Perhaps one of the most confusing and challenging decisions to make in business is the pricing decision. Although pricing strategy can be a bit nerve wracking, the good news is that there are some established pricing methods available to help you. In this guide, we’ll talk you through how to optimize prices, and outline the top 5 pricing methods (and when to use them), putting you in the best possible position to get the most from your products, services and market.
Before we go into the specifics of the pricing decision, let’s start by thinking about how to optimize prices. Price optimization establishes the foundation for a sound pricing decision. Even armed with knowledge about what pricing methods are out there and how they’re used, you’ll still need to consider price optimization before settling on a pricing approach. Read on to learn about what we mean by price optimization and why it should be at the heart of your pricing strategy.
Price optimization is essentially a fact-finding process that you should follow in order to find the best possible price point for a product or service. The challenge of pricing is that it essentially involves a tradeoff. Low prices usually mean better value for the customer, which drives higher volumes of sales, but can represent a loss to you in terms of revenue that each individual sale brings in. Higher price points may mean that each sale represents higher overall profit, but if customers see the higher price as representing lower value for money, overall sales volumes will be lower. What price optimization does is help you to find that lucrative sweet spot between value and volumes, and that’s a precarious balance that can have a major impact on customer satisfaction, loyalty, sales, and ultimately— profitability and growth.
Sounds great, so how do you go about it? In fact, successful price optimization is far from an easy enterprise. It will require in-depth research of both your internal operations and your market. By combining market, business and consumer data, you’ll be able to answer questions like:
Price optimization isn’t a game of trial and error. In order to get it right, you’ll need hard facts and data. The types of data you should think about gathering and incorporating into your analysis includes:
So, what do you need to optimize for? In addition to your basic, everyday pricing, we recommend performing price optimization for:
The point at which your product first launches is vital to establishing it in the market and in the minds of customers. If you start with too low a price, you may gain some early traction, but you could lose sales in the long run as you begin to raise prices, as customers begin to think you no longer represent value for money. Alternatively, too high a starting price could cause you to miss out on sales from that lucrative innovator/early adopter segment of consumer.
In order to drive sales, you might think a discount is the way forward. That’s often the case, but what level of discount should you offer? A 5% discount might be seen as measly by customers but could protect your bottom line. A 50% discount could be seen as a bonanza, but might undermine long term profit. Price optimization is a delicate process when it comes to discounts.
Which is better: slashing prices to half of their original price, or offering a buy one get one free (BOGO) deal? On paper, both strategies have the potential to yield the same revenues, but practice and paper are very different beasts. Price optimization can help you determine the most effective and profitable approach to promotional prices.
Price optimization is crucial for a myriad of reasons, all of which make a contribution to your bottom line:
If you’re just starting out with optimizing prices, take into consideration the following tips and guidance.
Cost-plus pricing is one of the most popular approaches used in pricing. It involves calculating the cost of producing one unit of your product, and then adding a mark-up percentage. That is why you’ll sometimes see this method described as mark-up pricing. Cost-plus pricing is focused solely on the cost of producing your product or service (COGS) and the amount of profit you’re hoping to gain, rather than what customers are willing to pay, and pricing is not manipulated in a way to persuade or attract customers.
The main advantage of cost-plus pricing is its ease. You do not need to go through rounds and rounds of price testing: simply calculate your costs, add your mark-up and you’re good to go. Assuming that the price is affordable to customers, profit may be guaranteed, and stability is built into the pricing structure.
Cost-plus pricing is common both among manufacturers who want to cover their costs, and by retailers who sell physical products purchased from suppliers. This is because there is a guaranteed cost that needs to be covered by sales.
Competitive pricing is similar to penetration pricing in that the goal is to drive the target audience away from competitors and towards your brand. Using this approach, you’ll continually track competitor prices and then take appropriate steps to try to beat them out. Some businesses, especially retailers, even use price-matching as a strategy, either by constantly reviewing and adjusting prices in line with those of rivals, or by providing customers with a guarantee to refund the difference if they come across the same product or service at a lower price. As you might imagine, while this approach helps to make sure that your prices are in line with market averages and expectations, over the long-term, this can be hard to sustain.
Competitive pricing is best used in highly rivalrous or saturated markets, or where there is a lack of differentiation between your products and those of your competitors. If your product is on the shelves alongside competitors, and customers are unable to distinguish them, they’re likely to make their choice on the basis of prices. This is why goods like milk, bread, gas and other indistinguishable products are often priced competitively.
In today’s competitive and saturated markets, value pricing is arguably one of the most important pricing methods. This approach takes into account how beneficial, high-quality, and important your customers believe your products/services to be. In other words, it takes into account what your customers view as good value for money, and tries to match that value with an appropriate price. This strategy is often a core part of retailers’ promotional campaigns, as they seek to appeal to customers who place a high premium on getting bang for their buck.
The main advantage of this approach is that it can deliver high levels of customer satisfaction. Customers love getting value for money and are highly dissatisfied if they think they’re being ripped off. As long as your products and services meet customers expectations and deliver on the value proposition, value pricing can be the key to happy, loyal customers.
Value pricing can be used in a number of different scenarios and for products and services of different types. The most important thing is to make sure that you understand what value means in the minds of your buyers—and we can help you obtain that all important insight.
Price skimming is a medium to long term pricing strategy in which you launch a new product or service at a higher price point initially, gradually lowering the price over time. Let’s take a look at some of the benefits of this approach.
There are two main scenarios in which a price skimming strategy should be considered.
For breakthrough products. If your product is the first to enter the marketplace, price skimming can be highly effective—and profitable. By selling your product or service at a higher initial price, you can generate the maximum profit in the shortest time possible, before competitors enter the market, and pricing pressures grow. The average price of products which were once novel but are now commonplace, such as Blu-ray and DVD players, has fallen over time because leading manufacturers followed a price skimming strategy.
For business to consumer (B2C) brands that rely on fast-moving trends. In retail, trends come and go quickly. So, it’s typically imperative to try to capture the majority of your sales while the trend is still hot, and before interest dwindles. Price skimming can help you maximize profitability at the top end of a trend.
Penetration pricing is essentially the opposite of price skimming: instead of starting with a high price that is gradually reduced, you enter the market with a low price, and steadily increase it as sales gain traction.
While price skimming can help you to maximize profit margin in the early period of a product’s life cycle, penetration pricing actually increases the risk that you’ll make zero profit, or worse, some financial losses at the beginning of a sales period. So, why use this strategy? As the name might suggest, penetration pricing is best used to penetrate a new market. If you’re launching a new product or service, or pivoting to a new geographical location, penetration pricing can help you gain a foothold.
That’s it in a nutshell: how to optimize prices and the top 5 pricing methods to help you do it. If you need help developing a pricing strategy based on market research, check out the pricing optimization solution by Momentive. Our custom market research services can also help you obtain the data you need to support your pricing decision.
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