Product Pricing Strategies
Discover how to properly price your products or services so you can drive both revenue and profit.
What is pricing
Pricing is defined as the amount of money that you charge for your products, but understanding it requires much more than that simple definition. Baked into your pricing are indicators to your potential customers about how much you value your brand, product, and customers. It's one of the first things that can push a customer towards, or away from, buying your product. As such, it should be calculated with certainty.
The importance of nailing your pricing strategy
Having an effective pricing strategy helps solidify your position by building trust with your customers, as well as meeting your business goals. Let's compare and contrast the messaging that a strong pricing strategy sends in relation to a weaker one.
A winning pricing strategy:
Portrays value The word cheap has two meanings. It can mean a lower price, but it can also mean poorly made. There's a reason people associate cheaply priced products with cheaply made ones. Built into the higher price of a product is the assumption that it's of higher value.
Convinces customers to buy A high price may convey value, but if that price is more than a potential customer is willing to pay, it won't matter. A low price will seem cheap and get your product passed over. The ideal price is one that convinces people to purchase your offering over the similar products that your competitors have to offer.
Gives your customers confidence in your product If higher-priced products portray value and exclusivity, then the opposite follows as well. Prices that are too low will make it seem as though your product isn't well made.
Four Types of Pricing Strategies
1) Margin Expanders
For many companies in mature markets where there is heavy competition, the prudent and realistic pricing strategy involves small, incremental steps to improve margins, usually within the existing segments, products, and pricing structure. This can mean expanding margins through small regular price increases, defending against unnecessary giveaways, segmenting the offering, applying surcharges, passing on changes in the cost to serve, and pricing in additional sources of value (e.g., service). This approach allows companies to expand their profitability over time without disrupting competitive dynamics or customer expectations. To succeed, margin expanders must have clear insight into margin leakage (i.e., where, when, and how the “pennies roll off the table” and what the impact of that is) and relentless discipline in rectifying the issue.
Example—Dow Corning: Price and brand differentiation.
In the late 1990s and early 2000s, the silicone industry was seeing declining margins due to commoditization, unfavorable changes in legislation, and increased competition. As the company’s web site explains, Dow Corning did a deep analysis of their customer segments and discovered a large and emerging group of price-sensitive customers who were pulling prices down. Instead of succumbing to price pressure, Dow Corning introduced a different brand (Xiameter) with different service levels, different customer experience and lower price points. The tiered pricing and positioning strategy allowed Dow Corning to target a much broader part of the market while protecting the profits of its existing offering.
2) Pricing Disrupters
Companies in new categories or in categories under significant threat often look to bolder, disruptive pricing strategies to define or defend their business model. These approaches are often founded on a belief that more value can be unlocked for the customer and the supplier through a new model that reduces the downside or increases the upside for either party. These models can include profit sharing with customers, pricing agreements that factor in risk (e.g., cost-of-materials triggers), and changes in the unit sales model (e.g., per hour of use vs. per box). To succeed with this strategy, companies need to conduct in-depth analytics and model scenarios to understand the range of outcomes for both sides. In addition, they need to be thoughtful about how to manage the downside, how competitors will respond (disruptors can face dramatic reactions from competitors), and what to do if / when others follow suit. Companies can gain an early advantage by disrupting the pricing model, but keeping that advantage can be difficult.
Example—BASF: Change in business model by moving to a pay-for-results pricing model
BASF, like many of its competitors, used to sell car paint at a price per gallon to OEMs and automotive dealerships. Quite naturally, workshops wanted to keep paint consumption at a minimum to reduce costs, which led to lower-quality paint jobs, reflecting poorly on the customer and, by extension, on BASF. As BASF’s website details, the company decided to go from being a paint supplier for automotive OEMs to a solutions partner with its customers to improve the final product, so they moved from price per gallon to price per painted car. Taking over the OEM’s paint shops to deliver painted cars also removed a distraction from the customers’ core business, allowing the car-painting process to become better managed. The impact? With the new pricing model, BASF reduced paint consumption per car by 20 percent and saw 20 percent higher margins and a 40 percent increase in its European market share.
