Market conditions are always changing, so it can be difficult to increase or even maintain your profit margins. Since profit margins are your revenue minus your costs, you need to constantly monitor both sides of the equation—so you can figure out how to maximize revenue while minimizing costs.
One effective way businesses account for market fluctuations is developing an adaptable pricing strategy. The right pricing strategy can help increase revenue and, as long as costs are stable, in turn help you increase profit margins.
What is pricing strategy?
Setting the price for your products or services should not be random. Ideally, you’ll want to do some competitor research to see what others are charging. Your costs are also a factor in determining prices. The overall process of coming up with a final number is called “pricing strategy.” Doing it right could be the difference between profit and losses.
Strategizing on your pricing should be an ongoing exercise, not a one and done activity. Costs go up and down, competitors may change their prices, online niche markets can dry up quickly. Staying competitive in this ever-shifting landscape requires the ability to be fluid. Sticking to an outdated price structure too long could do serious damage to your business—that’s why it’s important to be adaptable and expedient.
How to avoid a price war with competitors
No one wins a price war. Competing strictly on price means that you’re constantly shrinking your profit margin. Two companies trying to undercut each other will often open the door for a third company to win market share with a better product. Consumers like low prices, but they also want value.
Low-price options often attract customers who don’t value quality, while deterring customers who do. Most businesses don’t want to be the brand known for giving customers “exactly what they pay for.”
The best way to avoid a price war is to build your brand recognition and find a way to differentiate your offering from your competitors. You can enhance that even further by creating exclusivity. If you’re the only place in town that offers a specific product or service, consumers will be forced to come to you. This strategy of carving out a space for your unique offering while keeping prices low is known in marketing circles as the “blue ocean strategy.”
5 common pricing strategies you should consider
Think of these as broad categories. The deeper you get into price strategy, the more you’ll find there’s no one-size-fits-all approach. The five strategies listed here are the most common, but many companies mix and match, or modify as they go.
1. Cost-plus pricing
Cost-plus pricing is simple math. You total your costs and add a markup to create a profit margin. Auto dealers often use this, but the margins are high enough where they’re able to make deals to bring prices down for consumers. The trick is to not set your prices too high—that could drive customers away and benefit your competitors.
2. Premium pricing
Positioning yourself as a premium service or high-end brand is a surprisingly effective pricing strategy. It works well when you’re in a specific niche or luxury market. You can also carve out a new niche by improving an existing product that’s already on the market or adding concierge service to the sales process. Either justifies a price increase.
3. Competitive pricing
Competitive pricing is a slippery slope because it can lead to price wars. It’s common in saturated markets (red ocean) where commodity product or service offerings are in high demand. Most of what you buy at the supermarket is priced based on what competitors are charging, making the margins in that type of business extremely small.
4. Penetration pricing
Successfully launching a new product or service requires mass adoption. Lowering the price to achieve that adoption is called penetration pricing. Think in terms of a limited-time offer or grand opening sale. This strategy is often used to gain traction in a new market and seize a competitive advantage.
You can raise prices after you’ve established your place in the market, but it’s important to be careful and sensitive to your audience’s perception of your brand. Raising prices too soon or too quickly could drive away customers, so it’s best to test price increases and raise them gradually when you decide it’s time.
5. Price skimming
Price skimming is basically the opposite of penetration pricing. You start out with a higher price, then lower it after you’ve enjoyed a period of high profitability. For this to work, you’ll need a product or service that’s in high demand, something consumers will be willing to pay more for. Try not to price too high, though—that could potentially backfire by not attracting as many customers as you’d hoped.
Other pricing strategies to increase sales
The five price strategies listed above aren’t the only pricing options available to you. As mentioned earlier, you can mix and match. An example of this would be adopting a cost-plus formula to calculate your lowest acceptable profit margin and using those numbers to come up with a buy one/get one (BOGO) deal. You can still make a profit if you trim your margins.
Bundling products or services together is another effective way to boost sales, particularly if part of the bundle is a product or service that isn’t selling well. Some companies use this strategy combined with penetration pricing or price skimming to break into a new market. After running the numbers or testing these methods out in your market, you may even come up with some creative pricing strategies of your own.