Below, you’ll find out how to optimize prices, outline the top 7 pricing strategies, and when to use them.
Perhaps one of the most confusing and challenging decisions to make in business is the pricing decision. If you make the wrong decision, it can be very costly: price your product too high, and you stand to lose lucrative customers, but underprice it, and you’ll be missing out on additional revenues and profit.
Before we go into the specifics of the pricing decision, let’s start by thinking about how to optimize prices. Price optimization establishes the foundation for a sound pricing decision. Even armed with knowledge about what pricing strategies are and how they’re used, you’ll still need to consider price optimization before settling on a pricing approach.
Price optimization is essentially a fact-finding process that you should follow in order to find the best possible price point for a product or service. The challenge of pricing is that it essentially involves a tradeoff.
Low prices usually mean better value for the customer, which drives higher volumes of sales, but can represent a loss to you in terms of revenue that each individual sale brings in.
Higher price points may mean that each sale represents higher overall profit, but if customers see the higher price as representing lower value for money, overall sales volumes will be lower. What price optimization does is help you to find that lucrative sweet spot between value and volumes, and that’s a precarious balance that can have a major impact on customer satisfaction, loyalty, sales, and ultimately—profitability and growth.
Price optimization isn’t a game of trial and error. In order to get it right, you’ll need hard facts and data. The types of data you should think about gathering and incorporating into your analysis includes:
This is the best way to find out what customers are willing to pay, and to determine the linkages between willingness to pay at different price points, purchase frequency, likely customer churn, and the amount that customers will likely spend with you. The types of survey questions you might ask include customers’ perceptions of your current pricing, their ideas about what constitutes value for money, and their likely reactions to loyalty programs, sales tactics, discounts, or promotions.
When gathering survey data, don’t forget to capture demographic and psychographic information like age, gender, household income and lifestyles. This will be crucial because different segments and categories of consumers will likely respond differently to different price points. Price optimization often means not just setting one price, but setting several.
If you’re already running your business, great news: you already have access to some very powerful data. Analysis of historical sales data can help you understand whether and the extent to which sales have changed in response to price changes.
Profitable businesses need to cover their operating costs, so feed this information into your analysis too. This is especially the case if you’re using a cost-plus pricing strategy, or some kind of price designed to appear low in the minds of consumers, like penetration pricing or competitive pricing.
It may not seem obvious but consider how many products or supplies you have in stock before you embark on your price optimization journey. Many companies have inadvertently undermined their reputations in the minds of consumers by heavily discounting prices, and driving heavy levels of sales, only to find that they quickly went out of stock, disappointing customers.
Some companies may find that they can use machine learning models to optimize prices. Machine learning can gather together and automate very large datasets in order to reach optimal prices quickly, efficiently, and with limited manual effort.
If your business follows a subscription based model, don’t overlook the lifetime value of existing customers, as well as their churn rate. If you find that customers sign up and then quickly leave, you may find it is because prices are high compared to competitors, or that you need to lower prices in order to maximize subscription length, and hence customer value.
So, what do you need to optimize for? In addition to your basic, everyday pricing, we recommend performing price optimization for the following three types of price strategies:
The point at which your product first launches is vital to establishing it in the market and in the minds of customers. If you start with too low a price, you may gain some early traction, but you could lose sales in the long run as you begin to raise prices, as customers begin to think you no longer represent value for money. Alternatively, too high a starting price could cause you to miss out on sales from that lucrative innovator/early adopter segment of consumer.
In order to drive sales, you might think a discount is the way forward. That’s often the case, but what level of discount should you offer? A 5% discount might be seen as measly by customers but could protect your bottom line. A 50% discount could be seen as a bonanza, but might undermine long term profit. Price optimization is a delicate process when it comes to discounts.
Which is better: slashing prices to half of their original price, or offering a buy one get one free (BOGOF) deal? On paper, both strategies have the potential to yield the same revenues, but practice and paper are very different beasts. Price optimization can help you determine the most effective and profitable approach to promotional prices.
Price optimization is crucial for a myriad of reasons, all of which make a contribution to your bottom line. Here are a few other reasons:
Under- or over-pricing products and services are among some of the biggest causes of business failure and lack of profitability.
In contrast, if you optimize your prices, you’ll be best placed to grow quickly, because you’ll not only have the revenues to leverage growth, but you’ll also have a loyal customer base that you know is willing to pay the prices you set.
