Pricing Best Practices
September 25, 2020
THE FUNDAMENTALS OF PRICING
A common approach store owners make when pricing their products is relying on numbers set by competitors. It’s a strategy that may work for some, but it’s a missed opportunity for most. By disregarding the other fundamentals of pricing, these store owners are likely not asking for the amount customers are actually willing to pay.
This won’t be you.
The following is a breakdown of each factor you need to consider in order to strategically price for maximum profitability.
1. MARKET RESEARCH
Set aside time to learn more about your target customers. Understanding them will help you understand their purchase decisions. Look for valuable information such as location, age range, hobbies, average salary or household income, gender, etc. This data ultimately helps you determine the likelihood that they purchase your products.
This a page from the beauty industry. In 2015, a study from New York’s Department of Consumer Affairs, called “From Cradle to Cane: The Cost of Being A Female Consumer,” revealed that women consistently paid more than men for similar goods, with the highest disparities belonging to personal and grooming products.
Tip: A market research agency can compile the information you need, though it may cost a considerable portion of your marketing budget. Consider starting with publicly available information first, such as government wage and employment statistics at www.census.gov.
2. BUDGETING AND ACCOUNTING
Do you know the cost of running your business? When setting prices, don’t forget that your first goal is to cover expenses like:
- Salaries of Full-Time Employees
- Hourly Wages for Contractors
- Product Costs
If you’re unsure on how to approach budgeting and accounting, consider purchasing user-friendly accounting software or hiring a CPA for help.
3. REVENUE GOALS
How much money does your business need to make to break even? You can find an example with formulae and a walkthrough here.
Maintaining a revenue target for every month, quarter, and year can influence your product pricing strategy.
4. COMPETITIVE ANALYSIS
As we mentioned from the start, your competition’s pricing should not be your main focus. However, it is an important factor that deserves consideration in your overall strategy.
Competitive analysis is as easy as conducting a Google search for products targeting your key phrases. Look within both organic listings and sponsored results to gauge their pricing strategy. Additionally, you can use Google’s keyword planner to gauge how much competitors are paying to show up there.
5. PLANNING AHEAD
Regardless of what you sell, planning ahead is especially difficult for every new business. That’s not nearly a good enough excuse to disregard it. Having financial projections for the next quarter, year, or even 3-5 years will help you prepare for market gains and losses. Remember, you can always change your projections as the industry changes.
7 APPROACHES TO PRICING
The right pricing strategy can help you attract more customers, encourage larger orders on average, and create repeat purchases. Use this guide to determine which of these 7 common approaches to pricing is best for your business.
TIP: Combine or adjust these strategies to meet your unique business goals.
- KEYSTONE PRICING
Keystone pricing is one of the most common pricing strategies, thanks to its simplicity. The final selling price is 2X the item’s cost.
Keystone pricing is the best place to start whenever possible. However, the likelihood that it remains your only pricing strategy is low. Many of today’s products simply cannot be set at keystone due to high product costs versus the general market rate.
Consider another pricing strategy if your business competes at either ends of the spectrum — from discount competitors to high-end luxury brands. Adopting keystone pricing at either end nearly guarantees a loss.
Keystone pricing is a simple and straightforward approach to pricing. However, it doesn’t account for supply and demand, a critical component of maximizing revenue.
- MULTIPLE UNIT PRICING
Multiple unit pricing, multiple pricing, or bundle pricing offers shoppers a lower price per unit for the purchase of two or more products of the same type.
Multiple pricing is particularly useful for clearing excess inventory or introducing new products. Use this strategy sparingly or customers may think your regular items are overpriced and will eventually be discounted.
The ideal time to use multiple pricing is at the end of a season for products that have not sold well or when you need to introduce new products that customers may be hesitant to try.
TIP: Read up on your state’s regulations when considering these strategies. For example, some states will not allow you to sell products below cost or giving products away for free.
- DISCOUNT PRICING
Discount pricing offers price reductions to customers through sales events or special offers.
