Pricing Strategy Guide: Benefits, Types, and Strategies

• The five main types of pricing strategies are cost-plus pricing, competitive pricing, price skimming, penetration pricing, and value-based pricing.
• It’s important to select a pricing strategy that balances competitiveness and profitability.
• Your pricing strategy should influence your target audience’s perceptions of your product or service and their willingness to pay.
• Know your market and competitive landscape. Adjust pricing appropriately to avoid losing customers or diminishing brand value.

Customers are flooded with options when buying products and services. Your product needs to enter the market at the optimal price to capture your audience's attention.

Choosing the right pricing strategy is one of the most important decisions you can make to increase sales and reduce operational costs. Learn about various pricing strategies, how to choose the right one, and how to create an effective strategy to grow your business.

Your pricing strategy is the baseline you use to determine what to charge for your products and services. There are different options to explore, but before you can decide which pricing strategy to use, you must first understand your production costs and calculate the lowest price at which you’d at least break even. Then you can consider your desired profit margins and what’s realistic given the competitive landscape. Considerations should include how your product or service compares with your competitors’ in terms of quality, features, and price.

By doing your research before you jump in, you can create a pricing strategy that attracts the right customers, makes a profit, and keeps shareholders happy.

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If you choose the right pricing strategy, it can mean the successful launch of your product and faster market penetration. These are just some of the big wins from pricing correctly.

Here are additional advantages of choosing the right pricing strategy:

• Conveying the value of your brand: The perception consumers have of your brand will help determine how much of their current pain they are willing to tolerate in relation to the relief your product or service offers. Think about when you use a delivery service instead of going out and buying something yourself; how much is the convenience worth to you?
• Adding new customers: Expanding your customer base can increase sales, which leads to increased profits.
• Increasing the value of current customers: It’s a lot easier to upsell or cross-sell a new feature or service to a current customer than it is to find new customers. Pay close attention to your pricing with your best customers to encourage additional sales.
• Improving sales: When products or services are priced well, you’ll usually see an uptick in sales. This is where research into your target audience can pay off.

If your pricing strategy falls short of supporting your business goals, you might attract the wrong kind of customers, leading to mistrust and diminishing the perceived value of your brand. That’s why it’s vital to find a fair, reasonable price that the market will bear.

Choosing the right pricing strategy for your business means balancing competitive pricing with short- and long-term profitability. Five of the most popular strategies are cost-plus pricing, competitive pricing, price skimming, penetration pricing, and value-based pricing. Let’s cover what goes into each pricing strategy.

Also known as markup pricing, the cost-plus pricing strategy is a simple, straightforward way to determine the price of a product. It’s mainly based on the cost to produce each unit, without much emphasis on the prices set by competitors. To set your price using the cost-plus pricing strategy, start by adding up your production costs. Then determine your desired profit margin (or markup) and add that to the production cost. That sets your selling price.

Competitive or competition-based pricing uses competitors’ pricing as a benchmark. Instead of starting with production costs or customer demand, companies look at competitors’ pricing data and set their own prices at, below, or above the industry average, depending on their unique selling proposition and their business goals. Those that offer a similar product and want to quickly grow their market share will likely set a comparatively low price. On the other hand, a company that’s bringing a premium product with unique features to market may set a higher price.

Price skimming is a strategy in which a company initially charges a high price for its products or services when it first enters the market. Doing so can signal superior quality while creating an exclusive experience for early customers willing to pay a premium. Companies employ this strategy when they want to quickly recover development costs and have a buzzworthy product with enough customers clamoring to get it — even at a high price point. Over time, though, the company gradually lowers its product’s price to attract a larger customer base.

In contrast to price skimming, penetration pricing is when a business enters the market with a product or service offered at an exceptionally low price. This strategy initially draws attention and attracts hordes of cut-rate customers. However, for this to be sustainable (and ultimately profitable), prices must eventually go up after gaining market share. The hope is that customers will like the product or service enough to stay loyal after the price increases. If not, the company must find a way to produce the product at a lower cost than its competitors.

With value-based pricing, companies set a price based on what customers are willing to pay for their products or services according to their perception of its value. With value-based pricing, you need to build a brand focused on value conveyed by unique benefits, features, and offerings. To successfully use this pricing strategy, brands must invest more significantly in marketing for growing businesses, research, and PR.

Choosing the right pricing strategy for your business requires market research, target audience exploration, competitive analysis, and internal alignment on business goals. These best practices will help you create a strategy that attracts the right customers, generates profit, and keeps shareholders happy.

Think about your company’s overall business strategy. Consider how various pricing strategies can support long-term organizational goals and short-term objectives. For example, a company seeking high margins might prefer value-based or skimming strategies while one focused on growth might lean toward penetration or competitive pricing.

Guiding questions:

• Do we want to maximize profit, grow market share, or focus on brand reputation?
• Do we need to quickly grab customer attention with an enticing product launch?
• Are we trying to build a reputation for our luxury brand?

Make sure you understand what your competition offers in the marketplace and how much they charge. This will give you a sense of what current customers are willing to pay for similar products. If you notice outliers — those charging much higher or lower than most — check them out and try to understand how they justify their prices.

