How Different Pricing Strategies Work (And How to Choose the Right One)

Posted on November 8, 2024 in Blog

An effective pricing strategy impacts every part of a product’s success. Brands use a variety of pricing approaches to balance often contradictory priorities, from preserving margin to being competitive in the market. There’s no one-size-fits-all price strategy for any product or service, but you can find the numbers that work for you by understanding the common pricing models used by leading brands.

First, What Is Price Strategy?

Pricing strategy is the methodology brands use to determine prices for their products or services. Also known as pricing models or tactics, each approach has pros and cons and a few ideal use cases. As you work through this, remember that there isn’t a perfect formula for setting a price for a product. It requires careful consideration, deep market research, and a willingness to get it wrong before you get it right.

How to Set a Price for a Product or Service: Getting Started

Different pricing approaches offer advantages and disadvantages in the near term, pay off in the long run, or meet other organizational goals. Most product managers follow directions from higher-ups to make pricing decisions. Still, some have the ability to recommend price ranges that ultimately shape the highest product price (the price ceiling) and lowest product price (the price floor). These terms have considerable overlap between regulatory oversight from federal agencies and market realities.

A price ceiling is the maximum price a brand can charge for a product or service. Generally, this is set by a governmental regulator, but brands often use the term to describe the upper end of the price range in the market. An effective price ceiling maximizes profit per unit sold without lowering demand and substantially reducing sales volume.

A price floor is the minimum price a brand can charge for a product or service. Like a price ceiling, a regulatory body sets a pricing floor. Companies sometimes refer to their lowest possible price as their price floor, often this is a point at which they only break even or lose money on every unit sold. An effective price floor will increase product demand and market share for a brand as consumers select the less expensive product.

Selling at or below the unregulated price floor is a short-term pricing tactic; we’ll get to that in a bit!

Remember that all types of pricing strategies are flexible. Pricing will change based on several factors during the lifecycle of a product, including:

Brand goals
Market competition
Age of the product
Macroeconomic factors, such as inflation or deflation

Price Strategy vs. Place Strategy: The Difference

Your broader go-to-market strategy also impacts the price of your product or service. Where you sell your products matters, and that’s the basis of a place strategy.

Place strategy describes a brand’s approach to how and where it sells. Also known as distribution strategy, place strategy defines where customers can purchase products or services. Will you sell direct-to-consumer (D2C) or wholesale through retailers? Will you sell online or only in stores? Will you grant exclusive distribution rights to a third-party vendor?

Where you sell your product will impact how you price a product, especially if you work with retailers or distributors. Your product must suit the retailers’ customer base, so your $10,000 luxury horsehair mattress won’t be a good fit at value-focused Walmart.

The Five Most Common Types of Pricing Strategy

Amazon, Apple, Ford, Sketchers – name any brand, and it probably uses a mix of these pricing strategies across its range of products or services.

1. Cost-plus Pricing Strategy

The cost-plus approach takes the calculated cost of making the product or delivering the service plus a profit margin.

Cost-plus Pricing Pros and Cons

The advantages of cost-plus pricing are its simplicity and the ease of forecasting operating costs, revenue, and profits. Accurately forecasting these inputs is valuable for brands that accrue material costs (buying nuts, bolts, and batteries) and inventory (stuff waiting to sell). When these brands know the value of what they build and what they have on hand, they can manage orders, sales, and other operating costs more efficiently without taking financial risks or going too deep into debt.

The disadvantages of cost-plus are in the details. Accurately accounting for every input material can be time-consuming, and inaccurate inventory can result in accounting errors, lost profits, or wasteful spending. Additionally, cost-plus pricing doesn’t account for a consumer’s willingness (or unwillingness) to pay that price.

2. Competitive Pricing Strategy

Competitive pricing strategies focus on analyzing the market and setting prices based on those of the competition. However, competitive pricing isn’t always about selling below a competitor’s price.

