Businesses compete with each other in many factors, including price, value, convenience, social causes, and customer service. Customers often look at price first before considering the other factors. Hence, learning how you can implement different price strategies is an important part of building and growing a profitable business.
Pricing can be tricky for small business retailers because you have to find a balance between competitive and profitable. If you price products higher, you'll have a higher profit margin per item but you might drive away customers. If you offer lower prices, you'll need to sell more products to see profits.
Fortunately, there are many pricing strategies you can implement. This article will discuss common retail pricing strategies and how to implement them in your own business. Note that you may need to try different strategies until you find the one that's most effective for your company.
What Is a Pricing Strategy?
A pricing strategy refers to a model or method businesses use to determine the best price for their products or services. Using a model helps you set retail prices that maximize your profits while taking your business goals, competitor pricing, potential clients, and other factors into account.
There are several retail pricing strategies, including competitive pricing, markup pricing, bundle pricing, and value-based pricing. However, selecting a pricing strategy for your business starts with understanding your product, customers, and industry.
Common Retail Pricing Strategies
Many companies set prices based on two factors only: their competitors' rates and the cost of goods sold (COGS). This practice results in inefficient pricing. Your prices should be competitive but also set to maximize your profit and sales. The following sections discuss common retail pricing strategies you can implement depending on your company's short-term and long-term goals.
Cost-Based Pricing
Cost-based pricing, also called cost-plus pricing, calculates the price of the product by taking its cost and adding a percentage markup. The markup represents the profit from selling the item. The cost-based approach sets prices that cover the COGS and provide enough profit margin for the business to earn its target return on investment.
It's a popular strategy for small businesses because of its simplicity. An example of cost-based pricing is following the manufacturer suggested retail price (MSRP). The MSRP provides a single price for a product and avoids price wars between retailers while still giving them a decent profit.
Keystone pricing is also based on cost. It involves setting the retail price at double the cost of the merchandise. You can use this method for high-end items that are not price-sensitive.
Pros of cost-based pricing:
- The calculation is simple.
- The approach covers the cost of goods sold, which ensures a consistent profit if all costs remain the same.
- Businesses using this strategy can easily estimate revenue for a given period based on previous sales, marketing efforts, etc.
- It's a good starting point for businesses that have no information about what their customers will pay for or how much their competitors charge.
Cons of cost-based pricing:
- It's inefficient because it doesn't take into account market conditions, such as competitive pricing or the customer's willingness to pay for a product.
- Since it guarantees a profit, it doesn't provide an incentive for businesses to cut costs or look for efficient ways to allocate resources.
Competitor-Based Pricing
Retailers use competitive-based pricing to set prices for similar products that their competitors also carry. To implement this method, you'll research what other businesses are selling a similar product for. Then, you'll use that number to determine the selling price for your product.
Generally, there are three approaches to competitor-based pricing:
- Pricing below competition: Since customers are willing to shop around for the best price, discounting and markdowns are a part of retailing and e-commerce. The competitive advantage is to attract more customers and sell more to make up for the lower profit per item. You could implement this approach and still be profitable if you can reduce your costs, negotiate a lower wholesale price from your supplier, and be able to advertise your low prices. Discount pricing can be categorized under this approach. Retailers may set prices below cost to use the loss leader — the discounted item — as a marketing strategy to bring in customers who will buy other products with higher profit margins.
- Pricing the same as your competition: You can take this approach if you don't know how much to charge for your products or if you don't have any information yet on how much your customers are willing to pay.
- Pricing above the competition or premium pricing: This means setting higher prices for your products. You may use this approach if you offer convenience, exclusivity, high-end customer service, or other factors that are more important to your customers than lower prices.
Pros of competitor-based pricing:
- It's a simple, fairly accurate way of researching prices.
- The strategy takes competitor pricing and market share into consideration.
- Using a competitor's price as a benchmark may lead to missed opportunities for a business to establish its value and stand out on the market.
- Competitive pricing may not cover costs, which could result in low profits.
- Businesses that employ this strategy may need to spend more to provide excellent customer service, exclusivity, etc., to compete in other ways besides price.
Cons of competitor-based pricing:
- Using a competitor’s price as a benchmark may lead to missed opportunities for a business to establish its value and stand out on the market.
- Competitive pricing may not cover costs, which could result in low profits.
- Businesses that employ this strategy may need to spend more to provide excellent customer service, exclusivity, etc., to compete in other ways besides price.
Value-Based Pricing
Companies use value-based pricing when they set prices on the perceived or estimated value of the product to the customer. This strategy is based on the assumption that customers will pay more if they think they're receiving more value even for the same product or service.
Value-based pricing doesn't take a competitor's price and the cost of the new product into consideration, but it involves dynamic pricing. To be able to implement it successfully, you need to continually tweak your buyer personas as you get more information about your customers.
Price skimming is an example of value-based pricing. The strategy sets high prices during the initial phase to allow businesses to maximize profits on early adopters. Then, the prices are dropped to attract more customers.
Penetration pricing is the opposite of price skimming. This method attracts customers to a new product by offering a lower price during the introductory phase. Its goal is to use pricing to introduce the product to a large number of customers.
Pros of value-based pricing:
- Since companies need to know their customers' data and interests, using this method helps them prioritize customers in certain aspects of business, like marketing and customer service.
- When used correctly, this method provides the most profit.
Cons of value-based pricing:
- It requires a lot of research. You need to collect information about your customers to accurately forecast how much they'll be willing to pay for a product. It also requires that you know what your competitors are doing to stay competitive.
How to Implement a Pricing Strategy
There are a lot of factors that go into pricing decisions — your company's bottom line, sales volume, product prices, etc. Before you choose which pricing strategy to implement, you also need to know your COGS and operating expenses. Even though it's true that customers don't care about how much an item costs you, you need this data to gauge whether carrying a product will be profitable for your retail business.
Once you know how much you're spending to carry a product, research how much your competitors are charging as a benchmark for setting your own prices. The next step is defining your short-term or long-term goals. Your business goals could be to maximize profits, increase market share or sales, or match competitors' prices. Sometimes, your goal might even be simply to survive the off-season and make all your profits during the high season.
When you're clear on your goals, select a pricing strategy to implement. Define how you'll measure the success of your method. For instance, if your goal is to increase sales, keep track of the results and make adjustments as you go.
Give yourself time and grace when implementing a new strategy, whether price-related or otherwise, in your business. Start small and continuously refine and improve your methods as you learn.
Track and Manage Your Business Finances with Skynova
There's no right pricing strategy that will work for every company. You might need to do a lot of research and implement a couple of price points before you find the right price that provides the most value to your customers and maximizes your profits. Implementing pricing strategies takes a lot of work, but the alternative is to lose out on profits and the opportunity to grow your business.
With all that work, save time tracking your income and expenses with Skynova's accounting software for small businesses. It helps organize your receipts and invoices in one place. You can easily compare your company's profitability from one period to another through automatically generated financial reports whenever you need them.
You're welcome to explore our platform for free templates and helpful resources to help you run and grow your business.
Notice to the Reader
The content within this article is meant to be used as general guidelines and may not apply to your specific situation. Always do more research and consult with a professional to ensure that you're making the best decisions for your business.