Pricing Strategy

The 5 most common pricing strategies
Cost-plus pricing. Calculate your costs and add a mark-up.
Competitive pricing. Set a price based on what the competition charges.
Price skimming. Set a high price and lower it as the market evolves.
Penetration pricing. Set a low price to enter a competitive market and raise it later.
Value-based pricing. Base your product or service’s price on what the customer
believes it’s worth.
Cost, margin and markup
Underlying all pricing strategies is the basic mathematics of making a profit and keeping your revenue at
a healthy level. To do this, you need a strong grasp of costs, margins and markups.
Here’s a quick recap:
Cost
This is the amount you spend to get your product or service to market. It includes things like
manufacturing and materials, cost of labor to produce tangible goods, payment to your suppliers, and
any loss or wastage that happens along the way. For pricing purposes, cost of goods and services doesn’t
include general overheads like heating, lighting, rent etc. or auxiliary business functions like marketing
and sales, which are categorized as operating costs.
Margin
The margin (aka profit margin) is the part of the price you have left over once the costs have been taken
out.
Markup
Markup is what you add on to the cost of producing or providing your products and services to arrive at
the price your customer pays. It’s often set using a percentage formula.
5 pricing strategies to know about

1. Penetration pricing
A new business enters the market with goods priced well below what its competitors are charging.
Customer interest is drawn by the low price and good value on offer. Once the brand is established and
has acquired a strong customer base, it begins to bring its prices in line with what’s typical for the
industry.
Adopting this strategy involves risk. It means taking a hit on profits during the initial phase, which not all
new businesses will be able to survive. However, it’s a powerful way to capture market share from well-
established competitors and can help develop a company culture of focus and efficiency.
2. Premium pricing
If an item costs more, a customer will perceive it as having more value. That’s the logic behind premium
pricing. A business using premium pricing intentionally charges more than its competitors, trading on a
brand that’s all about quality and prestige.
To make this strategy work, brand value and product quality must be carefully built and maintained. The
upside is that markup and margin will be higher than typical for the product category.
3. Price skimming
Taking its name from the world of dairy goods, price skimming is the strategy of charging a high price
when a product is new on the market. The “cream” of the customer base are early adopters eager to be
the first to access the product and willing to pay a price premium. Over time as the product is less novel
and appealing, the price may be reduced to appeal to successive levels of the customer base who have
less appetite and higher price sensitivity.
This approach has the obvious advantage of bringing in more revenue early in the product’s lifecycle, and
maximizing profit by taking advantage of every level of price tolerance within the customer base. It can
also help support perceptions of premium quality and make the product more desirable.
On the downside, it’s well-recognized by customers and many people are likely to wait it out rather than
pay more early on. Its success also depends on the nature of the product – aspirational tech companies
do well out of this strategy, but other sectors may not.
4. Bundle pricing
As much about product packaging as pricing, bundling is the practice of grouping several items together
under a single price tag.
Bundle pricing can be a useful psychological nudge technique to motivate customers, especially if you let
them know that the collective value of the items in the bundle is greater than the bundle price.
It can increase appeal in terms of utility and ease, especially where the items are complementary in
function or form (think shampoo & conditioner sets, or burger and fries meals). Bundling is also used to
help with inventory management – you can bundle together a less-popular item with a top seller in
order to help move it off the shelves.
5. Loss-leading
Like penetration pricing, loss-leading uses very low prices to grab customer attention. This might be in
the form of a special offer, or single product line which is sold at a heavily reduced margin. The business
recoups the loss on other products with healthier margins which customers discover after they have
been drawn in by the loss-leading item.
Note that loss-leading has a more extreme cousin, known as predatory pricing. This is where a company
aggressively underprices a product in order to defeat its competition. Predatory pricing is illegal in many
regions. In the US, predatory pricing is often gauged using the Areeda-Turner test.
How to choose a pricing strategy
Choosing how much to charge and how to structure your pricing is a big decision, and one that deserves
some consideration and research.
Be clear on costs
Before you think about price, you need a clear understanding of the cost of your goods or services. Make
sure you include every element of product development, manufacture and supply, and the delivery of
services (including things like equipment and uniform costs if applicable). Add a percentage to cover
losses and waste too.
Benchmark against competitors

Carry out competitor analysis to learn what comparable businesses are charging in your market. As well
as looking at current prices, explore historical price patterns to see if they’ve employed techniques like
penetration pricing or loss leading in the past.
Think about your timeline
If you’re considering a time-bound pricing strategy such as price-skimming or penetration pricing, you
need to know how long you will do it for and what the impact will be on your profits over that
timeframe. Is an initial loss sustainable? If price skimming, can you predict when to take down your
prices on a schedule in order to get the best results?
Research price sensitivity
Last but not least, it’s crucial to get to know your target audience’s price sensitivity and what they are
willing to spend. You can use established research methods like Van Westendorp’s Pricing Index and
Gabor-Grainger pricing technique to get precise, detailed data about what your customers will be
prepared to spend with you.

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The 5 most common pricing strategies

Cost-plus pricing. Calculate your costs and add a mark-up.

Competitive pricing. Set a price based on what the competition charges.

Cost, margin and markup

Here’s a quick recap:

5 pricing strategies to know about

How to choose a pricing strategy

Benchmark against competitors

Think about your timeline

Research price sensitivity

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