When starting a company, most entrepreneurs focus their creative energy on developing an idea and turning it into a sellable product. But before you can begin selling any product or service, you need to decide what it’s worth. This is where pricing strategy comes into play.
A pricing strategy is a method for determining the price of a product. An effective pricing strategy takes revenue, profit, consumer behavior, and business goals into account. It also requires you to also consider human psychology—and how that impacts perception of price.
Read on to learn about the importance of competitive pricing and how to choose the pricing model that’s best for your business.
15 common pricing strategies for small businesses
- Cost-plus pricing
- Competitive pricing
- Value-based pricing
- Price skimming
- Discount pricing
- Penetration pricing
- Keystone pricing
- Manufacturer suggested retail price
- Dynamic pricing
- Multiple pricing
- Loss-leader pricing
- Psychological pricing
- Premium pricing
- Anchor pricing
- Economy pricing
When it comes to choosing a pricing strategy, there are 15 common tactics to get you started:
1. Cost-plus pricing
Cost-plus pricing, also known as mark-up pricing, is the easiest way to determine the price of a product. You make the product, add a fixed percentage on top of the costs, and sell it for the total. Let’s say you just started an online t-shirt business and you want to calculate the selling price for a shirt. The cost for making the t-shirt are:
- Marketing and overhead costs: $10
You could then add a markup–say 35%—to the $45 total it cost to make your product. Here’s what that formula looks like:
Cost ($45) x [1 + Markup (1.35)] = Selling price ($60.75)
- Pros: The upside of cost-plus pricing is that it’s relatively easy to calculate. You’re already tracking production costs and labor costs. Next, just add a percentage on top of it to set the selling price. It can provide consistent returns if all your costs remain the same.
- Cons: Cost-plus pricing doesn’t consider market conditions such as competitor pricing or perceived customer value.
2. Competitive pricing
Competitive pricing refers to using competitors’ pricing data as a benchmark and purposely pricing your products below theirs. For example, for businesses in industries with highly similar products where price is the only differentiator, you may rely on price to win customers.
- Pros: This strategy can be effective if you’re able to negotiate a lower cost per unit from your suppliers while cutting costs and actively promoting your special pricing.
- Cons: This strategy can be difficult to sustain as a small retailer. Lower prices mean lower profit margins, so you’ll have to sell a higher volume than your competitors. And depending on the products you’re selling, customers may not always reach for the lowest-priced item on a shelf.
3. Value-based pricing
Value-based pricing, also known as price-to-value, refers to setting a price based on how much the customer believes a product or service is worth. It’s an approach that takes your target market’s wants and needs into consideration when establishing the value of the product. Companies that sell unique or highly valuable products are better positioned to benefit from value-based pricing compared to ones that sell standard day-to-day items.
With value-based pricing, customers are more concerned about the perceived value of products (such as how they enhance self-image) and are willing to pay more for them. For this pricing strategy, positive brand equity is especially important.
Value-based pricing is common in markets where a product enhances a customer’s self-image or offers a unique life experience. For example, people normally assign high worth to luxury brands like Gucci or Rolls-Royce. This gives the brand the opportunity to apply value-based pricing.
- Pros: Value-based pricing lets you command higher price points for your items. Art, fashion, collectibles, and other luxury items often perform well with this pricing scheme. It also pushes you to create innovative products that resonate with your target market and increase brand value.
- Cons: It can be challenging to justify the added value for commodity products. You need to have a special product to apply a value-based pricing strategy. Perceived value is subjective and can be influenced by cultural, social, and economic factors that are beyond your control.
4. Price skimming
A price skimming strategy is when an ecommerce business charges the highest initial price that customers will pay; then lowers it over time as market competition and saturation rise. As a result, there are higher short-term profits.
The goal is to drive more revenue while demand is high and competition low. Apple reportedly uses this pricing model to cover the costs of developing new products like the iPhone. Price skimming also works when there is product scarcity. For example, high-in-demand, low-supply products can be priced higher, and as supply catches up, prices drop.
- Pros: Price skimming can lead to high short-term profits when launching a new, innovative product. If you have a prestigious brand image, skimming also helps maintain it and attract loyal customers that want to be the first to gain access or have an exclusive customer experience.
- Cons: Price skimming isn’t the best strategy in crowded markets unless you have some truly standout features no other brand can imitate. This strategy can also attract competition. Lastly, if you drop prices too quickly or too much, it can leave a negative impression on early adopters and erode brand image.
5. Discount pricing
It’s no secret that shoppers love sales, coupons, rebates, seasonal pricing, and other related markdowns. That’s why discounting is a top pricing method for retailers across all sectors, with one survey finding that 28% of shoppers usually seek out coupons before buying online.
