Developing a Pricing Strategy: 7 Types of Pricing and How to Implement Them

Choosing the right pricing strategy is one of the most important decisions you will ever make as a business owner.

The right pricing strategy will effectively convey the value of your brand, meet the expectations of customers, and maximize your revenue potential.

Conversely, the wrong strategy can completely undermine a new product or service before it finds its footing in the market. 

In this article, you will discover the major types of pricing strategies, examples of companies effectively using each strategy, and how to choose the best pricing strategy for your business.

TL;DR

• There are seven major pricing strategies, including cost-plus pricing, value-based pricing, competitive pricing, skimming pricing, penetration pricing, premium pricing, and dynamic pricing.
• The right pricing strategy lets you achieve your business objectives within the constraints of your resources and prevailing market conditions.
• The product/service price you settle on based on your chosen pricing strategy shouldn’t be set in stone, and you should A/B test various prices until you arrive at one that works perfectly for you and your customers.

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Types of Pricing Strategy and Who Should Use Them

Many entrepreneurs focus the bulk of their time on product development, while paying little attention to finding and implementing a right-fit pricing strategy.

There is a tendency to just opt for the established pricing methodology in the industry—a shortsighted approach that can cause you to leave money on the table and lose market share to competitors with pricing that better reflects customer expectations and market conditions.

In fact, research shows that less than 5% of companies on the Fortune 500 Index (they represent two-thirds of the United States GDP) have dedicated mechanisms for setting the best possible pricing strategies. 

To help ensure you are not making such a mistake, here are seven popular pricing strategies and why they may be well suited for your business.

Cost-plus pricing

This is a straightforward strategy where you calculate the cost of producing a product and add a percentage on top of it.

It is also known as markup-pricing, and unlike software development where you develop one product and resell the same product to multiple customers, it’s practically only applicable to physical products that require you to invest capital to produce each product unit.

For example, let’s say Jennifer makes and sells hand-made leather bags to students at Texas A&M University.

Below are the costs to produce one bag:

• Material (leather imported from China): $50
• Labor (based on the 15 hours it takes to produce one bag): $7.25 [federal minimum wage] X 15 = $108.75
• Rent for manufacturing space & utilities: $40

When we put it all together, the total cost to produce one bag is $198.75. Let’s say we round it up to $200 and Jennifer decides to add a markup of 50%. The selling price for each of Jennifer’s bags will be $300.

 Pros of cost-plus pricing

• It is easy to calculate and it ensures you cover all your production costs
• It guarantees a healthy profit margin 

Cons of cost-plus pricing

• It ignores market conditions like competitor pricing
• It may not be responsive to changing customer sentiments about product price 

Who should use it: 

You can use this pricing strategy if you are in a stable, predictable industry with clear production costs.

Value-based pricing

With this strategy, you set the price of your product based on your target customer’s perceived value of your product and services.

Perceived value is the implied worth of your product or service in the eyes of your customers, which shapes their pricing expectations.

For example, if customers view your product type as a luxury item, and you opt for a lower price than what they expect, they may brand the product as poorly made and gravitate towards competing higher-priced products. 

Value-based pricing is usually used for products that enhance the customer’s self-image or services that offer an exclusive and enriching experience. 

For this strategy to be successful, you must first have a superior product and then invest in marketing and public relations to build a unique brand identity that customers will associate with luxury and exclusivity. 

Rolls Royce is a good example of a company that uses its market positioning as a luxury brand to apply value-based pricing.

Here is the price of a Rolls Royce Cullinan SUV

Here is the price of a Toyota Land Cruiser SUV

As we can see from the images above, both vehicles are SUVs made in the same year, yet customers are willing to pay a whopping $477,575 for the Rolls Royce SUV, and much less at $53,272 for the Toyota Land Cruiser.

The reason is because of the difference in perceived value. The Toyota will drive you to the same places as the Rolls Royce, but years of brand messaging and the outstanding craftsmanship that goes into the Rolls Royce has made it a status-symbol product for which customers are willing to pay a premium price.

Pros of value-based pricing

• You can comfortably set a higher price point for your product
• You are motivated to constantly innovate to have a reason to charge even higher prices

Cons of value-based pricing

• You can overestimate the value of your product and find it difficult to overcome the resultant stigma of it being seen as an overpriced product 
• The perceived value of your product can suddenly diminish due to economic factors that are often outside your control 

Who should use it: 

You can use this pricing strategy if you have a unique product or service that customers are willing to pay a premium for.

Competitive pricing

This pricing strategy involves setting your prices below what your competitors are charging.

