9 pricing strategies every small business should know

Choosing from different pricing strategies for your business is a fraught process: too low and you won't generate enough profit; too high and potential customers will look elsewhere for cheaper alternatives.

Understanding different pricing strategies can help you set realistic prices, create a robust business plan and win customers while generating sufficient profits.

Why pricing is difficult to get right

Pricing is complex. It's hard to fathom why some products and services command a premium despite seeming similar to cheaper versions.

A good example is the smartphone market.

Apple's latest iPhone XS Max costs £1,449, while the OnePlus 6 with a similar specification sells for just £399. Yet, iPhones outsell rival models by huge margins, which has helped propel Apple to become the world's first $1tn business in 2018.

Pricing isn't just a number that you put on a product or service. Instead, it's the result of a mix of marketing, brand, promotion and desirability – with customers often making an emotional decision about what to buy, rather than a logical decision based purely on price.

That's why it's a good idea for your business to investigate different pricing strategies.

Pricing strategy definition

Setting the right price involves juggling a number of factors.

Some directly impact price, such as the cost of manufacturing, while others are more nebulous such as how much customers are willing to pay.

These include:

Target customer and willingness to pay

The most important factor, this boils down to how much your target customer is willing to pay for your product or service.

Targeting bargain-seeking customers with expensive products is likely to fail, whereas targeting affluent customers with luxury items can be a route to success.

Competition

Competitors are a good barometer for the level of pricing customers are likely to respond to.

Undercutting competitors with lower pricing can win market share.

Variable and fixed costs

Fixed cost are the costs your business will incur even if you don't make or sell anything.

Variable costs directly relate to the number of customers you have or sales you make, such as postage and packaging costs.

You can get a price advantage over competitors with more efficient cost control.

Pricing strategy examples

There are a number of pricing strategies to explore when choosing a price that works for your business.

1. Penetration pricing

Many startups adopt a penetration pricing strategy.

This approach is designed to quickly establish your business in an existing market, win customers and gain market share.

It works by initially offering low prices that undercut competitors to win business, then gradually increasing prices as market share grows.

Many technology-based businesses adopt penetration pricing, forcing less agile competitors out of business.

Pricing strategy example: Supermarkets regularly feature price penetration, either for their own-brand products in a bid to take on established brands or as the platform for new product launches. New products – from cleaning products to ready meals – can debut with a low ‘introductory' price designed to woo shoppers and find a place in shopping baskets. After establishing market share, the introductory price is abandoned for a more expensive retail price.

Pros: It's an effective way to grow market share, achieve dominance and then increase prices when there is less competition, reaping more profit in the longer term.

Cons: Many businesses make a loss in the early years of trading while they establish a market presence.

2. Economy pricing

Pricing strategies such as this target price-sensitive consumers in search of a bargain.

It relies on paring back manufacturing, distribution and marketing costs to the minimum to keep pricing as low as possible.

It's a popular tactic with discount retailers such as Poundland and low-cost supermarkets such as Aldi and Lidl.

Pricing strategy example: Ikea's launch in 1943 came with an economy pricing strategy that transformed the previously costly home furniture market. Doing away with fancy showrooms, Ikea offers a warehouse environment where customers pick their own flatpack furniture to assemble at home. Ikea's low-price strategy involves mass production, standardised components such as fixings, and low-cost materials such as veneer.

Pros: Allows a business to use price as a key differentiator. As a business grows its ability to reduce costs increases thanks to greater buying power and operational efficiency.

Cons: Hard to achieve for a small business as it demands scale, mass production and an efficient supply chain. It demands a large volume of customers and margins can be small.

3. Premium pricing

At the other end of the pricing spectrum is premium pricing.

Used predominantly in the fashion and luxury goods market, premium pricing involves selling your goods and services for significantly more than competitors.

Factors such as exclusivity or greater customer benefits compared to similar cheaper products affect premium pricing.

Premium pricing is found in all types of business – from first class seats on aircraft to smartphone manufacturers.

Pricing strategy example: With a heritage stretching back over 100 years, Rolex provides an example of premium pricing. Its signature Submariner gold watch can set you back more than £26,000. Despite its use of precious materials and skilled craftsmanship, such a price should in theory serve it poorly when compared to other cheaper watches that fulfil essentially the same function. Its premium price, however, reflects its worth as a status symbol: wearing a Rolex shows how affluent and successful the wearer is.

Pros: Profit margins can be significant, and fewer customers are needed to generate a profit.

Cons: Your marketing must communicate luxury brand values and reasons to buy beyond price. Everything – from packing to a retail experience – must reinforce the premium-feel of the brand.

4. Competitor pricing

Pricing strategies based on competitors is a reactive move, though stores such as John Lewis & Partners have made it part of their brand.