Failure to meet customers’ expectations is a surefire way to drive them to competitors. You can only meet customers’ needs if you understand what those needs are, and that includes the prices they expect from you.
Research to support price optimization can be complex, but once you’ve got the data, you’ll be able to replicate the analysis over and over again, saving you time and driving sales in the long run.
Optimal prices are the best way to portray that your prices are value for money. For example, there is a fine line between what customers consider a bargain, and what they consider to be too cheap. It’s not worth trying to guesstimate where that sweet spot lies—use hard facts and data to help you.
If you’re just starting out with optimizing prices, take into consideration the following tips and guidance:
Offer a price that conveys value for money, and that customers are willing to pay (as well as a price that covers your costs!) and you’ve reached an optimal price. You’ll never be able to achieve that fine balance unless you get to know your customers.
What is value in the minds of your customer? This is actually a pretty difficult question to answer. The best way to answer this, of course, is to ask them directly. Using tools like the Van Westendorp Price Sensitivity Meter, you’ll learn a lot about what customers consider to be too cheap, what they consider a bargain, and what they think represents value for money.
Customer demands, needs, expectations, and their willingness to pay your prices are not static, and as a consequence, your pricing should be dynamic. Make it a habit to continually analyze data in order to make sure your pricing is always optimal.
After reviewing your data and adjusting your prices, make sure you monitor impact. Did that discount land effectively? Did that promotional sale help you acquire new customers, and how many? Price optimization is a long-term process so don’t forget to keep an eye on the consequences.
Price skimming is a medium to long term pricing strategy in which you launch a new product or service at a higher price point initially, gradually lowering the price over time. Let’s take a look at some of the benefits of this approach.
Imagine you’re bringing a new premium or highly innovative product to the market. Products like these have the potential to appeal to broader market segments, but your first task is to capture the interest of trendsetters or early adopters. Why? This important segment can influence others to buy because their decision to purchase essentially acts as a stamp of approval.
For highly appealing products or services, a price skimming strategy can drive long-term sales. That’s because the broader market, who may find the initial price unaffordable, will continue to keep an eye on the product and your marketing campaigns, waiting for prices to fall.
If you’ ve invested considerably in the development of a new product or service, price skimming can provide you with a measure of security that your sunk costs will be covered. Provided that the initial price you choose isn’t too extreme, you can quickly recover your costs soon after launch using this approach.
There are two main scenarios in which a price skimming strategy should be considered.
If your product is the first to enter the marketplace, price skimming can be highly effective—and profitable. By selling your product or service at a higher initial price, you can generate the maximum profit in the shortest time possible, before competitors enter the market, and pricing pressures grow. The average price of products which were once novel but are now commonplace, such as Blu-ray and DVD players, has fallen over time because leading manufacturers followed a price skimming strategy.
In retail, trends come and go quickly. So, it’s typically imperative to try to capture the majority of your sales while the trend is still hot, and before interest dwindles. Price skimming can help you maximize profitability at the top end of a trend.
Penetration pricing is essentially the opposite of price skimming: instead of starting with a high price that is gradually reduced, you enter the market with a low price, and steadily increase it as sales gain traction.
The main advantages of penetration pricing are:
Customers who feel that they’re getting value for money can often be customers for life. A discounted experience often feels like a reward for customers, and if they know that your prices are regularly lower than your competitors’, they’re likely to hang around.
Low market prices are a great way to boost awareness and perceptions of your brand. If the price is very low, you can often acquire customers who might not ordinarily have considered buying from you. And, if you’re confident about the quality and appeal of your products and services, penetration prices are an excellent long-term customer acquisition strategy: customers will remain keen even once prices rise.
If you gather data on customer responses to your low prices, either through sales data, or more explicitly through surveys and similar, you’ll have some critical insight that you can use to make decisions about future prices. Once you’ve achieved market penetration, you can rise to an equivalent or high price depending on customer feedback.
While price skimming can help you to maximize profit margin in the early period of a product’s life cycle, penetration pricing actually increases the risk that you’ll make zero profit. So, why use this strategy? As the name might suggest, penetration pricing is best used to penetrate a new market. If you’re launching a new product or service, or pivoting to a new geographical location, penetration pricing can help you gain a foothold.