You will look at the pricing data of your competitors for the particular product, determine the industry average price, then set your own price below that benchmark. 

The idea is that lower prices will help you rapidly gain market share from your competitors. 

Costco is a good example of a company that uses a competitive pricing strategy. The company applies discounts to all sorts of products, from toilet paper to bread to give it a leg up on the competition.

Here is the price of rotisserie chicken on the Costco website: 

Here is the price of rotisserie chicken on Erewhon’s website:

From the images above, it’s clear that there is a big difference in the prices of a similar product from two different retailers. 

Costco prices its item so low because it positions itself as the company that offers the lowest possible prices for wholesale purchases of grocery items, which explains why the company has a 90% membership renewal rate worldwide (93% in the U.S.).

In contrast, Erewhon is an upscale grocery chain that caters mainly to wealthy buyers, so it can charge higher prices for relatively premium products.

Pros of competitive pricing

• It helps you stay relevant with price-sensitive customers in a highly competitive market
• It encourages you to constantly find ways to cut costs in your business

Cons of competitive pricing

• The need to charge lower than the next competitor can lead to price wars, which can negatively impact your profit margins
• It can be very difficult to differentiate your product/service even when you have other unique features 

Who should use it: 

You can use this pricing strategy if you believe you can have the leverage to constantly negotiate lower product prices from your suppliers, and also constantly cut operational costs.

Skimming pricing

Price skimming involves charging the highest possible price when you first introduce a product or service to the market before lowering your prices as new entrants increase market competition and customer options.

This strategy is often used by tech companies to recoup the costs of developing the new product. The company will first introduce the product at a high price point to a limited pool of customers eager to be among the first people to use a new, buzzworthy product or service. 

As more competitors enter the market, the company will then lower its prices to compete better and attract a larger pool of customers.

For example, Salesforce was the very first SaaS (Software as a Service) CRM (customer relationship management) platform on the market and the company was able to leverage its groundbreaking innovation at the time to charge high prices for access to its platform.

Over time, other software companies introduced their own cloud-based CRM offerings, and the company gradually lowered its prices to ensure price-sensitive small businesses will consider its platform.

Pros of price skimming

• It allows you to use higher short-term profits to cover product development costs
• It’s easier to retain the first group of customers who were attracted by the exclusivity and novelty of your product, while setting up different pricing groups for newer, price-sensitive customers 

Cons of price skimming

• It’s not a sustainable long-term pricing strategy 
• High starting prices may severely limit your sales volumes because new customers may be conditioned to view your product as a high-priced item even after you have lowered prices 

Who should use it: 

You can use this pricing strategy if you are introducing an innovative product or service to an expectant customer base, especially in the tech industry.

Penetration pricing

With this strategy, the company will introduce its new product at a low price point to attract customers, before gradually increasing prices over time.

The idea is that once customers get hooked on the new product, they will be willing to shrug off the price increases and stay loyal to the brand.

Netflix is a good example of a company that used penetration pricing to out-compete an established market player before raising prices after it had successfully dominated the market.

In the 1990s, Blockbuster Video was the dominant home video rental brand. Customers could rent DVDs with a fixed return date and strict late fees.

This business model had key flaws, including limited selections, late fees, time-consuming store visits, and zero recommendations.

Netflix capitalized on this opportunity to introduce a new business model that allowed customers to order DVDs on the internet at cheaper prices to be delivered at their homes for free. There was a large catalogue of movies to choose from and customers could keep DVDs indefinitely with zero late fees. 

Netflix rapidly gained market share and made Blockbuster Video obsolete, forcing the company to file for bankruptcy.

With its dominance established, the company gradually raised its prices to achieve sustainable cash flows and maximize its profits.

Pros of penetration pricing

• It helps you to quickly build market share
• It makes it much easier to convince customers to switch from established businesses to your brand 

Cons of penetration pricing

• Low or even non-existent profit margins at the beginning can make the model unsustainable for entrepreneurs without deep pockets 
• It can be difficult to raise prices later with new competitors offering a similar low-priced model 

Who should use it:

You can use this pricing strategy if you want to gain market share quickly for your new product and you have the capital to sustain the significant upfront capital investment the model requires.

Premium pricing

The strategy involves using product differentiation to charge a higher price than the competition.

Companies that use this strategy use tactics like exclusivity, prestige, customization, and luxe design to justify higher prices.

It should be noted that these products are often not qualitatively better than competing products to any significant degree and the production costs can be similar or even cheaper than that of competitors.

Basically, customers are convinced their products are worth more, so the company charges higher prices accordingly. 

