The point of a good pricing strategy is to increase how much people are willing to pay for your products or services. Not to figure out how much they’re willing to pay and put that on a price tag, but to increase it.
There. Now that the point is out of the way, let’s see what a pricing strategy really entails, because it’s probably not what you think.
The truth is that good pricing strategies include:
Let’s start by briefly going over what these are.
A pricing method refers to the way you set your prices. And broadly speaking there are three different methods for setting prices:
Note that value-based pricing's name can be a bit misleading, since the price isn’t really based on value, but on willingness to pay.
And, willingness to pay is mostly influenced by perceived relative value and ability to pay, and not so much by the product’s value itself. That’s a very important detail that most people don’t realize.
So, one of the decisions you must make when creating your products or services’ pricing strategy, is which one of these methods you will use to get to your prices.
Note that most of this post applies mostly to value-based pricing, although you could pick and chose some elements to upgrade a mostly cost-based or competitor-based methodology if they make sense in your particular case. You’re the one who knows your business, so…
Moving on, after we selected which pricing method we will use, it’s time to select a pricing model.
Selecting a pricing model means that it’s time to decide how we will charge. We need to select the unit of what we are selling, and how we will be charging for it.
For example, let’s say you’re a website designer. You can charge for:
- Time (per hour, per day…), or
- Deliverable. For example per website, or even offer bundled services in “complete packages”, including everything from visual branding, to logo design, to actual website creation (vs. having a “pick and choose” offer, allowing your clients to buy each one of those services separately).
These may seem like small changes, but they can have a dramatic impact on a business’ profits.
Very noticeable cases of changes in pricing models can be seen for example in the software industry, where a lot of companies are moving from selling software, to selling software as a service.
So, instead of a model based on a one-time payment for a software product, now they use subscription pricing models.
Another very noticeable example comes from the airlines industry, where a while back companies unbundled their offerings, and started charging separately for a lot of things that we were used to getting included in the flight price but that weren’t an essential part of the service.
These include things such as checked-in luggage, meals on board, or seat selection, which started being charged as add-ons.
And as you may know, this seemingly small change in pricing model towards unbundling led to the rise of the low-cost segment, and ended up having a huge impact on the industry.
Another major change in the airline industry’s pricing model was the change from a fixed fee per seat to a dynamic pricing model, where flight prices increase or decrease according to demand.
The fact is that a well-thought-out pricing model can be a key component of a pricing strategy, since it can play a major role in both the likelihood of making a sale, and in the achievable final selling price.
So, you may have noticed that pricing models can be different in terms of the nature of what you charge for. You can charge for product or deliverable, for time, for usage (think of pay-as-you-go models), or even for results (think of pay per click ads).
Pricing models can also be different in terms of the unit of what you’re selling; for example, you can bundle and sell items as a unit that would otherwise be sold separately – think of McDonalds menus, or “all included” offers) or unbundle (and sell separately items that might traditionally be considered as part of a unit – think of low cost airlines).
And finally, you can be creative in terms of the way you charge. You can use freemiums, where you offer a simplified free version of your product in hopes that people will want to pay for the full version, pay what you want models, dynamic pricing models, auctions…
I don’t want to go into too much detail about this here. It needs its own post to be properly covered. Unfortunately, I don’t have one yet, but I’ll probably make it at some point.
Another important aspect of a pricing strategy is your price positioning.
Now that you have decided how you will set your prices, and how you will charge for what, you need to decide whether you want your products and services to be on the low-price end of the market, on the premium or even luxury ends of the market, or… if you want to fall somewhere along the middle.
Evidently, this decision is very important, since your price positioning has implications not only for your pricing strategy, but also for your overall brand image, and even for the way you conduct business, since:
- A low-price business must develop the competencies required to generate and deal with high unit-sales volumes.
- A premium or luxury business must develop the competencies required for value-selling and possibly customer service.
Those are very different ways of conducting business! When you select your price positioning, you're effectivelly selecting the activities you will have to master to compete in your industry.
So… you are in fact making a decision that has a major impact on the type of business that you will need to create to be successful, and which goes well beyond pricing and marketing at large.
I have a post on premium pricing with further details on how selecting a premium positioning affects business.
But it’s time to move on to the 4th component of an overarching pricing strategy, and that is selecting among some ad hoc supporting pricing strategies to do a final optimization.
Some examples of the most widely used ones could be:
For product launches: penetration pricing and price skimming
A penetration pricing strategy consists of launching a product or service at price intentionally below its value to speed up adoption rates.
This is not to be confused with a low-price strategy. That’s a positioning, it’s permanent; it’s not a temporary sales booster as penetration price is. For more details on penetration pricing, you can read the linked post.
