Pricing strategy guide: Getting started with pricing strategies

When starting out in business, pricing your products or services can feel like walking a tightrope. After all, your pricing strategy will determine your revenues, profit margins and cash flow.

There are many different pricing models available to businesses, and choosing the right one for your needs and circumstances can have a colossal impact on your company’s financial well-being. Set your sights too high and you risk alienating your target market. Set them too low, on the other hand, and you may struggle to turn a profit during your vulnerable early years.

In this pricing strategy guide, we’ll explore the many different types of pricing strategies to help you choose the right one for your business.

Types of pricing strategy

Below, you will find a detailed breakdown of the many different types of pricing strategies. Some of these are widely used in business while others are more specialised and lend themselves to very specific business models and circumstances.

For each, we will also provide a breakdown of the pros and cons and provide some pricing strategy examples that are used in business.

Competitive pricing strategy

When starting out in business, it may be tempting to look at what similar companies are charging and price your offering accordingly. This is known as a competitive pricing strategy. A competitive pricing strategy does not necessarily mean choosing the same price point as your competitors. You may want to price your offering above theirs if you deem yours to be of superior quality or below them if you want to gain quick market appeal.

Competitive pricing strategy pros:

• Simple

• Low-risk

• Can be used alongside other pricing strategies

Competitive pricing strategy cons:

• Doesn’t account for why competitors price the way they do

• May be harder to differentiate your brand

• May not be sustainable in the long term

Competitive pricing example

Supermarkets and e-commerce giants like Amazon are good examples of competitive pricing, gathering competitive pricing intelligence and using this to offer the cheapest options on the market.

Dynamic pricing strategy

Dynamic pricing is constantly fluid, and fluctuates in line with variables like supply, demand and competitor pricing. While it inevitably requires an investment in automation, it can be a great way to insulate profit margins in markets where demand fluctuates.

Dynamic pricing strategy pros

• Can help to maximise profit in times of higher demand

• Can help to stabilise profit margins

• Businesses can leverage machine learning to price dynamically at scale

Dynamic pricing strategy cons

• Can be costly and hard to manage for small businesses

• Customers may respond negatively or view it as price gouging

Dynamic pricing example

Uber is a clear example of dynamic pricing. Ride costs will fluctuate depending on consumer demand, weather, and driver availability.

Full-cost pricing strategy

A full-cost pricing strategy accounts for all costs associated with making or sourcing the product, as well as selling and administrative costs before a markup is added to generate a profit margin.

The formula for full-cost pricing is as follows:

(Total production costs + selling and administration costs + markup) ÷ Number of units expected to sell

Another form of full-cost pricing is cost-plus pricing. This is where the markup that is added is a fixed percentage of the cost of goods sold (COGS).

Full-cost pricing strategy pros

• Easy to implement

• Profit is built into the equation

• Prices are fair and easy to justify

Full-cost pricing strategy cons

• Prices are based on predictions that may be rendered inaccurate by changing circumstances

• Does not account for competitor pricing, which may lead to under or over pricing

• Can become harder to manage as you scale up your business and boost your offering

Full-cost pricing example

Full-cost pricing is used in a diverse range of fields such as manufacturing, construction and retail. Wherever the cost of selling and production needs to be taken into account, full-cost pricing may be used. It may also be cross-referenced with competitive pricing to ensure that the pricing retains a competitive edge.

Price creaming strategy

A price creaming (also known as price skimming or high-low pricing) strategy is where a company establishes a high price point before gradually reducing it over time. Price creaming is often used when a product is new to the market and has few competitors, but other competing businesses replicate the offering as time goes by.

Price creaming strategy pros

• Can be used to recover startup, research and development costs

• Can help to maximise profit margins

• Provides customers with a feeling of prestige and exclusivity

Price creaming strategy cons

• Requires relatively high volumes of early sales to capture the market

• Can only be used with an original, innovative and high-value product

Price creaming example

One of the most obvious examples of price creaming is the consumer technology sector. Whenever a new type of mobile phone, computer or television comes to market the price point is usually very high, catering to a niche of early adopters. As the technology becomes more commonplace, the price lowers in order to become more competitive.

Freemium pricing strategy

The freemium pricing model uses a free product (or a free version of a product) as a means to generate interest, build customer relationships and create sales leads. Additional capabilities and bolt-ons can be added to this free product to make it more scalable or better suited to the user’s needs.

