Choosing a pricing strategy for your products and services is fundamental to the success of your business. It sets the tone for everything that follows: defining customer expectations, determining your target market, and, of course, governing your profit margins and how much money you make with each sale.
Three main factors will govern the prices you end up charging:
- Customer: Who is the target audience for your product, and what would they be willing to pay? Understanding your target audience requires significant market research, determining buyer profiles, their average salary, how much disposable income they have, and how much money they spend on similar products. For small businesses in particular, it’s important to target specific markets, developing a product or service that differentiates itself from larger-scale operations.
- Competition: Your product isn’t competing for customers in a vacuum. It’s likely in a crowded marketplace and needs to find its niche among the competition. Research businesses with similar offerings to determine their unique value proposition and what they’re charging for it. Determine where your product fits in the existing marketplace to gain an understanding of what it would be possible to charge.
- Costs: How much does it cost to make and sell your product? To be profitable, your prices need to cover all of your costs (both fixed and variable costs) with money left over. Before setting a price, dive deep into every single cost you incur, not just the obvious ones such as raw materials, rent, payroll, etc. For example, how will you sell your products, what payment types will you accept, and what transaction fees will that incur? Much of running a business is finding ways to keep costs to a minimum. Many businesses save money on transactions by utilizing cheaper forms of payment, such as EFTs and learning how to do an ACH transfer.
While other factors can come into play, most pricing strategies are the result of balancing these three factors. Listed below are six pricing strategies to consider for your business.
Six pricing strategies
- Cost-plus pricing: A simple pricing strategy that calculates the total cost of selling a single unit (whatever that entails for your business) and adds a markup for profit. For example, the cost of one unit is $20. You add a 20% markup and sell the unit for $24, making $4 on each sale. Cost-plus pricing is generally applied to lower-cost goods. It ensures the business makes a profit on each item. However, competing with other businesses on price is limited by your internal costs, and it also may lead to untapped earnings if your target market is willing to pay more.
- Value-based pricing: A strategy that sets the price of goods based on the customer’s perceived or estimated value. Value-based pricing requires significant market research to understand what the perceived value of a particular product is. Typically, a business would set its price slightly below the perceived value to maximize profits while giving the customer what they see as a good deal. Value-based pricing is more successful when there are fewer competitors in the market. Also, businesses must remain up-to-date on customer perceptions as the estimated value of products changes with time. For example, if a new business offers a product of similar quality at a lower price, undercutting the market.
- Premium pricing: A type of value-based pricing that targets premium markets by increasing the perceived value of your product. To utilize premium pricing and charge more for your goods, you need to establish the quality of your product compared to the competition. You also need to support the product by building the brand around your product and targeting specific customers. While challenging, premium pricing offers higher profit margins.
- Competitive pricing: This pricing strategy is based solely on the price of the competition. Factors related to the customer and your costs are secondary to the competitor’s price. This value is used as a baseline, with businesses either choosing to undercut the market (at a lower profit margin) or to charge more based on the higher quality they offer. Competitive pricing is simple to implement, as all you need to do is keep track of your competitors. You don’t have to develop specific customer profiles.
- Price skimming: A strategy that sets prices initially high before lowering as new competitors join the market. Generally used for new products on the market or if a business is able to corner the initial market (e.g., first business open in a new location).
- Penetration pricing: The inverse of price skimming, penetration pricing sets prices low at first with plans to raise them later. Penetration pricing aims to build market share when there is a lot of competition and then raise prices once the product is established.
Competing solely on price as a small business
Unfortunately, as a smaller business, the economy of scales is stacked against you. No matter how efficient you are, if you’re trying to compete with Amazon on price, you will fail. Big operations will always have the resources and the scale to offer lower prices.
So, if you can’t win on price, don’t make that your win condition. Small businesses need to find another way of competing. That could be:
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- Creating a unique product based on your skills or connections to locally sourced materials.
- Offering great service and building a rapport with customers.
- Great marketing and brand building.
- Targeting a niche market with your products and services.
- Finding customers who want to support smaller or local businesses rather than buying generic products the same as everyone else.
Finding a pricing strategy that works for your business
Pricing is critical to every business, and you need to find an approach that offers value to the customer and is in line with your direct competitors while also turning a profit.
However, as a small business competing in the modern marketplace, you can’t rely on pricing alone. You need to find a way to differentiate yourself from the competition and target customers looking for something different than mass-produced products and faceless customer service.
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