Finding the right price for your product or service is tough. Just simply calculate your costs and add a markup is not enough anymore.
Whether you are a total beginner or already advanced in pricing, this blog will introduce you the five main models for pricing strategy to help you get a better feeling about what to choose for your business to get paid for the value your customers perceive.
The 5 most common pricing strategies
In previous posts, we have spoken in general terms about the importance of pricing strategy and why, out of all the other factors which impact on profitability, pricing has the biggest effect. We have also looked at the relationship between pricing and demand, explaining the role of demand curves in identifying an optimum unit price for a product.
Depending on the literature you read, the number of defined pricing strategies out there easily runs into double figures. But most analysts agree that these can be boiled down to five main categories which we will now share with you.
1. High price
Also known as premium or luxury pricing, this approach is commonly adopted by brands that want to build and maintain their identity around quality and exclusivity.
It is based on the reasoning that certain customers would prefer to pay higher prices in return for a brand with an exceptional image and credentials
– price in itself becomes a key differentiator.
Because unit prices are kept high, margins are also extremely healthy. The calculated risk is knowing you have the kind of brand equity, as well as the quality of products, that will keep demand and sales strong.
There are high profile examples of brands that thrive on premium pricing strategies right across the world. It is often the choice in commerce business, from luxury motor car marques like Bentley and Rolls Royce to watchmaker Rolex. For these brands, paying more than you would have to pay for similar products from other vendors is part of the appeal for customers. It’s like buying your way into an exclusive club.
A pricing phenomena we see in fashion at the moment are exclusive “Drops”. By using this tactic, brands release very limited runs of a new garment and charge exceptionally high prices for them.
Widely credited to have been masterminded by New York streetwear brand Supreme, it is an approach that has been adopted successfully by the likes of Gucci, Adidas, Nike and Louis Vuitton in recent years. Besides enjoying high profit margins, this approach has another goal. “Drops” are also enabling fashion marques to get the most out of their own direct-to-consumer online channels, attracting consumers away from mainstream retail channels to their own websites with the promise of cutting edge, limited edition runs.
Although the likes of Nike and Adidas have become well known for their premium-priced ‘drops’, the majority of their business is built on what might be called a mid-price model
– an everyman, all-things-to-all-people approach.
A mid-price strategy can be seen as trying to strike a balance between a reputation for quality and good value. Unlike premium pricing models, the aim is not to target people who like to spend big, but rather to appeal to the mass market and therefore gain deeper penetration. At the same time, many brands are also conscious of pushing prices too low, as they don’t want customers to start questioning if the quality stands up and start thinking of them as a discount brand.
Mid-range pricing strategies are the most common type you see in mass market goods because they seek to find a middle-ground compromise between all competing factors – costs versus revenues, quality versus value, demand versus competition.
3. Low price
Low or economy pricing is arguably the strategy that takes the principle of the demand curve most literally – that if you drop your prices, demand will increase. That’s great if you want to boost your sales volumes, but the flipside is that lower unit prices mean lower margins.
Economy pricing is widely employed by specialist discount or value brands that seek to
– make high demand profitable by cutting back costs as far as possible.
Most supermarkets engage in economy pricing on the core grocery lines they sell, using their buying power and economies of scale to drive down wholesale costs. Most also now produce their own ‘no frills’ product lines, pushing down costs further still with minimal branding and marketing expenditure.
Budget airlines like Ryan Air are also renowned for their low price strategy. They are focusing on offering the cheapest price in the market and bring you from A to B on time. No more, no less.
4. Price skimming
Price skimming can be seen as an attempt to straddle the divide between premium and mid-range pricing strategies.
What it typically involves is brands rolling out new products at a high price point, banking on creating a lot of hype around the launch and the fact that early adopters are often prepared to pay whatever it takes to get first look. After this early shot for profits, prices will be scaled back to more of a mid-range point, seeking to broaden the appeal and keep sales volumes high.
Skimming is very common in electronic device markets such as smartphones and games consoles. Brands like Apple, Samsung and Sony are renowned for skimming – the Playstation 3, for example, originally retailed in the US for $599, but was reduced over a period of a couple of years to just a third of that original price.
– Skimming aims to segment consumer markets into different bands:
● Early adopters who show inelastic demand however high the price is
● Mainstream shoppers
● More value-conscious buyers
By treating each segment as separate, and drawing a different demand curve for each, brands determine a series of optimum price points that they can adjust to over time, trying at each stage to minimise the consumer surplus – the difference between what people are prepared to pay for a product, and what they actually pay. In other words, price skimming tries to find the optimum price for different groups at different times.
This strategy works well for brands that exert a near-monopolistic influence over a market – Apple, for example, at various stages has known that the main obstacle to people buying its iPods, iPads and then iPhones is price, rather than competition. Adjust the price, and you can hoover up everybody. But once competition increases and rivals are prepared to undercut a brand’s price on launch, skimming becomes much harder.
Finally, penetration price strategies can be seen as working in the opposite direction as skimming.
They see products launched at a budget price point, and then gradually increase towards the middle ground. This is the classic “special introductory price” strategy, and
– the goal is to rapidly grab market share, rather than aim for profitability.
Penetration pricing is the model often adopted by disruptors looking to enter an already crowded market and attract customers away from incumbent brands. It works most effectively when markets are highly saturated with little product differentiation – someone coming along and offering a better price is then enough of a point of difference to attract custom.
To follow on from the consumer gadgets example used above, smartphone vendors like Samsung and, later, Huawei adopted penetration pricing as a way to grab market share from Apple, which dominated smartphone sales at first. Both companies were highly successful, and now boast a bigger share of the global smartphone market than their Californian rival.
Plus, in classic penetration pricing style, both Samsung and Huawei have gradually moved away from aiming to undercut the market to now providing products at a wide range of price points – including the premium end Apple deals in.
Unlike economy pricing, penetration pricing is not about squeezing every last drop of margin out of low prices through aggressive cost cutting. It is about deferring profitability until you have the market muscle to either gradually raise prices, or start to up-sell more profitable products.
A classic example here is Uber. Widely regarded as one of the greatest disrupters of the digital age – a ride-sharing app that changed the private vehicle hire market the world over – Uber spread like wildfire on the back of a ground-breaking, uber-convenient app-based purchasing model and lower prices than most standard taxi firms. It grabbed market share ok, but profitability has remained stubbornly elusive.
Ironically, Uber is now the target of dozens of new entrants all over the world looking to grab its market share with lower prices – DiDi in China and south-east Asia, DiDi-backed Lyft in the US, Bolt in northern and eastern Europe. That makes it virtually impossible for Uber to get to where it wants to be, raising prices in a market it thought it had snatched control of.
Pricing is a Process
Considering everything that goes into an effective pricing strategy can easily make your head spin: labor, material costs, logistics, demand, competition … the list is endless. Thankfully, you don’t have to master everything at once.
Simply sit down, look at your current sales data and see how effective your pricing is today. Start with playing around with your prices and consider the impact on your sales volume. This will help you pinpoint the right kind of pricing strategy to use.
More than anything, though, remember pricing is an ongoing process. It’s highly unlikely that you’ll set the right prices right away — be assured that it often takes a trial and error approach until you find the right prices for your business, and that’s OK.
th!nkpricing is a brand of Smart Pricer. We are making professional pricing accessible to everyone by offering a platform to understand, simulate, and optimize your pricing with machine learning-driven algorithms and advanced demand prediction.
Want to stay in the loop and become a #pricinghero? Subscribe to our thinkpricing newsletter to not miss any upcoming blog posts.