Competitive pricing is similar to penetration pricing in that the goal is to drive the target audience away from competitors and towards your brand. Using this approach, you’ll continually track competitive pricing and then take appropriate steps to try to beat them out.
If you pride yourself on obtaining the most expensive raw materials, your products are handmade, or your costs cannot be controlled, competitive pricing is not for you because it could cut into your bottom line. However, if you’re able to keep costs low, you can adopt a pricing strategy that tracks the market, rather than internal processes and costs.
Customer loyalty is highly lucrative, and it is to your advantage to take steps to retain customers and convince them to return to you time and time again. If you know that your market consists of at least some price sensitive consumers, consider using a competitive pricing strategy to foster long-term, repeat customers.
Competitive pricing is best used in highly rivalrous or saturated markets, or where there is a lack of differentiation between your products and those of your competitors. If your product is on the shelves alongside competitors, and customers are unable to distinguish them, they’re likely to make their choice on the basis of prices. This is why goods like milk, bread, gas and other indistinguishable products are often priced competitively.
When your target audience seeks quality over a good deal, you need to demonstrate the advantages your brand provides. In this case, a premium pricing strategy can help you build the perceived value of your product or service from the moment of your initial launch.
The main advantage of premium pricing is that it often leads to customer loyalty. Customers with aspirational tendencies buy brands that reflect the values that they hope to achieve. If the quality of the brand is reflected in the premium price, customers will be more aot purchase your brand over a competitor despite equal products
Loss leader pricing occurs when you offer one major discounted product or product line while encouraging customers to purchase more from a higher priced line. Usually the product is priced so low, that it actually is below the cost that it takes to produce. The product that is priced cheaply is known as a loss leader because it may constitute a loss to your bottom line. In conjunction with the higher priced goods, it actually generates or leads sales.
The main advantage of loss leader pricing is that it can lead to more consistent sales, which eventually surpass what you would have sold by only pricing items individually. It may seem counterintuitive, but many companies, especially retailers, have driven major success and profit by bundling goods in this way.
As a short-term strategy, it might be a strategic attempt to get new customers in the door: some physical retailers, for instance, place their loss leaders in the window of their stores or in baskets at the door in order to entice new customers. As a long-term approach, loss leader pricing can be a core part of your business model. Liquidators are one type of company that regularly use loss leader pricing as part of their business strategies.
Psychological pricing aims to change perceptions about what the price even is in the first place. It is a way of tapping into customers’ psyches in order to make them feel a certain way about products and services:
This is one of the most widely recognized and well used forms of psychological pricing. If you end a price with an odd number, you can make a customer feel like they’re spending much less. This is why you often see dollar store prices at 99c instead of $1.
Using larger font sizes for dollar amounts and smaller font sizes for cents is not just an aesthetic decision: it’s actually a very powerful psychological pricing strategy. Paired with charm pricing, you can further emphasize a customer’s feelings that they’re paying significantly less.
Placing an original price next to a sale price to show customers how much they’re saving. This is sometimes known as anchor pricing.
The advantage of this approach is that it can lead customers to buy in higher volumes than they would otherwise. For example, if you use anchor pricing, customers may be spurred to buy more by the perception that they're getting a bargain.
Psychological pricing can be a very impactful strategy for brands that are targeting price-sensitive customers. This is because it suggests that customers are getting a deal or a bargain. Customers who tend to have an affinity for luxury may not want or be motivated by the perception of bargains.
This approach takes into account what your customers view as good value for money, and tries to match that value with an appropriate price. This strategy is often a core part of retailers’ promotional campaigns, as they seek to appeal to customers who place a high premium on getting bang for their buck.
The main advantage of this approach is that it can deliver high levels of customer satisfaction. Customers love getting value for money and are highly dissatisfied if they think they’re being ripped off. As long as your products and services meet customers expectations and deliver on the value proposition, value pricing can be the key to happy, loyal customers.
Value pricing can be used in a number of different scenarios and for products and services of different types. The most important thing is to make sure that you understand what value means in the minds of your customers—and we can help you obtain that all important insight.
So, while pricing is certainly not straightforward, figuring out the optimal price for your product or service can be very powerful indeed. Ready to optimize prices? Take a look at our Price Optimization solution. Our expert researchers deliver the highest quality data along with acceptable price points for your product or service. Get started today.