Posted by Pamela Swift in Operations
Article Contributed by Bernard Meyer
Small business owners often have so much responsibility on their shoulders that they often don’t have much time or energy into really researching effective pricing strategies.
Pricing is one of the four main components of an effective marketing mix, along with the product, promotion and place. In fact, besides the actual product, a company’s pricing strategies may be the main driver of sales.
Many small business owners’ first strategy is to look at their closest competitor’s prices and then decide to go a bit lower. There are many pricing strategies available for small businesses, and this may not be the most effective for your business.
That’s why today we’ll look at the 7 most effective pricing strategies to make your small business more competitive and profitable.
Right off the bat, we’ll go with the most popular strategy: the direct challenge to your competitors’ prices. However, effective competitive pricing relies on two conditions.
First, you need to take into account multiple competitors, and not just a single one. Then take their average price and decide if you want to go lower or stay at the same level and offer other benefits.
Secondly, you need to take into account whether your business’ cost structure is similar to that of your competitors. Only then does their average make sense for your business. If your cost structure is different, then your price is too low and you may end up cutting into your own profits.
Customer Perceived Value pricing
Customer perceived value (CPV) pricing is one of the many pricing strategies that require quite a bit of data to work. Essentially, you have to determine the perceived value of your products compared to your competitors’.
CPV is calculated as:
CPV = Total Perceived Benefits – Total Perceived Costs
Here, the CPV is equal to the net benefits of your product or service, converted into dollar amounts.
For example, if a customer is eager to purchase your furniture or consulting services, he may perceive the benefits at something equal to $1200 (including any emotional benefits as well). He may perceive the costs to be around $800.
Therefore, anything between $800 and $1200 would be a fair price, although the lower the price, the greater the CPV and the greater the incentive for the customer to purchase. If you charge above $1200, you will essentially be pricing yourself out of the market.
Cost-plus pricing is based on your cost structure with margins added on so that you can turn a profit. Essentially, you first need to calculate what your business costs are related to producing a product or delivering a service.
After that, you need to decide what a good margin will be that will allow you to cover your costs but also won’t scare off your customers.
For example, let’s say that a business comes up with the following costs:
- Direct materials: $25
- Direct labor: $15
- Allocated overhead: $12.50
In total, the costs come to $52.50. Let’s imagine then that you prefer to have a standard markup of 30% on all products. That means the final price will come to $68.25.
While cost-plus pricing is one of the more straightforward pricing strategies available, it does have some drawbacks.
It most importantly ignores the competition, therefore the prices may not be competitive enough in the market or even could be below the market value. Secondly, it doesn’t place a lot of incentive for the business to work too hard to eliminate costs.
Captive product pricing
This pricing strategy is also known as the razor blade pricing technique, whereby one item is sold for a low price (or even free) but requires another premium product to work effectively.
In the popular example, Gillette may sell its razor blade (something which is not replaced often) for $7, but a pack of 5 razor blades (replaced regularly) will cost you $20.
As in the above example, the two or more items required for captive product pricing must work together. Gillette razor blades don’t work with any other razors except for Gillette’s.
Similarly, a pillowcase from IKEA (higher price) will only fit IKEA’s pillows (lower price), as they have specific dimensions.
Versioning & Freemium pricing strategies
A common pricing strategy for many services, including SaaS (Software as a Service) businesses is the versioning and freemium pricing.
This involves selling the same services at different prices for different versions.
There is often an introductory price that could be much lower than the medium or higher prices. The introductory price for freemium is free. However, this version is often limited in certain ways. If the customers want to get more features from the service, they will have to pay for the higher version.
This has the benefit of inducting the customer into the service or software ecology. A customer is more likely to continue on with a service if they have taken the time and energy to learn about the service. During their introductory period, the business will encourage the customer to upgrade by showing off the higher features.
The first of the psychological pricing strategies is charm pricing, a technique commonly employed by the supermarket and retail industry. In charm pricing, products with round dollar figures are reduced by one or more cents. So, instead of a bag of candy being $3, it is now reduced to $2.99.
Although mathematically the difference in prices is only 1 cent, psychologically it has a stronger effect. Our brains view the left-most number as being very significant.
Therefore, while the price goes down by 1 cent only, we see the round-figure price at $3 and the lower price at $2.
For that reason, the effect doesn’t work when you go one cent lower on other prices. For example, if you lower a price from $3.80 to $3.79, the effect is insignificant because the left-most number is still the same.
This can be seen as the opposite of charm pricing. Instead of decreasing the price, here the retailer will increase it to a much higher value.
This is most effective with luxury goods that are seen as more prestigious than other comparative products.
For example, women may be more willing to buy Kiehl’s shampoo for $30 rather than a L’Oreal shampoo for $3.97. The round number (and prestigious brand) convinces the shopper that it is high quality.
According to a study conducted in 2015, these prestigious, rounded numbers encourage shoppers to make feelings based on their ‘gut feelings’ rather than any calculation. In the study, the authors discovered that shoppers were more willing to buy champagne at $40 rather than the lower price of $39.71.
Pricing strategies for your small business
These pricing strategies may be very effective for your business. However, again, as with most of them you will need to first be aware of all the costs associated with your product or service. Also, you will need to be aware of your competitors and your own business structure before you consider any pricing strategies.
When you determine the best pricing for your products, however, you will see your sales increase and measurable boosts in your profits.
Author bio: Bernard Meyer is the Head of Marketing at InvoiceBerry, the online invoicing software committed to helping small business owners send out invoices quickly and professionally. You can also find him on Twitter and LinkedIn.