Lowering the price of a product to encourage purchases is a conventional strategy employed in every area of sales, but simply announcing your latest price drop may not be enough. It can even have adverse effects if your customers perceive the discounted price as the product’s true value. Effective discounting dispels this idea and creates a sense of urgency.
Discount offers are not a one-size-fits-all. Let your product influence your strategy — specifically, gauge its relevance to the market and its sales history.
Discount pricing is an easy way to attract new customers and works best when timed for special events or holidays.
TIP: Provide a reason for every discount. Otherwise, customers will think less of your brand and product value.
- LOSS LEADER
A loss leader is a product priced below its market cost to stimulate the sales of more profitable goods or services.
Loss leader strategies are great for traffic generation and product introduction. For example:
- Magazine publishers can attract more long-term subscribers by offering the first few editions at little to no cost.
- Cable service providers can offer lower pricing on a competitive feature to recruit new annual contract signups.
- Hardware stores often sell larger tools for cost or below, expecting customers to buy accessories along with the new tool. Accessory items tend to have a much higher profit margin, and are often impulse buys.
The past success of loss leader pricing has led to many states passing laws that severely limit — or explicitly forbid — selling products below cost. For some, these limitations may actually be a blessing. Loss leader strategies can backfire, with customers purchasing only products that are priced near or below acquisition cost. Such purchasing patterns effectively foil the strategy underlying loss leader pricing.
The loss leader strategy is great for marketing efforts and acquiring new customers. However, carefully consider your loss leader product and how you intend to promote other offerings in parallel so that your loss is actually a gain. Most importantly, be aware of your state’s laws on loss leaders.
- PSYCHOLOGICAL PRICING
Psychological pricing relies on the nature of human psychology to make prices appear more attractive to consumers.
There are several types of psychological pricing: odd-even pricing, prestige pricing, anchor pricing, and price lining.
- Odd-Even Pricing: The practice of setting prices in odd numbers just below an even price. For example, marking an item $19.99 rather than the even price of $20.00. This strategy makes the price appear considerably lower than it is.
- Prestige Pricing: On the opposite end, prestige pricing inflates prices in order to create a sense of greater value. For example, a “limited edition” canvas print might be priced at $70 rather than $30 to give the impression that it is a better and rare product.
- Anchor Pricing: Anchoring refers to the consumer’s tendency to heavily rely on the first piece of information offered when making decisions. To apply, place premium products and services near standard options to help create a clearer sense of value for potential customers. They will perceive the less expensive option as a bargain in comparison.
- Price Lining: Better suited for businesses with an extensive product line, this tactic involves creating a price range for a particular line. For example, Brandless.com has built an entire business on this strategy with all items priced at $3.
Psychological pricing allows business owners to influence how consumers perceive a product’s value without actually changing the product. This makes it a cost effective way to influence consumer purchase decisions.
TIP: Research shows prices ending in “9” are more likely to drive sales.
- BELOW COMPETITION
This pricing strategy requires retailers to list competing products at prices lower than the competition’s.
Pricing below competition can help businesses carve out a market niche, appealing to every consumer’s love for low prices. However, by guaranteeing lower prices and therefore lower profit margins, you will not make a significant return on this strategy until you can realize a large sales volume. Additionally, even with low overhead costs secured, you remain subject to your competitors’ actions, i.e. price wars.
One of the worst outcomes of below competition pricing is a “price war,” where competing businesses race to cut costs and ultimately hurt their bottom line and their brand perception. Some companies have resolved price wars while still maintaining below competition prices by redesigning their products for fast and easy manufacturing.
Pricing below the competition is a common pricing strategy because it’s easy, but it’s also dangerous if you don’t have a clear understanding of your business’s financials.
- ABOVE COMPETITION
Retailers price above the competition when they have a clear advantage on non-priced elements of their products, services, and reputation.
In order to charge an amount above the competition, you must differentiate your brand and products. For example, Apple can consistently charge consumers more because they’ve established a reputation as makers of high-quality products, ensuring the market sees its offerings as unique or innovative.
Have a good reason if your products are priced significantly higher than the competition.