Pricing strategies: Which is best for your business?
Skimming, anchoring, penetration; all ways to price products and services, but what do they mean? Here's how to create a successful pricing strategy…
“How much should I charge customers?” For any new business, answering this question and deciding a price point for your product or service is no easy feat.
On one hand, you want to attract your customers to purchase your product or service while on the other hand you want to price accordingly so that your business can generate a profit.
Getting this balance right all depends on the pricing strategy you adopt and the type of business you’re running.
Before we explore the pricing strategies on offer to your business, you should consider the seven following pricing tips raised by Leigh Cauldwell, behavioural economist and pricing expert, in the book The Psychology of Price:
- Pricing should be based on the value to the customer, not the cost to you.
- Pricing should be tangible, so your customers can see what they get for what they pay.
- Prices should be comparable – on terms that you control.
- If you want to change your prices, you must reframe the product or service.
- Price differentiation is the key enabler of profit.
- Pricing communication shapes the customer’s perception of value.
- You must be prepared to lose some sales in order to increase profits.
Once you have these key pricing principles in mind, you should explore the following pricing strategies that businesses implement when setting prices.
We’ve outlined each pricing strategy below, along with an example of how this strategy works in practice…
Market penetration pricing
Penetration pricing strategies can help new start-ups stand out and, as the name suggests, penetrate the market.
Penetration pricing is when a business offers low prices on products and services. It is typically used by new companies or to support a new product launch to draw consumers away from the competition.
While the use of penetration pricing generally results in initial loss of profits for a business, in the long-term the exposure gained can drive profits up.
Businesses considering this pricing strategy should be able to afford to sacrifice profit margin for a period of time; you will often find that most companies that use this pricing strategy will have secured some funding to give them a runway.
After they’ve successfully penetrated the market, a lot of businesses will raise their prices to reflect their position within the market.
While it’s now a market leader, Netflix is a great example of a business which successfully used penetration pricing to its advantage when it first launched back in 1997.
Started as a mail-order, online and streaming movie rental business, Netflix used low price points initially to attract customers away from Blockbuster; its largest competitor at the time.
Its original package offered tiered price points and enabled customers to rent three DVDs simultaneously for $14.99; amounting to just over $1 per DVD per month for customers that took up the offer each week. This low pricing, combined with its streaming and online offering, enabled Netflix to pull in subscribers and gain a competitive advantage. Years later, in 2013, we would see Blockbuster go into administration while Netflix continued to thrive.
Premium pricing is when a business sets its prices higher than competitors. For new businesses with an unusual or luxury product or service, premium pricing often works best. The more unique your product is, the more you should aim for a premium price segment.
However, there is a caveat to this.
For premium pricing to be a success, you need to shape your customer’s perception of value (as highlighted by the sixth pricing principle). This is achieved in the way you market and communicate your product or service.
Consider the way you promote your business online and offline to support a premium price point. For instance, if you own an independent store premium pricing will only work if your store décor and website supports your premium price point.
Alternatively, if you own a product business you should guarantee that your packaging and design support your premium price point.
Vita Coco UK offers a good example of premium pricing. It was the first coconut water brand to come to market in the UK and has always set a premium price point, even after challenger brands came into the sector.
A one litre carton of Vita Coco coconut water RRP’s at £3.49 whereas competitors such as Rubicon and Innocent have markedly lower price points of £1.99 and £2.49 respectively.
Vita Coco UK uses clever marketing methods such as celebrity endorsements, social media campaigns and the use of memorable, colourful packaging to communicate and shape its customer’s perception of value.
Widely used by discount retailers and low-cost food suppliers, economy pricing is targeted at price-conscious consumers looking for a ‘no frills’ product or service.
Businesses can minimise the costs of marketing, packaging and production in order to keep prices down.
To successfully use the economy pricing strategy and generate sufficient profit from low prices, you will need to have large sales volumes.
With all of its items priced at £1, variety store chain Poundland is a great example of a business which has maximised on economy pricing to become a major brand.
Launched in 1990, orginally promoting their sales strategy through the slogan: “Yes, Everything's £1!” Poundland has scaled to achieve revenues in excess of £1bn.
On the back of its success of using economy pricing – and a single-price strategy which is easily understandable among consumers – several players have entered the discount store environment to compete such as Poundworld and 99p stores; the latter was Poundland’s biggest competitor prior to its takeover in 2015.
Price skimming is a pricing strategy whereby businesses set high prices for their product or service during the introductory phase.
Intended to help businesses capitalise on sales on new products and services, price skimming allows businesses to maximise profits from early-adopters. As competitor goods appear on the market, the business will then drop the price gradually to attract more price-conscious consumers.