Freemium pricing strategy pros

• Can enable fast growth

• Makes it quick and easy to build a reputation and a loyal following

• A good way to test new products with fairly minimal market costs

Freemium pricing strategy cons

• Can be harder to break even

• Free product can be too good, leaving customers with very little incentive to upgrade

Freemium pricing example

The software as a service (SaaS) sector is highly reliant on freemium pricing. Because digital products have no ongoing production costs, SaaS companies have the luxury of building their reputation on a free product that meets the needs of the many, while a more premium version of the product is available to cater to the more extensive needs of a smaller or more niche clientele. These are not exclusive to the B2B space. Spotify and YouTube are two examples of B2C companies that have built great success upon their free offerings.

Loss leader pricing strategy

A loss leader is a product that is sold at an appealingly low price, even though this will often be less than the cost of production. This is designed to ingratiate consumers with the brand and increases opportunities to upsell with products that have more favourable profit margins.

Loss leader pricing strategy pros

• Can generate interest, footfall and customer loyalty

• Can help to liquidate assets that have been sitting on the shelf as unsold inventory

Loss leader pricing strategy cons

• Loss leaders must be carefully chosen to ensure that they generate sufficient market appeal

• Can endanger profit margins without sufficient upselling

Loss leader pricing example

Supermarkets and other retailers often use loss leaders to increase footfall and attract customers.

Pay what you want pricing strategy

Pay what you want or pay as you feel is a pricing strategy where consumers decide for themselves what they pay for products or services. A minimum price may be used to ensure a modicum of profitability and tiered pricing may be used to encourage greater consumer spending.

Pay what you want pricing strategy pros

• A great way to showcase new products

• Can be very exciting for consumers

• Can be used to boost customer loyalty and create positive brand associations

Pay what you want pricing strategy cons

• May not be sustainable, especially for physical products with fixed production costs

• May de-incentivise customers to return or pay more in future

Pay what you want pricing example

Humble Bundle’s business model relies exclusively on pay-what-you-want pricing. Digital products such as videogames and e-books are placed in bundles that can be purchased for a price decided by the consumer. More recent or popular bundles require spending within an established price range.

Penetration pricing strategy

Penetration pricing strategy, also known as an aggressive pricing strategy, is where price points are set deliberately low. This aims to encourage greater volumes of trade and attract more customers, potentially luring them away from competitors. The key to using this effectively, however, is building sufficient value in your brand that customers want to stick around when your prices increase.

Penetration pricing strategy pros

• Can be a great way to establish a niche and build a customer base

• Can create positive associations with value for money

• Builds demand and future price potential

Penetration pricing strategy cons

• Future price increases may be perceived as a loss of value

• More pressure to create a positive brand experience for customers

Penetration pricing example

Businesses of all kinds leverage penetration pricing when they are entering a new market or expanding into a new territory. One common example is streaming services like Netflix or Audible which may offer a lower price for subscribers for the first month.

Premium pricing strategy

You get what you pay for. At least, that’s the logic behind premium pricing. Here, prices are kept deliberately high in order to give the product a sense of quality and prestige. If you have the product quality and inherent ‘cool factor’ to back it up, premium pricing can be very profitable.

Premium pricing strategy pros

• Easy to maintain profit margins

• Can help you target an affluent luxury goods market

• Can inhibit competition who would have to invest significantly in their own versions of the same products

Premium pricing strategy cons

• Makes it difficult to target cash-strapped customers

• Requires a strong value proposition that may take time to establish

Premium pricing example

Apple is an excellent example of premium pricing. Apple is fairly unabashed about the cost of its products and almost never discounts its offerings. And yet, it still commands legions of faithful customers.

Price floor and price ceiling

This pricing model requires companies to establish an upper limit (ceiling) and lower limit (floor) for pricing. This allows businesses to adjust pricing in a dynamic way while maintaining value proposition and a minimum net profit margin.

Price floor and price ceiling pros

• Ensures a fair range of prices

• Allows for dynamic pricing

• Helps to maintain profit margins

Price floor and price ceiling cons

• Prices will inevitably fall in line with those of competitors

• Can inhibit revenues or make penetration pricing more difficult

Price floor and price ceiling example

Rent control is a pertinent example of a price ceiling. Where it may render housing unaffordable, the government may impose a cap on private rents. The recommended retail price of a product (RRP) may also be considered a price ceiling as pricing above this may make your product much less appealing if they can get it from competitors for less.

Full-cost pricing, on the other hand, may be seen as a pricing floor if it represents the minimum for which a product can be sold in order to turn a profit.

Economy pricing strategy

Where production costs are low but your business model demands that sales volumes be high, economy pricing may be the strategy for you. Economy pricing may be employed where brands want to build a dedicated consumer base in lieu of an established brand.

