Updated June 21, 2021

Introduction to Pricing Strategy

Pricing is an incredibly important decision-making process for any business because cash flow and profit determine success. Prices set too high lose sales and deter customers, while prices set too low rob the business of revenue. A good pricing strategy is aligned not only with business financials, but also marketing strategy, product design, and company core values.

External factors that impact pricing include consumer psychology, demand, competition, and broader market and economic trends.

Commonly overlooked pricing considerations are the cost of carrying inventory, unforeseen overhead, and the cost of time. Transactional costs are also a category to consider depending on where and how you sell our product or service. Payment processing fees, taxes, and point of sale systems all add cost to transactions.

Cash is the lifeblood of any company, and startups that face cashflow problems have a tough time staying afloat. In general, it is best to start high and adjust pricing as needed. During Covid-19, Alinea Restaurant in Chicago fought to stay afloat despite not being able to welcome guests in its renowned dining room. Nick Kokonas, co-owner of the Alinea restaurant group, detailed how Alinea pivoted their product offering and pricing model in an interview on the Tim Ferris Show.

Strategic Pricing Considerations

What are you selling?

Physical Product
Digital Product
Service

Who are you selling to?

Direct to consumer
B2B
Indirect/other e.g. healthcare

Pricing Economics

The Impact of Supply and Demand on Pricing

The law of supply and demand may be the most well known economic concept related to consumer purchase behavior. When something is in high demand and low supply, expect prices to soar. In contrast, when there are lots of options or a surplus of supply prices tend to drop.

Sensitivity to Price Increases

Price elasticity of demand describes how a change in price affects consumer demand. For example, Uber’s surge pricing shows that people are willing to pay more than standard cab fare to get a ride during peak times, inclement weather, and other surge-worthy events. When consumers still purchase a product despite a price increase that product is considered inelastic, and when consumers stop purchasing something after a price increase that product or service is elastic.

% Change in Quantity ÷ % Change in Price = Price Elasticity of Demand

Cost-Based Pricing Models

Cost-based pricing is the most well-known and commonly used strategy. In a cost-based model, Cost of Goods Sold (COGS) is calculated and a desired profit margin determines the markup. In a retail setting for example, a 50-100% is typical for MSRP. Geographic Pricing Models are a sort of cost-based model that take into account the cost of labor and other factors heavily dictated by the place of business. In the digital marketing landscape, one downfall of traditional cost-based models is the calculation of customer acquisition cost. Customer acquisition cost is a dynamic variable, as ads and campaigns will have different levels of success.

Dynamic Pricing Models

Dynamic pricing is a formulaic approach to pricing that is also known as surge pricing, demand pricing, or time-based pricing. It’s a mathematically calculated, flexible pricing strategy that considers variables such as competitor pricing, availability, demand, and time. Hotels, airlines, event venues, and utility companies are examples of businesses that employ dynamic pricing models. To use a dynamic pricing model a business tends to have complex algorithms and technology in place.

High-Low Pricing

If your product is seasonal or will become obsolete, high-low pricing might be effective. A high-low approach starts with a high price and lowers the price as the relevance or usefulness of the product declines. End of year car sales, retail clearance sales, and seasonal fashion are examples of high-low pricing models.

Hourly Pricing

Hourly pricing is a common wage-based model used for consultants, agencies and freelancers. Service-based businesses may also rely on project-based and outcomes-based pricing models to sell services.

Recurring Pricing

Subscription-based pricing models are popular for service-based businesses like online data storage or software. Product businesses that want to offer free shipping and other perks like Amazon offer memberships like Prime, or the Doordash Dash Pass.

Alternative Pricing Strategies

Radiohead released the “In Rainbows” album with a ‘name your price’ strategy. Fans had the option to download the album at no cost, or chip in what they wanted to the band through a digital tip jar. This was an innovative approach that led to anticipation and purchases of the $80 box set of the album they subsequently released. Developing a unique pricing strategy can fit nicely into a product launch or marketing plan.

Competition-Based Pricing Models

Competition-based pricing strategy uses the competitors’ prices as a benchmark. Businesses who compete in a highly saturated space may choose this strategy since a slight price difference may be the deciding factor for customers. With competition-based pricing, you can price your products slightly below your competition, the same as your competition, or slightly above your competition.

Penetration Pricing

Penetration pricing is a go-to-market pricing strategy where a company offers a very low initial price in order to capture market share. For example, Netflix was able to glean a large following of video rental customers by offering its mail subscription services for under $10. Many crowdfunding campaigns utilize this go-to-market strategy that many times leads to a short term loss.

Bundled and Tiered Pricing

Freemium Pricing

A combination of the words “free” and “premium,” freemium pricing is when companies offer a basic version of their product hoping that users will eventually pay to upgrade or access more features. Online services, digital gaming, and professional services like Google Drive are examples of Freemium products. Free trials and tiered pricing are common, as are ‘good, better, best’ options to steer consumers toward the most popular option.

Bundle Pricing

Bundling products or services is a way to offer more value to consumers while increasing your average sale. Gift sets, home security systems, and kits are examples of bundled products.

Loss Leader

Big retailers may lure shoppers in with a great deal that they lose money or break-even on in order to get customers to buy other things in store. This loss leader approach panders to consumers who love deals (and don’t we all?).

Psychological Pricing

Consumer psychology is an interesting and complex topic. Psychological pricing on a basic level refers to a consumer’s willingness to pay for something, but also relates to the mental and emotional biases that impact the way we make buying decisions. For example, studies have shown that consumers tend to buy things with prices ending in odd numbers, and especially the number 9 - explaining why many items you see end in $0.99. High end brands may opt for rounded pricing with the cents not shown. Brands like Costco have pricing structures that show items that will be discontinued. Seeing a price with a line through it and a red sale price excites consumers looking for deals. It is important to consider psychological factors and how design elements like font size, color, and other pricing content may impact sales. Anchoring and adjustment is an important cognitive bias to consider in the pricing discussion. If your product is placed next to a more expensive product, your product becomes a ‘deal.’ Offering three service plans to steer consumers toward the middle plan is an example of anchoring and adjustment. Another psychological buying phenomenon relates to fear. A consumer’s FOMO on not getting access to a limited edition product or missing out on a limited time deal can be powerful motivators for purchasing.

Value-Based Pricing

Value-based pricing seems like it would be rooted in economic costs, but a consumer’s perceived value and willingness to pay for something may have emotional and other psychological factors. This pricing method focuses on economic demand and consumer psychology. When consumers have high perceived value for a product or service, their experience with the brand and long term customer loyalty is positive.

Premium Pricing

Premium or prestige pricing focuses on the perceived value of a product rather than the actual value or production cost. Prestige pricing is a direct function of brand awareness and brand perception. Brands who apply this pricing method are known for providing value and status through their products — which is why they’re priced higher than other competitors. Fashion and technology are often priced using this strategy because they can be marketed as luxurious, exclusive, and rare. While scarcity drives up price in the law of supply and demand, exclusivity and false scarcity can drive up price in prestige pricing models.

Social Enterprise Pricing

Whether a non-profit or for profit business, social impact is woven into many businesses. Omaze, which raffles experiences with celebrities to raise money for causes, is actually a for-profit company, despite their primary mission being based on social impact. When integrating social causes into your product or service offering, it’s important to make it clear and easy to understand what impact a purchase has toward a cause. For example, when customers purchase a pair of BOMBAS, the sock company donates a pair of socks to a person in need.

Online Business Pricing Strategy