- Pros: Discount pricing strategies are effective for attracting more traffic to your retail store and getting rid of out-of-season or old inventory in-store and online.
- Cons: If used too often, discount pricing could give your brand a reputation of being a bargain retailer and deter consumers from purchasing products at regular price. It can also limit your customer base and negatively impact your brand equity due to a perception that lower prices equal lower quality.
For more information on how to build a discount pricing strategy, read these related posts:
6. Penetration pricing
A penetration pricing strategy is useful for new brands trying to break into a market. That’s because this strategy introduces a new product at a low price in an effort to gain market share, then increases the price over time.
- Pros: This tactic can help you stand out in an already crowded marketplace, and strengthen brand awareness. In the process you may gain new customers, including attracting some from the competition.
- Cons: By unveiling a product at a lower price point to capture customers, it may be more challenging to raise prices later without risking customer churn. Plus, lowering prices in the short term can sacrifice profit and revenue.
7. Keystone pricing
Keystone pricing is a product pricing strategy in which you mark up the retail price by simply doubling the wholesale cost paid for a product. The simplest way to think of keystone pricing is:
Wholesale price x 2 = Retail price
For example, if a product costs you $15 from the manufacturer, your retail price would be $30.
$15 x 2 = $30 retail price
- Pro: Keystone pricing works as a quick-and-easy rule of thumb that ensures an ample profit margin.
- Con: Depending on the availability and the demand for a particular product, a retailer doubling its markup might be risky for customer acquisition and sales.
8. Manufacturer suggested retail price
As its name suggests, the manufacturer suggested retail price (MSRP) is the price a manufacturer recommends retailers use when selling a product. Manufacturers first started using MSRP as a pricing strategy to help standardize prices of the same product across multiple locations and retailers.
Retailers often use the MSRP with high-ticket products such as consumer electronics and appliances.
- Pro: MSRPs standardize costs for consumers, which means that shoppers know they won’t be able to find the product on sale for less elsewhere.
- Con: Retailers that use the MSRP aren’t able to compete on price. With MSRPs, most retailers in a given industry will sell that product for the same price. You need to take into consideration your profit margins and cost. For example, your business may have additional costs that the manufacturer doesn’t account for, like international shipping.
Keep in mind, MSRP is a fairly niche pricing strategy. Although you can set whatever price you want, a large deviation from an MSRP could result in manufacturers discontinuing their relationship with you. This depends on your supply agreements and the goal manufacturers have with their MSRP.
9. Dynamic pricing
Ever try to get an Uber on a Friday night and notice the price is higher than usual? That’s dynamic pricing in action. Dynamic pricing is when a company continuously adjusts its prices based on different factors, such as competitor pricing, supply, and consumer demand. The goal is to increase profit margins for the business.
For brands like Uber, rider fares depend on variables like route time and distance, traffic, and the current rider-to-driver demand. Prices are determined by rules or self-improving algorithms that take these variables into account when making pricing decisions.
- Pros: Dynamic pricing strategies allow retailers and brands to price products and services at scale automatically, using machine learning to address pain points. They can customize prices to meet current market conditions, save time with automation, and maximize profits—in turn, improving customer satisfaction.
- Cons: It can be financially challenging to manage as a small business, as there are upfront costs such as software and investment in market research. Dynamic pricing is likely a better fit for large retailers with thousands of SKUs across their ecommerce and retail stores. When dynamic pricing results in frequent price changes, consumers may respond negatively, which can impact revenue.
10. Multiple pricing
It’s common for grocery stores, apparel companies, and ecommerce businesses to adopt a multiple pricing strategy, in which retailers sell more than one product (think socks, underwear, and t-shirts in apparel, where the items might sell five for $30 or buy one, get one free) for a single price. This tactic is also known as product bundling.
- Pros: Retailers use this strategy to create a higher perceived value for a lower cost, which ultimately can lead to driving larger volume purchases. Another benefit is that you can sell items separately for more profit. For example, if you sell shampoo and conditioner together for $10, you can sell them separately for $7 to $8 each, and that’s a win for your business.
- Con: If the bundle itself doesn’t increase sales volume, then you may come up short on profits.
Read more: Learn how bundling your products can help you increase your retail sales.
11. Loss-leader pricing
Loss-leader pricing is when consumers are lured into a store by the promise of a discount on a hot-ticket product, and they buy that product along with several others as well. With this strategy, retailers attract customers with a desirable discounted product and then encourage them to buy additional items.