Apple Inc. is a good example of a company that uses a premium pricing strategy to charge higher prices for its gadgets.

It all goes back to the aura of exclusivity that Apple has always used to distinguish its brand from other gadget-makers.

While other phone and laptop brands combine third-party operating systems (Android and Microsoft) with their gadgets (Samsung, HP), Apple offers its own in-house combination of software, hardware, and services.

It’s iPhones, iPads, and MacBooks sync seamlessly with each other to create an ecosystem that is uniquely Apple. 

Also, while most gadget makers sell their products via third-party retailers, Apple sells its products via its own stores to create a unique experience for customers.

Interestingly, the company makes most of its products in China to cut costs, and then markets them as luxury, premium items, even though they are mass-produced products just like any other phone or laptop in the same category. 

Apple can charge premium prices because customers see any Apple gadget as a status symbol item and are willing to pay prices set by the company.

Pros of premium pricing

• You can charge higher prices and enjoy robust profit margins for a prolonged period
• Customers rarely change their perception of premium brands provided the company continues to remain ahead of the curve of innovation

Cons of premium pricing

• It can be difficult to implement because it requires a unique product or service, and a robust understanding of the preferences of your target audience 
• It’s not effective in geographical regions with price-sensitive customers 

Who should use it:

You can use this pricing strategy if you have a product that is unique in style and design and can be marketed to high-income customers as an exclusive item. 

Dynamic pricing

This market strategy involves constantly changing prices based on evolving marketing conditions. 

For example, prices can be increased when there is high customer demand for the service and adjusted lower when demand drops.

Uber is a good example of a company that effectively utilizes dynamic pricing to serve its customers and optimize its profit margins.

The company uses the inbuilt algorithm on its app to set rider fares based on the time of the day, driver demand, distance, traffic, and other relevant variables.

This leads to increased profits for the company because it can easily charge more during periods where demand exceeds supply. For example, people looking to book a ride at night or people who want a car with more leg room. 

Pros of dynamic pricing

• It can help increase your profit margins
• It helps you charge customers based on the evolving costs of services or products you are offering

Cons of dynamic pricing

• Frequent price changes can alienate customers
• The required investment in software and market research staff to help monitor and respond to changing market conditions is out of the reach of most small businesses 

Who should use it:

You can use this pricing strategy if you are in an industry where you can get away with temporarily hiking prices during periods of peak demand.

Choosing the Right Pricing Strategy for Your Business

Before we explore how to arrive at the best pricing methodology for your business, we must establish the difference between pricing strategy and pricing model.

People tend to use both terms interchangeably, which is wrong, and we must clarify the differences to make it easier for you to understand the essence of the information contained in this section of the article.

Pricing strategy is the overarching philosophy that guides how you set prices for your products and services, while pricing model is how you package those prices when communicating with customers.

Examples of pricing models include per-seat pricing, tiered pricing, freemium pricing, usage-based pricing, bundle pricing, and flat-rate pricing.

Below we will outline a step-by-step process to help you pick the best pricing strategy for your business.

Step 1: Outline your business goals and clarify your market positioning

Your business goals, resources, and the external market factors you can’t control will ultimately determine your market positioning. 

For example, an eCommerce company looking to maximize profits in a geographical location with a significant number of high-income customers can opt to position itself as a luxury brand, while another eCommerce company selling similar products and looking to maximize profits but is based in a geographical location with price sensitive customers may have no choice but to opt for a dynamic pricing strategy.

Ask yourself the following questions to nail down your market positioning:

• What are your company’s core long-term objectives? Do you want to maximize profits, dominate your market, or establish a specific type of brand reputation? 
• How many competitors offer a similar product or service to yours?
• How differentiated is your product or service?
• What do your top three competitors charge for their product or service and how do they justify their prices?
• How do you want to position your brand in the market? Do you want to be seen as a luxury brand or as a cost-leader?

Step 2: Understand what your target audience is willing to pay

Target market research must be all-encompassing, and may be divided into two stages.

The first stage involves building customer personas of the various customer groups in your target market. 

This involves knowing their age, gender, education level, income level, pain points, buying habits, and so on.

That data will tell you the specific customer segment in your target market that will be more receptive of your market positioning.

For example, a high-income Gen Z customer is likely to be more willing to purchase sustainable and eco-friendly products at a significant premium than a well-off but price-conscious baby boomer customer. 

Once you have nailed down the right customer segment to target, the next step is to determine the exact amount they will be willing to pay for your product or service.

