Product Pricing: A Complete Guide On Models And Strategies in 2024

June 23, 2023

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There are numerous studies that prove: pricing can impact not just the immediate desire to buy but more long-term aspects like customer loyalty, brand positioning, churn rate and many more. Hence, choosing the right pricing strategy or model is a life-and-death decision for any company’s management. Here’s a quick overview of the most common pricing models, their applicability for various industries, upsides and drawbacks.

When it comes to pricing products, businesses have different options to choose from. These options depend on the business's goals, target market, competition, the nature of the product, and obviously, the perceived value of the product. Pricing is not just a technical question of putting a certain price tag. Whenever you face a task of pricing, you have to think strategically and choose one of the following approaches.

Pricing Models

The most widely used today pricing models include:

  1. Cost-based pricing: This pricing model involves calculating the total cost of producing a product or service and adding a markup to cover overhead costs and profit. Great for small business and for selling physical goods.
  2. Value-based pricing: This pricing model focuses on the perceived value of the product in the eyes of the customer. The price is set based on what the customer is willing to pay for the product or service. Great for businesses that offer unique products or services (pieces of art, hand-made products, etc).
  3. Competition-based pricing: This pricing model involves setting a price based on the prices of similar products in the market. This pricing model is the most widely spread one in modern retail.
  4. Penetration pricing: Presumes that a seller sets a low price for a new product to gain market share quickly.
  5. Price skimming: This pricing model involves setting a higher price for a new product to capitalize on the novelty and uniqueness of the product. Basically, a variation of a value-based pricing.

Pricing is not just a technical question of putting a certain price tag. There are numerous studies that prove: pricing can impact not just the immediate desire to buy but more long-term aspects like customer loyalty, brand positioning, churn rate and many more.

Product Pricing Strategies

Now that we've established the different pricing models let's explore the various pricing strategies businesses might use.

1. Value-Based Pricing Strategy

It's a strategy based on an educated guess about what a customer is willing to pay for the product or service. It's about the emotional connection the customer has with the product, and businesses can use this to their advantage. According to Neil Patel, "value-based pricing is all about understanding what the customer wants and what they are willing to pay for it."

This strategy is unthinkable without building a strong brand around the product, the company, or the founder.

For example, Apple uses value-based pricing as they had spent years investing in the Apple brand associated now with quality and uniqueness. Tesla can price its cars higher than the market average, because Elon Musk is a controversial figure and has gained a wild popularity online. Think of any D2C brand launched by a celebrity — and you’ll get an idea. Remember that hilarious story when some sports celebrity girlfriend got away with selling her farts in a jar for hundreds and hundreds of dollars? This is a great example of value-based pricing strategy. Customers assigned ridiculously high value to the farts because they associated them with a well known football player.

Advantages of value-based pricing:

  • Higher profits: By setting a higher price based on the perceived value of the product, businesses can increase their profit margins.
  • Competitive advantage: By offering a unique product or service, businesses can differentiate themselves from the competition.

Disadvantages of value-based pricing:

  • Limited market: Not every customer would see the price as fair, as they have no affinity with the brand.

2. Competition-Based Pricing Strategy

Competition-based pricing strategy is about setting a price based on what the competition is charging for similar products. This pricing strategy is often used in highly competitive markets where businesses need to keep their selling price in line with the competition. According to Eric Siu, "competition-based pricing means you have to gain deep market understanding and have a 360-degree view."

Competition-based pricing is pretty straightforward. The tricky part is identifying the right competitor. That is, choose the products that are similar to yours not just in price and quality. But also the ones that are perceived as similar by consumers. This requires a lot of leg-work from your marketing team, numerous surveys and focus-groups.  

Another challenging aspect is collecting market price data. If you’re selling a limited number of products or services it’s relatively easy to do that. But you can’t realistically ask your category managers to go and check out your competitors' prices daily if you have thousands of items in your catalog. Years ago retail companies started using web-scraping bots to automate this task. Today plenty of tech companies offer price monitoring and competitor price comparison services. The idea is to choose the right service provider (you can read more about it here How to choose price monitoring service).

Advantages of competition-based pricing:

  • Scalability: Once implemented properly, it can be scaled to any type of business, location and product. No matter what you sell: consumer electronics, garden tools or pet food, competition-based pricing will help you grow your business predictably while raising the level of control you have over inventory turnover. This is why competition-based pricing is most suitable for medium-sized or big businesses.

Disadvantages of competition-based pricing:

  • Limited differentiation: By keeping prices competitive with other retailers, you can’t use a price as a differentiator for your product. You tell a consumer: we’re just like many other sellers but our offer is better today, so please come and buy with us.

3. Penetration Pricing Strategy

Penetration pricing strategy involves setting a low price for a new product to gain market share quickly and get rid of possible competition. Real-life text-book example: Uber. When entering a new market Uber makes taxi rides prices ridiculously small. In several months other players lose price wars and leave the market. Consumers end up having no other choice but to use Uber. Then the company can take prices up.

It is obvious that this pricing strategy can be only used by really big players who have unlimited runaway, and can burn cash as long as they want until they kill all the competition. Also, it involves proprietary relationships with the product you sell. If the service or the product doesn’t really belong to you it might cause big troubles. Example: in February 2023 Twitter made API changes. 90% of Twitter-related products that were making money on scheduling tweets experienced huge churn. They were unable to offer the service, and customers left.

Advantages of penetration pricing:

  • High profitability in the long run. As soon as you kill your competition you may increase prices as much as you want.

Disadvantages of penetration pricing:

  • High risk. It is risky to enter the market sacrificing your margin and having negative profit for some time. Customers might choose not to use your product and find some other alternative.

4. Price Skimming Strategy

Price skimming strategy is rare. Businesses that use a price skimming strategy must be able to convince customers that their product is worth the higher price. They must also be able to maintain the higher price until the competition catches up. It presumes huge investments in staying ahead of everyone else, building an objectively better product.

The textbook example — Google search engine, For years it stayed ahead of everyone else. It allowed the company to price their advertisement-related services as high as they wanted. But again, 2022 changed everything. With Microsoft getting access to the ChatGPT technology, Bing became a very visible and real competition. Which will probably lead to changes in Google pricing strategies in the nearest future.

All these strategies can be implemented manually or in automated mode using smart repricing solutions. They eliminate human-factor-related erros and allow businesses leverage the benefits of technology at full scale.

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