A prime example of loss-leader pricing strategy is a grocer that discounts the price of peanut butter and promotes complementary products like loaves of bread, jelly, jam, and honey with normal prices.
While the original item might be sold at a loss, the retailer can benefit from having an upselling and cross-selling strategy in place to encourage more sales. Loss-leading usually happens for products that buyers are already looking for, with high product demand, that drives more customers in the door.
- Pros: Encouraging shoppers to buy multiple items in a single transaction can boost overall sales per customer and also cover any loss from cutting the price of the original product. This tactic can also be an effective means to promote underperforming products.
- Cons: Similar to the effect of using discount pricing too often, overusing loss-leading prices can lead customers to expect bargains, leading them to potentially become hesitant to pay at full retail price. You could also cut into your revenue if you’re discounting something that doesn’t increase cart size or average order size.
12. Psychological pricing
Psychological pricing, or charm pricing, leverages prices to influence a consumer’s spending behavior—with the goal of increasing business sales and revenue. A strategy to accomplish this is pricing items so they end with “99”; a product that’s priced at $4.99 appears substantially cheaper at first glance than a product priced at $5.
- Pro: Charm pricing can trigger impulse buys. Ending prices with an odd number gives shoppers the perception that they’re getting a better deal—and that is sometimes tough to resist.
- Con: Using charm pricing can make consumers less inclined to pay more in the future, which can negatively impact sales.
13. Premium pricing
With premium pricing, brands benchmark their competition then price products higher to give the impression of being more luxurious, prestigious, or exclusive. For example, a premium price works in Starbucks’ favor when people choose it over a lower-priced competitor like Dunkin’.
Alternatively, premium pricing proved less effective for Netflix in certain markets where consumers earn less and are more price conscious—a reflection of the importance of knowing your target market.
Be confident and focus on the differentiated value you provide to customers. For example, excellent customer service and strong branding can help justify higher prices.
- Pros: A premium pricing strategy can affect consumer perception of your business and products. Consumers see your products as better quality compared to your competitors’, due to the higher price. This pricing strategy has the potential for higher profit margins and sales.
- Cons: A premium pricing strategy can be difficult to implement, depending on the preferences of your target audience. If customers are price sensitive and have several other options to purchase similar products, the strategy may not be effective. This is why it’s crucial to understand your target customers and conduct market research.
Read more: Learn how to conduct market research so you can better understand how to price your products, identify your target customers, and discover the quirks of your chosen niche.
14. Anchor pricing
Anchor pricing is when a retailer lists both a discounted price and the original price to establish the savings a consumer could gain from making the purchase.
Creating this kind of reference pricing triggers what’s known as anchoring cognitive bias. In a study from economics professor Dan Ariely, students were asked to write down the last two digits of their Social Security number and then consider whether they would pay that amount for items such as wine, chocolate, and computer equipment.
Next, they were asked to bid for those items. Ariely found that students with a higher two-digit number submitted bids that were higher than those with lower numbers. That’s due to the higher price, or “anchor” number. Consumers establish the original price as a reference point in their minds, then “anchor” to it and form their opinion of the listed marked-down price.
The other way you can take advantage of this principle is to intentionally place a higher-priced item next to a cheaper one to attract a customer’s attention.
Many brands across various industries use anchor pricing to influence customers to purchase a mid-tier product.
- Pro: If you list your original price as being much higher than the sale price, it can influence a customer to make a purchase based on the perceived deal.
- Con: If your anchor price is unrealistic, it can lead to a breakdown of trust in your brand and erode brand loyalty. Customers can easily price-check products online against your competitors, including with a price comparison engine—so ensure your listed prices are reasonable.
15. Economy pricing
An economy pricing strategy is where you price products low and gain revenue based on sales volume. It’s typically used for commodity goods with low production costs, such as groceries or drugs. This business model relies on selling a lot of products to both new and returning customers on a consistent basis.
The formula for economy pricing is:
Production cost + Profit margin = Price
- Pros: Economy pricing is easy to implement and is good for retaining customers with price sensitivity.
- Cons: The margins are typically lower, you need a consistent, steady flow of new customers, and consumers may not perceive the products to be high-quality.
How to choose a pricing strategy
- Understand costs
- Define your commercial objective
- Identify your customers
- Find your value proposition
Whether it’s the first or fifth pricing strategy you’re implementing, there are key steps to creating a pricing strategy that works for your business. Here’s where to start:
1. Understand costs
To figure out your product pricing strategy, you need to add up the costs involved with bringing your product to market. If you order products, you have a straightforward answer of how much each unit costs you, which is your cost of goods sold.
