Finding your best prices for your products is a balancing act. A low price is not always optimal, as a product may experience a high volume of sales without generating a profit (and we all need to eat and pay the rent, right?). Similarly, when a product's price is too high, a retailer may experience fewer sales and "price out" more budget-conscious consumers, thereby losing market position.
Ultimately, every small firm must conduct research. Retailers must consider production and business costs, consumer trends, revenue objectives, and pricing strategies of competitors. Even so, pricing a new product or even an extant product line requires more than simple math. In fact, this may be the simplest phase in the entire procedure.
Because numbers behave logically, this is the case. Humans, on the other hand, are significantly more complex. Yes, you must perform the math. But you must also take a second step that goes beyond analyzing raw data and numbers.
The art of pricing entails calculating the extent to which human behaviour influences how we perceive price.
To accomplish this, you will need to examine various pricing strategy examples, their psychological impact on your consumers, and how to appropriately price your product.
Types of pricing strategies
Retail price
Numerous retailers base their pricing decisions on keystone pricing (described below), which is essentially tripling the price of a product to establish a healthy profit margin. However, depending on a variety of factors, you will often need to price your products higher or lower than that.
Here's a simple formula for calculating your retail price:
Price at retail = [cost of item (100 - markup percentage)] x 100
For instance, if you want to sell a $15 product at a 45% margin instead of the standard 50%, you would calculate the retail price as follows:
Retail price = [15 ÷ (100 - 45)] × 100
Retail price = [15 ÷ 55] x 100 = $27
Although this is a relatively straightforward margin formula, this pricing strategy is not applicable to all products or retail businesses. Because every retailer is different, we've compiled common pricing strategies and evaluated the pros and cons of each to help you make an informed decision.
The initial consideration when determining retail prices is "what will the customer pay for it?"
Keystone pricing
Keystone pricing is a simple pricing strategy utilized by retailers. Essentially, it is when a retailer determines the retail price of a product by multiplying the wholesale price they paid. Using keystone pricing can result in a product being priced too low, too high, or just right for your business in a variety of situations.
With keystone pricing, you may be selling yourself short if your products have a low turnover rate, have substantial shipping and handling costs, or are distinct or scarce. In any of these instances, a vendor could likely use a higher markup formula to increase the retail price of these popular products.
However, if your products are extremely commoditized and readily available elsewhere, keystone pricing may be more difficult to implement.
Pro: The keystone pricing strategy functions as a simple rule of thumb that guarantees a healthy profit margin.
Con: depending on the product's availability and demand, it may be unreasonable for a retailer to charge such a high markup.
Manufacturer suggested retail price
The manufacturer suggested retail price (MSRP) is, as its name implies (no metaphor intended), the price a manufacturer recommends retailers use when selling a product. MSRPs were initially implemented by manufacturers to help standardize product prices across multiple locations and retailers.
With highly standardized products (e.g., consumer electronics and appliances), retailers frequently utilize the MSRP.
Pro: As a retailer, you can save time by utilizing the MSRP when establishing your prices.
Con: retailers using the MSRP cannot compete on price. With MSRPs, the majority of retailers in a particular industry will sell the product at the same price. You must take into account your profit margins and expenses. For instance, your business may incur additional expenses, such as international shipping, that the manufacturer does not account for.
Remember that MSRP is a very specialized term. Despite the fact that you can set any price you want, a significant deviation from the MSRP could result in the termination of your relationship with the manufacturer, contingent on your supply agreements and their MSRP-related objectives.
Multiple pricing
This pricing strategy is prevalent in clothing, cosmetics, and skin treatments, as well as grocery stores. Retailers sell multiple products for a single price using the multiple pricing strategy, also known as product bundle pricing.
Pros: Retailers use this strategy to create a greater perception of value for a reduced price, which can ultimately result in greater volume purchases. Additionally, you can sell products separately for a higher profit margin. If you sell shampoo and conditioner together for $10, you can offer them separately for $7 to $8 each, which is a business win.
Cons: Bundling decreases profits. If the bundle does not increase sales volume, then profits may be insufficient.
Discount pricing
It is common knowledge that consumers enjoy promotions, coupons, rebates, seasonal pricing, and other discounts. Therefore, 97% of businesses use discounting as their primary pricing strategy.