Economists usually divide competitive pricing into three subtypes:

Co-operative pricing focuses on matching your competitor’s price. All things being equal means both brands maintain similar (but not identical) market prices and, as a result, similar profit margins. If Aunt Millie’s raises its price by 5 cents, Wonder Bread raises its price on its most similar product.
Aggressive pricing means your brand beats a key competitor’s price no matter what. If Nike raises prices, Adidas will keep its prices the same. If Nike lowers prices, Adidas lowers its prices even lower. Long-term, this can lead to increased market share but often at the expense of operating at a loss on some products or services.
Dismissive pricing completely ignores the competition. You price products based on your own value criteria, which is often based on raising prices until demand shifts. Dismissive pricing is usually only an option for luxury brands or firmly established market leaders like Apple.

Competitive Pricing Advantages and Disadvantages

In many ways, the pros and cons of competitive pricing are the exact opposite of cost-plus pricing. Competitive pricing is outward-focused and accounts for competition and the consumer, but it largely ignores internal costs and protects profits. Competitive pricing is most common in markets with similar products, like bread. That’s a big reason there are so many kinds of essentially commoditized products: the more varieties of bread, the more diverse price points and pricing options a brand like Auntie Millie can use to realize profits.

3. Price-skimming Strategy

The first to market sets the market price – for a while, at least. Price skimming is a pricing tactic used by brand introducing an innovative new product. Take personal computers. Early PC companies set very high prices for home computers because there was little competition and no alternatives. Early adopters absorb initial high prices. As demand from those early adopters declines, or as more competitors enter the market, the price gradually dips.

The Advantages and Disadvantages of Price Skimming

The advantage of price skimming is its high profits early on, but that’s also its disadvantage; the good times won’t last forever. As a result, price skimming is a short-lived strategy that brands often eventually abandon in favor of other pricing options.

4. Penetration Pricing Strategy

Setting a low price point allows brands to compete in a new market or with a new product. This is an especially useful pricing method for subscription-based businesses, as it can lure customers away from their existing products or services. The underlying motivation in penetration pricing is volume, where scaling quickly at a low margin (or even a loss) builds a loyal customer base in the future.

Hardware is also an area where penetration pricing shines. Amazon sold millions of its Echo devices at a loss to gain market share in connected devices and generate retail sales from Echo users. At least in Amazon’s case, it didn’t exactly pan out.

The Advantages and Disadvantages of Penetration Pricing

Penetration pricing offers brands an effective way to enter a new market, especially when selling a product consumers will access or purchase again and again. However, it’s risky; there’s no guarantee that consumers will stay loyal, and penetration pricing often requires considerable capital for early-stage companies and result in rapid cash burn.

5. Value-based Pricing Strategy

The value-based pricing method is the most nuanced and balanced between internal and external price considerations and blends components of other methods. Setting a value-based price is a process that requires:

Evaluating a competitor’s product.
Finding specific features that set your product apart.
Assigning a financial value to the differentiating features of your product.
Assigning a financial value to the features your product lacks.
Making sure the value to your brand (cost) is less than the value it offers your customers (price).

The key to value pricing is marketing; it can be difficult to communicate the added value your product offers compared to the competitor’s, especially if switching brands poses additional costs, like time, training, or education. It’s why so many companies stick with a project management software, even if there are better, more competitively priced options; switching is just too much to work.

There are advantages and disadvantages to value-based pricing, but there are so many variables that it’s hard to see them in definitive black and white. What works for Company A may not work for Company B if how they calculate value or anticipate consumer demands differently.

Which Pricing Strategy Works Best for Your Product or Service?

Luckily, no rule says you must choose just one pricing strategy for your company. It’s often best to use a mix of pricing methods across product and service lines to diversify revenue streams and position new areas for growth.

For example, the same company might use penetration pricing to grow its new advertising display network, competitive pricing on its retail sales platform, and price skimming to capitalize on its expansive cloud-based networking investments. Yep, that’s Amazon’s entire playbook in three pricing strategies.

You Can’t Put a Price on Great Marketing

No matter how you set prices, it’s marketing that drives sales.

Oneupweb’s marketing strategists design effective multichannel marketing campaigns that can put your product in front of the right audience to meet your goals. Whether it’s a new product launch or breathing new life into an established service offering, our integrated team provides creative solutions to even the toughest marketing challenges.

Let’s get started; contact our team or call (231) 922-9977 to get the ball rolling.