However, if creating products yourself, you need to determine the overall cost of that work: How much does a bundle of raw materials cost? How many products can you make from that bundle? Also, account for the time spent on your business.
Some costs you may incur are:
- Cost of goods sold (COGS)
- Production time
- Packaging (retail and ecommerce)
- Promotional materials
- Short-term costs like loan repayments
Your product pricing will take these costs into consideration to make your business profitable.
2. Define your commercial objective
Think of your commercial objective as your company’s pricing guide. It helps you navigate through any pricing decisions and keeps you heading in the right direction.
Ask yourself: What is my ultimate goal for this product? Do I want to be a luxury retailer? Or do I want to create a chic, fashionable brand that’s at the affordable end of the spectrum? Identify this objective and keep it in mind as you determine your pricing.
3. Identify your customers
Your objective should be not only to identify an appropriate profit margin, but also what your target market is willing to pay for the product.
Consider the disposable incomes of your customers. For example, some customers may be more price sensitive when it comes to clothing, while others are happy to pay a premium price for specific apparel products.
4. Find your value proposition
Your value proposition is what makes your business genuinely different. This statement identifies how you stand out against your competitors, and it’s important for you to find the best pricing strategy that reflects the unique value you bring to the market.
For example, direct-to-consumer brand Tuft & Needle offers exceptional high-quality mattresses at affordable prices. Its pricing strategy has helped it become a known brand because it was able to fill a gap in the mattress market.
Pricing strategy examples
Premium pricing: Gucci
One of the top luxury brands, Gucci applies premium pricing to its products. The Italian fashion house is a successful manufacturer of high-end leather goods, clothing, and other fashion products, and it is known for its signature Gucci logo.
Key attributes include:
- High-quality goods
- Creativity and innovation
Its products are unique in style and design, with strong brand awareness and a reputation for luxe style and exclusivity, especially among high-income consumers. This prestige image allows Gucci to command high prices. Gucci items are typically never on sale through official retailers, which upholds the brand’s image as high end.
Value-based pricing strategy: Fashion Nova
Global fashion brand Fashion Nova made a name for itself through influencer marketing. The brand works with influencers around the world to showcase its clothing in luxurious locations, and it has teamed with celebs for special collections.
This marketing strategy has been effective for Fashion Nova, making it a status symbol for buyers. Women who purchase from the brand value its brand image and what they perceive it adds to their life. This allows Fashion Nova to have freedom in setting prices for its products.
Penetration pricing strategy: Netflix
Netflix is a primary example of a brand using penetration pricing to eliminate competitors. In the late 1990s, DVD rentals gained popularity, with Blockbuster leading the market.
Yet Blockbuster had two major flaws: late fees and limited selections. Netflix offered a solution. Customers could order DVDs online through the standard pay-per-rent model with a better movie selection and no late fees. In 1999, you could rent four movies at a time without return dates for less than $16 per month. Blockbuster charged $4.99 per three-day rental.
The Netflix model gained market traction and dominance, while Blockbuster filed for bankruptcy in 2010. Netflix eventually raised its prices to maximize profit margins. The low price point let people try the service and get familiar with the brand, which helped Netflix launch its online streaming service in 2007.
Competitive pricing strategy: Costco
Costco is known for its discounts on all types of products, from bread, produce, and giant lobster claws to personal steam saunas and travel packages.
The brand uses a competitive pricing strategy based on market conditions. It aims to offer the lowest possible prices for bulk and wholesale purchases compared to other grocers and retailers in the market. Shoppers get the discounts through a Costco membership, which has a nearly 93% membership renewal rate.
Find the best pricing strategy for you
There’s not a black-and-white approach to setting an effective pricing strategy. And not every pricing strategy works for every type of retail business. It’s up to each entrepreneur to do their homework and decide what approach works best for their products, marketing, and target customers.
Now that you have a deeper understanding of the different pricing strategies available for retail businesses, you can make more informed decisions and create more personalized shopping experiences for buyers by giving them the best price possible.
Pricing strategies FAQ
What is a pricing strategy?
Pricing strategy refers to the tactics a business uses to set the best price for its products. Businesses base product or service prices on production, labor, and marketing expenses, then add on a certain percentage so they can maximize profit and shareholder value.
Why is a pricing strategy important?
What are examples of pricing strategies?
- Keystone pricing
- Multiple pricing
- Penetration pricing
- Loss-leading pricing
- Psychological pricing
- Bundle pricing
- Economy pricing
- Cost-plus pricing
- Premium pricing
What does MSRP stand for?
The manufacturer suggested retail price (MSRP) is the price a manufacturer recommends you sell its product for. MSRP is also referred to as the list price.