Competitive Pricing: What Is It, How It Works, and Pros and Cons

Imagine you've built a great product, launched it, and your customers love it — but competitors still outperform you. What's going on?

Start by looking at your pricing strategy. If your prices are too high, customers might skip over your product and choose a competitor instead. Even if your product offers real value, selling it becomes an uphill battle if your prices aren't aligned with similar products on the market.

This is where competitive pricing comes into play. In this guide, we'll explain what competitive pricing is, key strategies for using it effectively, and how it can drive revenue growth over time.

Competitive pricing is a pricing strategy where a company sets prices close to what competitors charge, aiming to stay relevant in the marketplace and attract customers. It's often used in markets with tight competition where products and user experiences are relatively similar. Take coffee shops, for instance. Whether they're owned by global corporations or independent operators, most charge between $3 and $4 for a large cup of black coffee, so customers have become accustomed to (and now expect) a price within that range.

Competitive pricing involves monitoring your competitors' prices for similar products to set your own rates to help you get an edge. Competitive pricing doesn't necessarily mean pricing below your competitors. It could mean pricing the same or even slightly above. But staying within a close range — or keeping prices competitive — is key to this strategy.

Using competitive pricing helps you stay relevant in the marketplace. If your prices are much higher than your competitors', customers might not even consider your product when deciding what to buy.

Competitive pricing works best in markets with many competitors, similar products, user experiences, and price-sensitive customers.

When used in the right way, competitive pricing ensures that cost isn't the barrier to customers choosing you. This gives you a way to reach the most prospects possible. It can also reflect positively on your brand, because it shows that you're fair, knowledgeable about the landscape, and willing to meet customers where they are.

You still need to stand out from the competition in other ways — like with better service, faster delivery, and unique features — but removing price as an obstacle for consumers can make your job much easier and boost your lead conversion rates.

Depending on various factors — market segment, maturity, geographic location, etc. — competitive pricing can be a great solution for your business. Here are just a few of its potential advantages:

• It can help grow or protect market share: Whether it's a market leader or a new player in the field trying to erode the lead of an established competitor, every company strives to land the biggest piece of market share it can. Competitive pricing can help peel away those valuable customers or keep them where they are.
• When successfully used, it can boost profits: If the price is right, you'll likely attract more customers, which leads to greater profit on that higher sales volume.
• It's fairly easy to implement: There are times when a high-risk, high-reward strategy is appropriate. But minimizing risk tends to be a smart move, and competitive-based pricing falls into that category. And if you use software that intelligently determines pricing based on what your competitors charge, the strategy becomes even easier to implement.

Competitive pricing also comes with risks. Even if a business is the ideal candidate for this strategy, there are potential disadvantages:

• It can lead to the dreaded price spiral: An industry with competitive price maneuvering can get out of control, leading to a race to the bottom. All the players begin to see profit margins sink or disappear entirely, and the perceived value of the product type can take a hit, too.
• It can become the path of least resistance, even when no longer effective: As mentioned, competitive pricing can be easy to put in place, but doing it automatically — even when it no longer makes sense — can be a risky move. Like any business tactic, competitive pricing must be reviewed regularly to see if it still helps the company achieve its goals. If profit margins become razor-thin or customers start to doubt the value of the product, it's time to change tactics.
• It can lead you to follow in the ill-advised footsteps of the competition: Nobody's perfect, and that includes your competition. If they undervalue their product and you match their price, you will have undercut your profitability and brand image.

When evaluating a competition pricing strategy, there are two factors that will determine whether your efforts succeed. First, a rock-solid understanding of your products and services and the value they bring to customers should be considered table stakes. And that understanding must work hand-in-hand with data: accurate, timely information about your customers' needs, demands, and pain points, as well as every aspect of what your competitors are doing. Let's take a look at some commonly used competitive pricing strategies.

In competition-based pricing, price matching is one of the least risky strategies (though it can be dangerous if it leads to a "race to the bottom" scenario). As the name implies, it's just matching the prices of your competition, a move preceded by price benchmarking, in which you evaluate and then meet a competitor's pricing. This approach helps prevent losing market share and allows your business to concentrate on adding value, such as improving customer service or making your product easier to use. This strategy applies to almost any market, be it software or shampoo.

This strategy relies heavily on customer perception of value, and it's one in which targeted marketing plays an important role — both in consumer analysis and messaging. It involves highlighting the perceived value differences between your product and a competitor's offerings, as well as playing into a customer's desire to "keep up with the Joneses." This strategy often works in high-end electronics, automobiles, and so on.

A penetration pricing strategy involves drastically discounting a product, even to the point of selling it below cost. This tactic is often used by companies just entering a market, especially one marked by competitors with almost identical products. This can be risky, but it can make sense if a business plans to rely on upselling and cross-selling. However, it's important to understand that this competitive pricing strategy should only be used temporarily. While it can work, the initial success of penetration pricing can evaporate if customers don't perceive value or your business fails to cultivate loyalty. One example of penetration pricing is if an upstart solar panel manufacturer enters the marketplace: To get traction, it might heavily discount its panels to gain a foothold.

Counterintuitively, sometimes competitive pricing entails raising prices above what competitors are charging. This tends to be more effective in luxury markets or when customers perceive that a particular product or service is of higher quality. Take musical instruments. Discerning musicians might pay more for a guitar branded by a well-known star, associating the name with quality, expertise, and status. That instrument might not be materially much different than a similar make, but the customer sees value in it that spurs them to make a purchase. In cases of premium pricing, marketing can play a significant role in creating that sense of value; meanwhile, in-depth market analysis will illuminate whether customers will adopt and respond to the cachet associated with a higher-priced product.

Say that two chain coffee shops are in direct competition in a neighborhood near a college campus. While the two shops might have slight differences in their coffee — such as roasters and suppliers — one might lower prices slightly to attract cost-conscious students, creating a competitive advantage. Betting that lowering the price will result in more customers, the manager assumes volume will offset the lower profit made from a single cup.

That's competitive pricing using a value-based pricing strategy. The shop is lowering costs to be more competitive with its competitors. But the shop could also try raising costs to enhance competitiveness.

Let's say those same chain coffee shops have locations in another part of the city in a wealthier area. One of the coffee shops keeps its prices low, in line with what it's charging at its college campus location, while the other raises its prices in that more affluent area. When wealthier customers choose between the two, they might assume the one with higher prices offers better quality coffee, making them more likely to pick that shop. This also illustrates competitive pricing, but it uses a premium pricing strategy instead of a value-based one.

If you're in a mature marketplace featuring rivals with similar products or services to yours, now is the time to explore competitive pricing. Easy to implement and eminently flexible, this important business strategy can help you gain new customers and keep the ones you have, and it can be the linchpin in an agile, responsive sales plan.

Remember, the irreplaceable element in a successful competitive pricing strategy is data. A solid CRM paired with an effective, easy-to-use sales management tool will make this tactic far easier and more effective. But be sure to consider how technology is currently evolving — just as the marketplace constantly changes, so do the tools. Consider exploring the use of AI — specifically, large language models — to gain real-time feedback on your pricing strategy as well as your product and pricing composition. Your bottom line will depend on it.