A way to make early profits, price skimming is also an effective tool to make your product or service appear more exclusive or unique when it is first introduced as it creates an aura of prestige around your product.
Tech businesses are known to adopt price skimming as they can use their proprietary technology to their competitive advantage.
One industry that’s synonymous with price skimming is the smart phone market and Apple is a great example of a business that has successfully capitalised on price skimming. When Apple launched its iPhone to the market it set a high price point, despite being an entirely new product. This price point maximised on consumer willingness to pay more for cutting-edge technology and helped generate an aura around the iPhone.
Apple has since evolved its approach to price skimming, and while prices have dropped slightly for it smartphones it has largely maintained and defended its price by increasing the value of its product in future iterations. For example, on the Apple shop the iPhone 7 Plus retails at £719 while the iPhone 7 retails at £599.
Price anchoring is a tactic which businesses use to capitalise on a consumer’s cognitive bias. According to pricing expert Cauldwell it is “one of the most powerful psychological effects relating to prices”.
Anchoring is when businesses place premium products and services near standard options to give prospective customers the impression that the less expensive option is a bargain in comparison, making them more likely to make a purchase.
Anchoring works because consumers have an unconscious tendency to rely on the first piece of information offered to them when making a decision. For instance, if a store has three watches in its watch-front; one at £10,000, one at £8,000 and one at £2,000 – research has shown that consumers are almost always likely to perceive the £2,000 watch as being good value.
Learn more about price anchoring and how to use it to increase the attractiveness of your product or service here.
Retail marketplaces often employ price anchoring strategies and Amazon is just one of many e-tail businesses which has mastered price anchoring.
The e-commerce giant will often show similar products in a carousel of seven to eight items, with higher valued good placed next to lower value goods.
Consumers are more likely to be attracted to the lower-value item in the carousel, despite the fact that they could find a cheaper, or more relevant, item by conducting a more thorough search on the Amazon site. We've used the business book carousel to reference this.
Psychology pricing is a strategy used by businesses to encourage customers to respond on an emotional level rather than a logical one. It seeks to create an enhanced illusion of value for the customer.
The ’99 effect’ is a good example of psychology pricing. It’s proven that consumers are more likely to buy a product or service when it’s priced at 99p, rather than £1, or £9.99; rather than £10, and so on.
Researchers believe this is because consumers focus on the big denomination rather than the small denomination and partly because there is an emotional incentive – people feel like they are getting more value for their money.
If your product or service is likely to be compared with a rivals then cutting a penny off the price to make it ‘.99’ could make people more likely to buy it.
Psychology pricing, particularly the 99 effect, is one of the oldest tricks of the retail trade.
You’ll notice that most, if not all, businesses will incorporate psychology pricing, alongside other pricing strategies, when setting prices.
From technology giants like Microsoft to supermarket chains such as Tesco and Sainsbury’s, most companies will employ psychological pricing tactics to entice consumers to part with their cash.
Bundle pricing, otherwise known as product bundling, is when a business sells multiple products for a lower rate than customers would face if they purchased each item individually.
Bundle pricing is a great strategy for businesses that are able to offer courtesy products. For instance, if you run a cosmetics brand you could maximise on bundle pricing by offering a free eye liner with every mascara purchased. Or, if you run a café you could offer a free muffin with every coffee on a certain day of the week.
However, businesses using this strategy do need to ensure that they can afford to make up for the losses on the lower-value product and must be able to generate a good profit on the high-value product.
Bundle pricing is an effective pricing strategy for businesses for two reasons:
- It enables businesses to get rid of unsold stock
- As the business is giving away something for free, the approach can increase a customer’s value perception.
A number of companies and brands have adopted bundle pricing tactics. Car dealerships now offer option packages on new cars, restaurants and fast-food chains offer value meals, and TV companies and service providers will use bundle pricing to offer TV, film and broadband packages.
Supermarket retailers are experts in bundle pricing and Marks & Spencer offers a great example of using bundle pricing to attract customers.
The retailer has become synonymous with its ‘Dine in for two for £10’ deal where it offers customers a starter, main, desert and a bottle of wine or non-alcoholic drink for £10 all-in. While the offer used to run on a regular basis, Marks & Spencer now uses the offer to drive up sales during seasonal peaks; Valentine’s Day, New Year’s Eve. etc.
In summary, these are the top pricing strategies you should consider for your new business:
- Market penetration pricing
- Premium pricing
- Economy pricing
- Price skimming
- Price anchoring
- Psychology pricing
- Bundle pricing
Once you’ve considered you pricing strategy, click here for more advice on budgeting and setting prices.