There are numerous advantages to discount pricing. The more obvious ones include increasing store foot traffic, liquidating unsold inventory, and attracting a more price-conscious consumer base.
Pros: The discount pricing strategy is effective for increasing store foot traffic and getting clear of out-of-season or outdated merchandise.
Cons: Excessive use could give you the reputation of a discount retailer and discourage consumers from purchasing your products at full price.
Additionally, it has a negative effect on the consumer's perception of quality. For instance, dollar and pound stores have low prices, but their products are perceived to be of inferior quality, regardless of the veracity of this perception.
For new firms, a penetration pricing strategy is also beneficial. In essence, a temporary reduction in price is used to introduce a new product in order to acquire market share. In order to gain a foothold in the market, many new brands are willing to sacrifice additional profit for consumer awareness.
Loss-leaders
We've all been enticed by the promise of a sale on a popular item to enter a store, only to leave with multiple additional items.
If this has occurred, you have experienced the loss-leader pricing strategy. With this strategy, retailers entice consumers to purchase additional items by offering a discounted, desirable item.
This strategy is exemplified by a grocery store that reduces the price of milk and promotes complementary products, such as tea, coffee, and breakfast cereals. Rather than simply selling a carton of milk, the grocer may offer a special bundle pricing to encourage customers to purchase these complementary products together.
While the original item may be sold at a loss, the retailer can benefit from an upsell/cross-sell strategy that encourages additional purchases. Loss-leading typically occurs for products that consumers are already seeking (such as bananas in a grocery store) and for which demand is high, bringing in more customers.
Pros: This strategy can perform miracles for retailers. Encouraging consumers to purchase multiple items in a single transaction not only increases overall sales per customer, but it can also compensate for any profit loss incurred as a result of lowering the price of the original product.
Cons: Similar to the effect of overusing discount pricing, when you overuse loss-leading prices, consumers become accustomed to bargains and are reluctant to pay the full retail price. If you discount an item that does not increase the account size or average order size, you could also jeopardize your revenue.
Psychological pricing
According to studies, when merchants expend money, they experience pain or loss. Therefore, it is the responsibility of retailers to alleviate this suffering, thereby increasing the likelihood that customers will make a purchase. Historically, this has been accomplished by retailers with prices concluding in an odd number, such as 5, 7, or 9. For instance, a retailer might price a product at $8.99 as opposed to $9. From the customer's perspective, it appears that the retailer has reduced the price by every cent possible. Their brain interprets $8.99 as $8 rather than $9, making the item appear to be a superior value.
However, how do you determine which odd number to employ in your pricing strategy? In terms of many retail pricing strategies, the number nine reigns paramount. Researchers conducted an experiment with apparel items priced at $24, $29, and $34. Guess which was the most popular.
In fact, items priced at $29 outsold their less expensive counterparts priced at $24.
Pro: attractive pricing enables retailers to encourage impulse purchases. Ending prices with an odd number gives consumers the impression that they are receiving a discount, which is difficult to resist.
Con: Charm pricing can sometimes appear gimmicky to merchants, decreasing their trust, whereas a basic whole-dollar price is perceived as clean and transparent.
Competitive pricing: beating out the competition
As its name implies, competitive pricing strategy involves using competitors' pricing information as a benchmark and consciously pricing your products below theirs.
This strategy is typically determined by the product's value. For instance, in industries where products are extremely similar and price is the only differentiator, you must rely on price to gain customers.
Pro: This strategy can be effective if you are able to negotiate a lower unit cost with your suppliers, while simultaneously reducing expenses and actively promoting your special pricing.
Cons: This strategy can be difficult for lesser retailers to sustain. lesser prices result in lesser profit margins, necessitating higher sales volume than competitors. And, depending on the products you sell, consumers may not always choose the item with the lowest price.
For products where apples-to-apples comparisons are difficult to discern, the need for price conflicts is diminished. Utilizing brand allure and concentrating on a specific customer segment eliminates the need to rely on competitor pricing.
Premium pricing
Here, you reverse the pricing strategy described in the preceding section. In order to appear more opulent, prestigious, or exclusive, brands intentionally price their products higher than those of their competitors. For instance, a premium price benefits Starbucks when customers choose it over a competitor with a lower price, such as Dunkin'.