Economy pricing pros

• Easy to implement

• Appeals to cost-sensitive customers

• Establishes a broader customer base

• Potential for high sales volumes

• Keeps customer acquisition costs low

Economy pricing cons

• Necessitates low profit margin

• Demands consistently high sales volumes

• Could cause some customers to question the quality of your offering

Economy pricing example

Look in any supermarket and you’ll find numerous examples of economy pricing in effect. Supermarkets often sell their own-brand products (or budget-friendly versions of the same) alongside higher-priced name brands.

Co-op pricing strategy (Cooperative pricing)

Cooperative or co-op pricing strategies are established in collusion with other businesses. This collusion may be explicit and decided upon in agreement with competing business leaders (thereby forming a cartel), or it may come about implicitly as a result of competitive pricing.

Co-op pricing strategy pros

• Ensures prices will be consistent for consumers

• Reduces the risk of being undercut on price by competitors

Co-op pricing strategy cons

• May conflict with UK competition laws

• Only works if everyone in the cartel adheres to it

Co-op pricing example

One example of cooperative pricing gone awry came in 2011 when Unilever and Procter & Gamble fell afoul of EU laws when they were found to have colluded to fix the price of laundry detergents throughout Europe. Together the companies were fined 315m euros (which equated to £280m at the time).

Aggressive pricing strategy

Aggressive pricing is a form of competitive pricing that seeks to outdo competitors at every turn. It is highly reactive and aims to put a distance between the company’s prices and those of its competitors. Therefore, if a competitor lowers its prices, the company may lower theirs even more. If competitors increase their prices, the company may leave its prices the same as they were.

Aggressive pricing strategy pros

• Sends a signal to consumers that your brand is on their side

• Helps to maintain a competitive edge

• Reduces the risk of losing loyal customers to competitors

Aggressive pricing strategy cons

• Can be difficult to stay abreast of competitors’ prices

• Usually requires a substantial investment in automation

• Can put a huge strain on profit margins

Aggressive pricing example

Wherever a retailer or service provider assures consumers that they will never be beaten on price, this is an example of aggressive pricing in effect. The electronics retailer Currys, for instance, offers to price match any product it sells if a consumer can find it cheaper elsewhere either in a physical store or online.

Dismissive pricing strategy

A dismissive pricing strategy is where prices are set solely at the discretion of the company without external influence. It is often used by market leaders or companies that have a unique offering and loyal customer base.

When companies adopt a dismissive pricing strategy, they stick to their guns, maintaining their prices even when competitors reduce the price of comparable products.

Dismissive pricing strategy pros

• Allows companies complete autonomy over pricing

• No need to invest in an infrastructure to track competitors’ prices

• Ensures desired profit margins as long as revenue targets are met

Dismissive pricing strategy cons

• Only works if your brand and product are a proven hit with your target market

Dismissive pricing example

Dismissive pricing is commonly used by luxury brands whose prestige affords them large profit margins and an affluent customer base that is not motivated by cost. Designer clothes and furniture or luxury sports cars are often sold using a dismissive pricing model.

Project-based pricing

Project-pricing is a common model within service-based business. Here, the client pays a flat fee for a project to be completed and this encompasses all of the labour and materials that the project requires. Payment may be made in advance of completion, or upon receipt of agreed deliverables. Alternatively, a portion of the project price may be paid upfront with the remaining balance paid when the client has received the deliverables to their satisfaction.

Project-based pricing strategy pros

• Costs are transparent and comprehensive for the client

• Companies can account for all overhead costs before a project starts so there are no unpleasant surprises

Project-based pricing strategy cons

• Companies may make a loss if a project runs overtime or needs extra work to complete to the client’s satisfaction

• Companies need to accurately project the cost of delivering the project in order to ensure a healthy margin

Project-based pricing example

Project-based pricing is usually used in services like construction, software development and copywriting.

Hourly pricing

Hourly pricing is used when an individual group is paid by the hour to work on a project. Therefore, the price of the project goes up depending on the number of hours required to complete it.

Hourly pricing strategy pros

• Ensures that time expended on a project is properly compensated

• Prevents projects from making a loss

• An optimal choice for short but high-volume projects

Hourly pricing strategy cons

• Could make you less appealing for longer projects

• May cause clients to worry about efficiency as it is not in your interests to finish a project quickly

Hourly pricing examples

Many professional service providers use an hourly pricing model. These include lawyers, accountants, personal trainers and business consultants.