Pricing is something that every business must consider. Quickly pricing products without much research or consideration can help to get a product to market in a short period of time. But pricing is one of the most important elements of a successful business. And for that reason, pricing should not be a quick, haphazard process - it should be an intentional sales strategy.
While there are many pricing variations, there are three pricing strategies that provide the foundation for the majority of the others. As a business owner, you can easily hack the pricing of your offering (product or service) by following one or more of these three pricing strategies:
The first of the three pricing strategies is the cost-approach. In this method, prices are based around the actual cost of offering a product or service.
For example, let’s assume a maintenance company employs a skilled worker that costs $24 an hour in wages and benefits. Because of travel and scheduling, the business is only able to bill 6 of the 8 hours the employee works. Therefore, the daily cost of the employee would be $192 a day ($24 x 8hrs). To break even on the employee expense at only 6 billing hours a day, the company would need to charge $32 per hour ($192/6hrs). If a revenue margin of 20% is desired from each billable hour, the pricing would be set at $40 per hour (20% of 40 = $8).
As we can clearly see in the example, this approach is designed from a bottom-up approach. This means that a price is set by first determining the cost of offering a product or service and then adding in a desired profit margin. This approach allows a business to offer prices at their lowest available price which can ensure that they do not take a loss on a product while also offering the lowest price to the customer.
Compared to the bottom-up strategy of the cost approach, value-based pricing is a top-down approach. This approach first focuses on the value of a product or service and then pushes the price down, well below the perceived value.
For example, I have an issue with heights. I would happily pay someone $50 to clean my upper gutters as it really isn’t something that I can do. Following the example we just discussed regarding the cost-approach to pricing, let’s say it would take the maintenance company 30 minutes to clean my upper gutters. Billing on a cost-approach, they would charge me $20 for the half hour job ($40hr/2), an amount far below what I perceive the service to be worth.
In a value-based approach to pricing, the maintenance company would convince me that the value of the service is $50 (or more) and then offer the service for less than the perceived value, such as $40. I am happy to pay less than my perceived value of $50 and they are happy to get paid more than their standard rate of $20 for the half hour job.
The last of the three pricing strategies is the market-driven approach to pricing. In this approach, pricing is set based on the market, such as competition or supply and demand.
When a product first comes to market the supply is often limited and the product may only be offered through a small number of sales channels. In this initial phase, pricing (and the associated profit margins) is often set fairly high as the demand outweighs supply. The product is somewhat difficult to find and consumers are willing to pay a premium for this rare product. Over time, however, more and more sales channels begin offering the product which ultimately drives down the price of the product.
For example, I remember the first time I saw a pair of Crocks for sale. Crocks are those light foamy shoes that are a mix between a shoe and a sandal. The Crock was very innovative and was initially priced fairly high. In fact, my father-in-law used to purchase large quantities of Crocks in one part of the country he traveled to and then would sell them at a local flee market for a fairly significant profit margin.
Over time, however, more and more retailers started selling Crocks and eventually Crocks could be purchased at Walmart for a less than what my father-in-law could buy them for. When this happened, my father-in-law had to look for a new product to sell as the supply of Crocks finally outpaced the demand.
Unlike the cost approach to pricing, the market approach sets pricing levels based on external factors such as supply and demand.
Other Pricing Variations
These three strategies are really just big-picture strategies, as many variations of each strategy are often utilized. Strategies such as decoy pricing and freemium pricing are versions of value-based pricing while penetration pricing and predatory pricing are variations of market pricing. Other strategies such as the cash flow consideration approach and the odd pricing approach also provide innovative strategies for pricing.
In addition, some pricing strategies utilize a combination of one of the three pricing strategies we discussed in this article. It is important to create a sales process that fits your organization.
A Question For You
What variations of these three pricing strategies have worked best in your business?