.
We’ve barely even scratched the surface of pricing strategy in this piece. Marketers are increasingly using psychology to guide their pricing strategy. The goal is to shift the decision from a purely monetary decision to an emotional decision. The most common example is the ‘left-digit effect’, where a product is priced at $99 rather than $100 to make the customer perceive it as cheaper, even though there’s only a $1 difference in price.
Integrating psychology isn’t by any means limited to pricing either. Businesses are getting smarter about their marketing every day. The key is to align your pricing strategy with your marketing strategy and ensure you’re sending a consistent message to the customer.