Price skimming, on the other side, consists of launching a product at a high price that only a small fraction of the market is willing to pay, before you start lowering that price to gradually reach more people.
It is known upfront that only a small fraction of the final target customers will buy, but the goal is to take advantage of the high willingness to pay that early adopters sometimes have (you know those people who always like to flaunt the latest model of everything? Those are the price skimming targets).
Note that price skimming should not to be confused with luxury-pricing; again, luxury pricing is a positioning; it’s permanent. Skimming is temporary.
Another price optimization strategy is price anchoring. The point here is to take advantage of a phycological effect. You see, when a potential customer is exposed to a price point, that price point becomes a reference against which other price points are judged.
You know when you read through a sales page or listen to a sales pitch, and the seller starts off the pricing part by saying something like… “how much would this be worth to you? A bazillion $?” He’s trying to anchor you.
And sometimes he may even go on and start staking up bonuses. (Which sometimes… let’s face it… are said to be worth completely absurd made up values that nobody would actually pay… to get to a total that can only be described as a completely ridiculous number… But I digress… :-D).
When well executed, what this does is create a reference against which you will judge the final price once it is revealed. And after pondering about these much higher numbers, the actual price will seem a lot more reasonable than it would have seemed if it had been shown to you beforehand.
And this leads us to the good-better-best strategy.
This one also takes advantage of the psychological anchoring effect. In this case, what you do, is have several product or service tiers (usually 3, preferably not more than 4), in which each tier adds an improvement vs. the immediately lower tier.
Here, the point is to have a higher priced option that anchors people to that higher price level, making the mid-range offer seem much more reasonably priced, thus boosting its sales. Adding to that, this price structure can also help take advantage of different customer segments’ willingness to pay.
There’s a lot more to be said about this strategy though, so I have a post dedicated to the good-better-best strategy looking at the purely psychological impact, as well as at how it would be done even for purely rational reasons. After all, psychological effects can only get you so far.
It’s now time to move on to the very popular: odd pricing.
This one consists of ending prices in odd numbers, usually 99, or 97.
This is again a psychological pricing strategy that probably takes advantage of people noticing the number on the left more, although there may be other aspects at play. There’s also a lot that can be said about this one, but for the purposes of this post you know what it is, so no point in dwelling on it.
So let’s move on to bundling again.
Yes, we mentioned it in the price model selection part, but sometimes it does not have to be that deep. Bundling may not be at the core of your strategy to the point of defining your product offering, and still be something that you use sporadically to boost sales when needed.
I also have an in-depth post on bundling where I go over a way of bundling that smart companies like McDonalds use to charge… more.
That’s right, not to offer discounts, but to increase the average price per individual product (makeup companies use it a lot too).
Note thought that in the case of McDonalds product bundling isn't an ad hoc optimization strategy, it's at the o core of the its pricing model (the same is often true in the case of makeup).
Anyway, at this point we’re just missing the final component of a pricing strategy: defining the actual price points and possibly plan how they’ll change in the future.
Defining price points
This must be done in the context of the rest of the pricing strategy, since actual profit-maximizing selling points aren’t often for you to choose, but to assess.
Depending on you pricing model, positioning, and complementary ad hoc pricing strategies, people will be willing to pay different amounts of money for your products or services.
For example, people are willing to pay more for a plane ticket if you progressively add on fees in sequential steps, than if you show the full price upfront; probably they don’t even realize they’re paying more.
Sounds silly, but it works. Extremely well.
So, if you assess willingness to pay per flight without considering the unbundled model, you will reach different conclusions regarding the achievable prices. That’s why the achievable price points must be assessed in the context of the overall pricing strategy.
All these pricing strategy components tie together to influence willingness to pay.
And that’s why all the components of the pricing strategy must be assessed as a whole.
Even though selecting price points is what people immediately think of when talking about pricing strategies, it doesn’t come first.
Finally, remember that prices aren’t static; a pricing strategy may also need to include how you will modify your prices in the future (and I’m not just referring to the cases in which we are using penetration pricing or price skimming).
You may realize that your price isn’t’ the most adequate one at any given point in time, and you may need to change it. Although price changes aren’t a problem in some industries, in others changing prices is very hard, especially upwards, since people may be driven away by the changes.
So… if you believe that a sudden change may be not well received, you may need to develop a strategy to increase prices in less noticeable and aggravating ways. Usually changing the pricing model can be very helpful if the required price level changes are dramatic, and changes in pricing model can be implemented.
And this is it for today. I hope that thinking about the different components of good pricing strategies helps you developing or improving yours. It’s not just about how much you charge, you know? The number on that tag isn't everything.