The answers you get to the following questions will help you arrive at the right price range:

• What do you think would be an appropriate price for this product or service?
• At what price point will you feel the product is of questionable quality, and at what price point will you feel the product is too expensive?
• What features would you be willing to forgo for a lower price point?
• What additional features would you be willing to pay more for?
• How sensitive will you be to a sudden change in the price of the product or service? Will you switch your loyalty to another brand if the price suddenly increases?

Step 3: Outline operational costs and specify your desired profit margins

Your market positioning will determine whether you price your product/service as a luxury or value item, your customers’ perceived value of the product will determine how high or low you can go with your pricing, but ultimately, whatever price you set must be one that allows you to at least break even. 

Once you know your break-even point, you can then set a realistic profit margin based on your business objectives and the prevailing market conditions.

You must first determine your overhead costs, before you can calculate the lowest price at which you can break even.

The five main cost drivers that make up your overhead costs are:

• Manufacturing costs/costs of goods sold (COGS)
• Rent
• Salaries for labor
• Insurance
• Public utility 

Step 4: Decide on a pricing strategy

This stage of the process is where you leverage all the information you have gathered in the preceding sections to select a pricing approach that is most likely to help you achieve your business objectives, especially in the area of desired profit margins.

We should add that your final decision must include buy-in from key stakeholders in your business. These include high-level managers, marketing staff, the sales team, and the financial department.

With input from all the relevant players, you should answer the following questions to arrive at the most ideal pricing strategy for your business:

• Is your product/service superior or inferior to that of competing brands in terms of quality, features, prestige, etc.?
• What is your target customer’s perceived value of your product or service? How high or how low are you permitted to go with your pricing?
• What pricing strategy best aligns with your market positioning and the current market landscape (as determined by your answers to the two preceding questions)?
• Does the chosen pricing strategy guarantee long-term profitability?
• Can the pricing strategy be realistically applied within the framework of relevant pricing models in your industry (for example, dynamic pricing may not be suitable for subscription-based businesses with a recurring pricing model)?

Step 5: Testing and iterating your product prices

The product/service price you settle on based on your chosen pricing strategy shouldn’t be set in stone, and you should A/B test various prices until you arrive at one that works perfectly for you and your customers.

For example, let’s say you sell laptops on your online store, you can create two different landing pages for customers in different states—one with the laptop priced at $950 and the other with the laptop priced at $999 (with an add-on perk like a laptop bag).

You should then review the data from both landing pages, the one that attracts the most customers may be the right path for you to take.

As your business grows, you should have a clearly defined process and assigned team members for evaluating and responding to market shifts that can influence product prices.

For example, if market trends show that customers are increasingly willing to pay for add-on features, then your team can come up with upselling and cross-selling features you can offer to customers. 

Best Practices for Implementing a Pricing Strategy

A botched implementation of your new pricing strategy can lead to customer mistrust and negatively impair your brand value.

The following tips can help ensure a smooth implementation of your pricing strategy:

Communicate your pricing clearly to customers

This means your pricing page and other outlets used to convey product pricing information must clearly state what customers can expect to get for that price, and you should only set expectations you can actually meet.

You will also make price changes to adjust to changing market conditions over time. Make sure you are fully transparent with customers about the rationale behind those price changes and readily engage with them on any feedback about how they have been affected with the new changes.

Robust customer support can help in this regard. Customers will have a channel to express their complaints, and you can correct any misunderstandings and reassure them.

Use pricing psychology to influence customer buying decisions

Psychological pricing refers to techniques that slightly alter the pricing of a product to convince customers that it offers better value for money.

A good example is the practice of setting product prices just a bit lower than the nearest round number.

Let’s say the retail price of a product is $1000, you can instead opt to set the price as $999 as a way to cultivate a perception in the buyer that $999 is a better deal than $1000. 

When launching your new pricing strategy, this technique can be used to increase the likelihood of prospective buyers converting into actual buyers.

Monitor your performance and make data-driven adjustments

You should use analytics software tools to keep track of your pricing strategy and ensure it’s been well received by your customer base.

Examine patterns to see how your newly introduced prices have influenced sales and profitability.

If you are underperforming, then you shouldn’t hesitate to make the requirement adjustments.

It’s Time You Adopt A Right-fit Pricing Strategy for Your Business

This article explored all the major pricing strategies in detail and you are now well equipped to set an effective pricing strategy for your business.

It’s a process that will require lots of research on your part, and you will have to evaluate different pricing strategies, but it will be well worth it at the end.

Once you get your pricing method right, you are looking at a bright future with loyal customers, sustainable profits, larger market share, and the flexibility to react to changing market conditions with ease.

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