It involves monitoring competitor prices and ensuring your prices either match or are cheaper.

Customers can either be refunded the price difference if they find the product cheaper elsewhere, or the price matched in store at point of purchase.

Pricing strategy example: Retailer John Lewis & Partners is founded on the principle of ‘never knowingly undersold'. It often reduces its prices in store and online to match promotions and discounts offered by competitors. Customers can obtain a price match if they can show the product is available for less from a rival retailer.

Pros: Builds customer trust as it removes concern that a customer could get the same product cheaper elsewhere, keeping customers loyal to your business.

Cons: Pricing and margin is susceptible to competitor activity, leading to lower margins. Costly to monitor competitors and change pricing regularly.

5. Price skimming

This involves selling products at a high price initially, capitalising on early adopters.

Technology firms such as games console and mobile phone makers use price skimming, charging more for products at launch and then gradually reducing their prices over time.

It allows companies to lower prices as competing products appear and attract more budget-conscious customers.

Pricing strategy example: Sony, like many other technology companies, favours a price skimming model. Its PlayStation 4 went on sale in the UK for £349 in 2013 and was lowered to a £229 bundle with an included game by 2018.

Pros: Useful when manufacturing costs are high in the early stages of a product lifecycle and reinforces desirability in the product. Initial high prices can bring in other competitors, which can drive component costs down for the entire market.

Cons: Risk of setting the initial cost too high, leading to fewer sales than forecast.

6. Price anchoring

Price anchoring involves placing premium-priced products next to lower-priced alternatives.

Customers view the cheaper model as better value, making them more likely to purchase.

It helps keeps price comparison within the range of products from the same company, stopping customers from comparing prices across a range of brands or businesses.

As a business, you'll need to create a tiered range of products, offering different features at different price points.

Pricing strategy example: For example, a store may place a £500 49-inch TV next to a 50-inch TV that costs £2,000 in a bid to encourage customers to consider the 49-inch TV better value for money.

Pros: Relatively easy to adopt and helps prevent customers looking elsewhere. As there's a price for everyone, it attracts both affluent and price-sensitive customers.

Cons: Once price anchors are set up it can be difficult to shift from the pricing model as customers expect similar tiered options in the future.

7. Psychology pricing

Pricing isn't a logical exercise for many customers at the time of purchase.

Lots of factors – many emotional – play a role in deciding pricing strategies.

Using pricing tricks can help push a customer into purchasing, with the most popular being the adoption of prices ending in .99, known as ‘charm pricing'.

The opposite – rounding up pricing – communicates feelings of prestige instead.

According to Monica Wadhwa and Kuangjie Zhang in the book This Number Feels Just Right: “A rounded price ($100.00) encourages consumers to rely on feelings when evaluating products, while a non-rounded price ($98.76) encourages consumers to rely on reason. When a purchase is driven by feelings, rounded prices lead to a subjective experience of feeling right.”

Pricing strategy example: Many UK retailers end prices with a 0.99, whereas luxury stores and brands adopt a fully rounded figures.

For example, British perfumer Penhaligon’s uses rounded pricing, selling its Eau de parfum Halfeti for £195 and The Coveted Duchess Rose for £220.

Pros: Tweaks to pricing don't affect your bottom line but can attract different types of customer and help reinforce your brand.

Cons: There's little to stop competitors adopting a similar pricing approach, leaving less to differentiate your pricing.

8. Bundle pricing

Pricing strategies that involve selling a package of individual products as a single-priced bundle can create a perception of greater value.

It can help clear inventory of products that aren't selling well or boost sales of specific products.

It can also be used to close a sale, such as TV shopping channels offering free exercise bonus DVDs when buying fitness products.

Pricing strategy example: Home broadband and TV companies offer bundles, combining TV, telephone, broadband and mobile phone into a single monthly price.

Pros: A good way to clear inventory and also offer good value to a customer, with products more expensive if purchased separately.

Cons: A lower bundle price means a lower margin for businesses compared to the margin made on individual components in a bundle when sold separately.

9. Captive product pricing

The phrase ‘it's a razor and razor blades business' sums up captive product pricing.

This is where a base product, such as a razor, is sold cheaply and consumables such as razor blades are sold with a higher price markup.

Customers are tied into buying replacement consumables, generating a profit for the business in the longer term.

Pricing strategy example: Printer manufacturers often sell cheap home printers with replacement ink cartridges costing more than the printer itself.

Pros: A captive audience means a more sustainable cash flow, more loyal customers and less money spent on marketing to retain customers.

Cons: Other businesses can offer cheaper consumables that work with your product, and pricing of consumables needs to be consistent across all markets.