Posted on 9 January 2020 Conjoint.ly
This Pricing Guide explores 7 of the most effective product pricing strategies; Dynamic, Freemium, High-Low, Price Skimming, Premium, Prestige, Tailored, & Fixed.
Once a business selects its pricing goals, the next step is to consider which strategy/ies can help achieve these objectives. Like most factors surrounding pricing, this depends on the industry, a business’ broader objectives, market performance, and brand image.
Setting the right pricing for products/services requires extensive testing, altering, and constant monitoring to ensure the most profitable strategy is in place. There are many strategies that a business may use to determine its pricing, each with its own strengths and weaknesses.
Identifying which strategy works best with the nature of your product is a challenge worth undertaking as it will serve as the pathway to higher revenue and higher profit margins for your business.
We’ve listed 7 popular pricing strategies and why and when to use them.
1. Dynamic Pricing
Dynamic pricing works off market demands and allows companies to set flexible prices for their products/services. Businesses determine customers’ willingness to pay in certain circumstances and adjust their prices accordingly. Dynamic pricing works in two ways:
1. Raising prices: Increased demand for a product/service (e.g. peak season) causes a business to raise its prices as a larger number of customers are willing to pay more. In some instances, such as air travel, most customers already expect to pay different rates during different times of the year and accept that busier flights will incur higher costs.
2. Lowering prices: Reduced demand for a product/service (e.g. off-season) causes a business to lower its prices, maximising revenue during the lull. The cheaper prices drive loyalty from existing customers and can help to attract new ones.
Example: A hotel anticipates a large event that will draw crowds of people from out of town by raising its prices considerably, knowing that many will pay the higher rate. Conversely, the hotel lowers its prices during colder months to attract more customers (including the price-sensitive to compensate for the reduced business during this time.
- Enable flexibility with prices that reflect periodic market demand.
- Maximise profit margins through increase in price.
- Sell more services/products during slow sales periods.
- Frustrate and confuse customers due to increased prices and lack of consistency.
- Lose out to competition offering lower pricing during times where price is increased.
- Suffer loss to profit when prices are lowered during slow sales periods.
2. Freemium Pricing
Freemium pricing splits product/service users into two categories – free and paid service. Free users have their access limited to certain product features, and paid users have full unrestricted access.
This strategy works off the premise that free users will see the value in purchasing the full product from the quality of the free service. The ‘no strings attached’ nature of the free service makes word-of-mouth advertising common for freemium pricing and sign-up rates can increase quite rapidly.
Example: Consider an online photo editing tool using a freemium model. The free option offers access to core tools which are valuable enough on their own but can work even better in conjunction with the full toolset, available with the premium option.
A graphic design firm employee signs up for the free service and eventually purchases the premium option, recommending it to colleagues. The colleagues further recommend the product to their peers and so on.
- Display product value in a practically and effectively.
- Encourage free advertising through word-of-mouth recommendations.
- Build brand loyalty and increase retention rates by easing users into the product.
- Lose profit from free service customers who are content with its features.
- Lessen customers’ perception of product value by having a free version on offer.
- Increase sales cycle from customers using free service before adopting premium.
3. High-Low pricing
High-Low pricing involves setting a high (reference) price for a product/service then lowering it during a sale/promotional period before once again increasing the price. The reference price serves to reflect the product’s value and reputation before it’s discounted.
This strategy works by pushing a sense of urgency onto customers to purchase the product during the sales period. The general increase in traffic during these periods results in high sales as customers often also buy full-priced products when in-store.
High-Low pricing works best in instances where customers are not sure of what a product’s pricing should be in ordinary circumstances, and with customers who directly relate promotional sales with low prices.
Example: A shoe store releases a new pair of sneakers for $110. A month later, the store holds a 30% off sale, reducing the sneakers to $77. Acknowledging the reference price from previous advertisements, customers rush to take advantage of the ‘bargain’.
Customers perceive the sneakers as being of high quality and value because of the reference price. Following the sale, the store prices the sneakers at $100.
- Establish value by showing the product’s worth through higher pricing.
- Drive store traffic and product demand through promotional efforts.
- Generate higher sales volumes by reaching broader markets during sales.
- Discourage customers who may perceive discounted product as lacking quality/value.
- Decrease profit during promotional periods.
- Lose sales during the reference pricing period for customers who wait for promotional sales.
Test your product pricing
Determine psychologically acceptable range of prices for a single product and chart approximate price elasticity curve.