A investigation by economists examined the desire for coffee. In this scenario, they had the option of purchasing inexpensive coffee from a grocery store machine or purchasing the same coffee, but at a higher price, from an adjacent coffee shop. People were significantly more inclined to pay higher prices at the outlet for the identical beverage.
This is the power of context and marketing your brand as premium. Be self-assured and focused on the differentiated value you offer consumers and verify that you are still offering value. For instance, excellent customer service, a brand that appeals to consumers, etc., will provide the necessary value for customers to demand higher prices.
Pro: This pricing strategy can have a halo effect on your business and products, giving consumers the impression that your products are of higher quality and more premium than those of your competitors.
Cons: Implementing this pricing strategy can be challenging, depending on the physical locations of your stores and their target consumers. If consumers are price-sensitive and have multiple alternatives for purchasing comparable products, the strategy will be ineffective. Therefore, it is essential to understand your target market and conduct market research.
Anchor pricing
Anchor pricing is a product pricing strategy utilized by retailers to establish favorable comparisons. Essentially, a retailer displays both the discounted price and the original price to establish the amount of money a customer can save by making a purchase.
The anchoring cognitive bias is triggered by this type of reference pricing (positioning the discounted and original prices next to one another). In a study, students were asked to write down the last two digits of their bank account number and then consider whether they would pay that amount for items such as pizza, shoes, or a phone peripheral whose value they did not know.
They were then asked to submit bids for the items.
Students with a higher two-digit number submitted proposals that were 60–120 percent more expensive than those with lower numbers. This is a result of the higher price "anchor," i.e., the written number. Consumers establish the original price as a reference point in their minds, then "anchor" their evaluation of the reduced price to it.
You can also take advantage of this principle by placing a higher-priced item next to a lower-priced item to attract customers' attention.
Numerous brands across industries use anchor pricing to persuade consumers to buy a mid-tier product.
Pro: If you list your original price as significantly higher than your sale price, it can influence a customer's decision to buy based on the perceived value.
Con: If your anchor price is unrealistic, your brand's credibility may suffer. Customers can readily compare the prices of your products to those of your competitors using a price comparison engine, so make sure your prices are reasonable.
Price skimming
A price skimming strategy is when an ecommerce business charges the maximum initial price that consumers are willing to pay, then gradually reduces the price over time. As demand from the initial customers is met and more competitors enter the market, the company reduces the price to attract a new, more price-sensitive customer base.
The objective is to increase revenue while demand and competition are high. This pricing model is utilized by large corporations to cover the price of developing a new product.
Skimming is advantageous in the following situation:
There are sufficient consumers who will pay a high price for the new product.
The price is too high to entice competitors
Price reduction has a negligible effect on profitability and unit costs.
The expensive price is regarded as exclusive and of premium quality.
Pros: Price gouging can result in high short-term profits when a new, innovative product is introduced. If you have a prestigious brand image, skimming also helps you maintain it and entice loyal customers who desire exclusive access/experiences. It also functions when there is a product shortage. For instance, high-demand, low-supply items can be priced at a premium, and as supply catches up, prices will fall.
Cons: In crowded markets, price skimming is not the best strategy unless you have genuinely unique features that no other brand can replicate. It also attracts competition and can irritate early adopters if the price is reduced too quickly or drastically after launch.
Cost-plus pricing
Cost-plus pricing, also known as markup pricing strategy, is the most straightforward method for pricing a good or service. You produce the item, add a fixed percentage to the cost, and then sell it for the ultimate price.
Consider that you have just launched an online craft business and are calculating the price of a lamp. The manufacturing cost for the lamp is:
Material costs: $15
Labor expenses: $10
Shipping expenses: $5
Marketing and administrative expenses: $10
As the "plus" of cost-plus pricing, you could add a 35 percent surcharge to the $40 your product cost to produce. This is how the formula looks:
Price to sell = cost plus markup
Price to sell = $40 * (1.35)
Selling price = $54
Pros: The benefit of cost-plus pricing is that it is simple to calculate. You are already keeping track of production and labor costs. To establish the selling price, it is sufficient to add a percentage to the cost. It can generate consistent returns if all costs remain constant.
Cons: Cost-plus pricing disregards market conditions such as competitor pricing and customer perceptions of value.