3) Revenue Drivers
Pricing improvements that focus on growing revenue look at the pricing strategy as an enabler to bring in more business and drive deeper penetration in the existing customer base. This can mean providing introductory offers to bring in new customers, subscription models to build on an installed base, contracting to extend the lifetime value of a customer, and bundling to increase revenue per customer. Success in this model requires maintaining profitability (i.e., not giving away too much), keeping churn low, managing customer acquisition costs, and monitoring competitive dynamics to avoid price or share wars. “Freemium” pricing has quickly emerged as a popular pricing model in online service offerings. With the Internet pushing the marginal cost of content distribution close to zero, and a large number of new players competing for users, freemium pricing (giving the basic offering for free and charging for a premium version or additional content) has quickly caught on.
Example—Expensify: Freemium subscription model enabled fast market penetration.
Expensify, an online expense-reporting, and management system established in 2008, uses a subscription model offering customers 10 free scans per month for its receipts-scanning and transaction-organizing service. Users can elect to upgrade to one of the tiered subscription models based on their needs. The service became hugely successful; by 2012 Expensify was used by over 100,000 companies.
4) Sales and Pricing Pioneers
Perhaps the most radical pricing strategy is to go after large-scale sales growth and radical margin change simultaneously. This is about more than just finding a new channel or replicating an established model from another sector; it’s a new way of thinking about pricing. Sales and Pricing Pioneers drive top-line growth by implementing completely different ways of working to find new pockets of growth and value, such as introducing new services or new business models that integrate new portions of the value chain. This approach is most often used in relation to new technological advances (e.g. tablets, apps, cloud computing) with the potential to disrupt the business environment. To succeed in this model, companies need to pay constant attention to balancing the objectives of sales growth with margin attainment while making selective adjustments to strategy when necessary.
Example: Rolls-Royce: New software advances to lure risk-averse customers.
The term “power-by-the-hour” first appeared in aircraft engine vocabulary in the 1960s. Rather than selling capital-intensive engines, Rolls Royce sold airlines “power-by-the-hour” contracts that charged a fee for every hour a plane flew. According to the company’s annual reports, it was an answer to the airlines’ capital shortage and its frustration with unpredictable service costs. It was a win for airlines since the more plane flew, the more revenue they earned. Rolls Royce considered it a win, too, since the company had bolstered aircraft engine performance by acquiring software companies to collect cockpit data and monitor engines, allowing them to develop predictive maintenance technologies that kept aircraft flying more. In addition, Rolls Royce differentiated its services, offering four packages with increasing degrees of service. According to the company’s annual reports, the bundled solution increased customer loyalty with a more tailored offering (“Pay only for what you want”). This radical approach to pricing provided the company with underlying services revenue growth of 9 percent per year between 2004 and 2011 and led to a greater than 30 percent improvement in average time between engine removals.
How to Conduct a Pricing Analysis
1. Determine the true cost of your product or service.
To calculate the true cost of a product or service that you sell, you’ll want to recognize all of your expenses including both fixed and variable costs. Once you’ve determined these costs, subtract them from the price you’ve already set or plan to set for your product or service.
2. Understand how your target market and customer base respond to the pricing structure.
Surveys, focus groups, or questionnaires can be helpful in determining how the market responds to your pricing model. You’ll get a glimpse into what your target customers value and how much they’re willing to pay for the value your product or service provides.
3. Analyze the prices set by your competitors.
There are two types of competitors to consider when conducting a pricing analysis: direct and indirect.
Direct competitors are those who sell the exact same product that you sell. These types of competitors are likely to compete on price so they should be a priority to review in your pricing analysis.
Indirect competitors are those who sell alternative products that are comparable to what you sell. If a customer is looking for your product, but it’s out of stock or it’s out of their price range, they may go to an indirect competitor to get a similar product.
4. Review any legal or ethical constraints to cost and price.
There’s a fine line between competing on price and falling into legal and ethical trouble. You’ll want to have a firm understanding of price-fixing and predatory pricing while doing your pricing analysis in order to steer clear of these practices.
Analyzing your current pricing model is necessary to determine a new (and better!) pricing strategy. This applies whether you're developing a new product, upgrading your current one, or simply repositioning your marketing strategy.
Next, let’s look at some examples of pricing strategies that you can use for your own business.