4. Price skimming
Price skimming is a strategy which businesses usually implement when a new product enters the market. A business sets the highest price that customers are willing to pay for the new product before lowering the price over time to appeal to the more price-sensitive segments of the market.
Reducing the price also allows businesses to align with any competitor products which appear over this time.
Effective marketing is crucial to a successful price skimming strategy, as customers must feel the product is of high quality and demand to justify the higher price.
Example: An electronics company releases a new gaming device. The company advertises the product for months before its release and boasts its new features. The product is originally released at $699 which the brand’s loyal customers are happy to pay.
After a few months, the company reduces the price to $549 to attract price-sensitive customers and to compete with the latest similar products.
- Generate maximum profit from initial product sales.
- Create a strong brand image by conveying quality and value of the product.
- Differentiate product by setting pricing higher than other products on the market.
- Isolate market initially through high pricing that drives away the price-sensitive markets.
- Lose sales to competition if pricing is not lowered at the correct time or to an appropriate amount.
- Decrease profit as market demand diminishes and product price is lowered.
5. Premium pricing
(see also Prestige Pricing)
Premium pricing involves setting product prices permanently higher than competitors’ prices in a bid to differentiate from the market. Businesses that use this strategy spend a large amount of time and money to market their product as superior, unique, and worth the extra cost.
Once a company cements itself as ‘luxury’ through initial marketing expenses, premium-priced products can drive high profit margins in the long-term and establish a reliable and reputable brand image.
Generally, premium pricing strategies determine that a business never discounts its products to ensure its perception is not ‘cheapened’ within the market.
Example: A food manufacturer releases a new chocolate bar which is made of 100% organic cocoa beans and ingredients, sourced from an exclusive location and priced at double its competitors’ prices.
Through effective marketing and packaging, customers perceive the chocolate as a delicacy and are willing to pay the extra amount.
- Increase long-term profit margins through higher pricing.
- Establish a renowned, sought-after brand with a loyal customer base.
- Differentiate from competitors through unique marketing and pricing strategy.
- Alienate the price-sensitive market due to higher pricing.
- Lose profits initially due to the high cost required to market premium products.
- Experience lower sales volumes as higher price appeals mostly to top tier of the market only.
6. Tailored pricing
Unlike fixed pricing, where customers pay a pre-determined amount for a product/service, tailored pricing determines that prices are set on a case-by-case basis. Businesses that offer custom offerings, with varying time, cost, and scale, will often use this strategy.
Tailored pricing works best in instances where the sales cycle is in-depth and lengthy as salespeople can better understand each clients’ needs, budget, and potential for upselling. It also means that customers are more likely to need assistance with their purchase, unlocking opportunities to provide the best/highest value product/service bundle.
Example: Consider a SaaS company who provide a CRM platform for businesses of varying sizes. As the company offers a broad range of software solutions and subscription tiers, which many businesses would need to use in combination, the sales process is too complicated to do without assistance.
Customers can request a quote and work alongside a salesperson to identify which products they need, the breadth of service required, and their budget. The salesperson generates a quote based on these factors (and others) to offer the customer the best pricing for the service provided.
- Better understand customer needs and align product/service with them.
- Maximise profit from each sale through scrutinised pricing.
- Improve customer retention through increased sales touchpoints.
- Discourage customers who are looking for an upfront cost.
- Lose visibility over profit margins/revenue due to fluctuating price points.
- Delay sales through lengthy nurturing period and quote determination.
7. Fixed pricing
Fixed pricing works off a set model that offers the same price to customers regardless of time, cost, and other determining factors. Due to its restrictive nature, fixed pricing is commonly used by businesses who offer rigid products/services with little to no variation across their customer portfolio.
Businesses must allocate ample time to devise appropriate rates for fixed pricing to ensure they’re covering all involved costs and resources required for the full scope of service. It’s also important that the products/services on offer have been available for long enough to gain an accurate understanding of the time and expenses involved before implementing fixed pricing.
Example: A graphic design firm offers fixed pricing on its services, with prices depending on service, e.g. infographic, website, flyer, etc. Some projects may take longer than others, requiring more resources and greater expenses.
The firm must determine a single price for each project type that considers the highest and lowest estimated time and cost for each and establish a price that can cover and compensate for both scenarios.
- Encourage customers with transparency and confidence in pricing.
- Predict profit margins/revenue through early knowledge of price points.
- Shorten sales cycle through straightforward transaction for customers.
- Misjudge service timing/costs and lose profit.
- Discourage customers who are asking for custom services.
- Lose control over unexpected additional costs.
Test your product pricing
Find revenue-maximising price points for your product or service and measure elasticity of demand.