Guiding questions:

• Is our product or service clearly differentiated? How?
• How many competitors are in the market?
• How do the top three competitors sell their product and justify their pricing?

Knowing your target audience is a key step in determining the right pricing strategy. When you understand your target audience — who your ideal customers are and what they value — you gain a better shot at appealing to the right people with the right offer at the right price.

Guiding questions:

• Who are we targeting and why?
• What do they value?
• What pain points do our products or services solve?

Look at the different pricing approaches and consider their benefits and drawbacks. Once you understand which ones best line up with your business goals, measure them against your target market. If customers prioritize quality and innovation, for instance, then value-based pricing may be appropriate. If your customers are more price-sensitive, then penetration pricing or cost-plus may work better.

Guiding questions:

• Is the pricing strategy sustainable for long-term profitability, or will we need to adjust it?
• Which pricing strategy’s benefits align with our short-term objectives?
• Which pricing strategy will work with our target audience?

Involve the right people and agree on a plan for how often to test, evaluate, and discuss your pricing strategy. Your stakeholders can include your market research team, sales leaders who understand your marketplace, financial leaders who advise on budgets, and high-level business leaders who can communicate enterprise metrics and goals.

Guiding questions:

• What are our metrics for success?
• What is a reasonable timeline to evaluate our strategy?
• When and how often should we meet to provide updates?

If sales are slow or market conditions shift, you may need to adjust your prices to compensate. Your team must remain agile and willing to flex with the flows of the marketplace. Don’t be afraid to reassess the pricing strategy and, if necessary, start over with a different version.

Guiding questions:

• Are there add-on features or cross-selling offers we can feature?
• Should we target other customers with varying price sensitivity?
• What are our margins, and are they sustainable in the long term?

Even if you follow best practices, you may still find money slipping through the cracks. Here are some proven ways to keep things running smoothly:

If you focus only on the cost to make a product, you're selling it short. Your audience might be willing to pay more if the product's benefits alleviate the headaches they currently experience.

• The fix: Determine the perceived value of your product with your target audience. Conduct market research by segmenting your audience. Use surveys to gauge how much customers are willing to pay based on how valuable your product is to them in solving their problems.

You might think that pricing your services lower than the competition will make you more attractive to customers. However, it might make them question the quality or effectiveness of your product.

• The fix: Highlight your product's unique value proposition in your sales and marketing strategy. This will put your best foot forward by showcasing your product’s benefits.

The marketplace is in constant flux. Your pricing strategy needs to adapt to the changing tides of inflation, recession, and shifting customer demands.

• The fix: Keep an eye on the market and a closer eye on your competition. Look for sales trends and use sales forecasting techniques to help predict when a drought or a sales deluge might be on the way.

Your customers have a variety of pain points. If you set a single price for your service or product, you could miss out on upselling additional capabilities.

• The fix: Segment your audience and consider a tiered pricing structure. This way, your customers can customize their product experience. They can select which capabilities to add at an additional price.

While a tiered pricing structure might be your ticket to meeting your target audience’s needs, you don’t want to make the pricing model too complicated or include surprises in the bill.

• The fix: Embrace transparent pricing. Make sure pricing, renewal dates, and capabilities are easy to understand.

If you want to see your business grow and flourish, you must develop an effective pricing strategy appropriate for your goals. Hitting the right price won’t just attract customers; it will also convey the value of your brand. If the price is right, your customers will feel like your products or services meet their expectations. And the price you decide on will ultimately determine the sales revenue and profitability of your company.

When creating a pricing strategy, the first thing I encourage people to do is understand their production costs. Doing so will help you set a price that allows you to not only break even but also eventually turn a profit. When you create your pricing strategy, consider things such as:

• Overhead: How much you pay in rent, salaries, insurance, manufacturing costs, services, and labor.
• Customer segments: What do they value? How much are they willing to pay for it?
• Long-term profitability: Is this your pricing strategy sustainable? If it’s not in the short term, how and when can you make price adjustments or offer add-on purchases that will build in profitability? Perhaps you need to build in a plan for upselling or cross-selling higher-value products.

No matter what, align your pricing plan with your overall business strategy, considering your long-term goals and how pricing can help you get there. Are you looking to access profit, grow market share, or create a certain brand reputation? Choose a pricing strategy that supports those goals.

As mentioned, the five main pricing strategies are cost-plus pricing, competitive pricing, price skimming, penetration pricing, and value-based pricing. Each strategy offers a unique benefit to specific industries or product offerings. Let’s look at some examples.

Who benefits: Industries with low or no market competition.

Cost-plus pricing example:

A former aerospace engineer sells a line of high-end boomerangs for collectors. He makes them by hand with balsa wood imported from Ecuador. Materials cost $5, labor based on industry averages is $20, and overhead for manufacturing space and utilities is $20 — making the total production cost of a single boomerang $35. The engineer decides to add a markup of 300%. The formula to set the price for his boomerangs looks like this:

Production costs ($35) + (Production costs ($35) x markup (300%)) = selling price ($140)

Who benefits: Mainly retail, utilities, and electronic industries

Competitive pricing examples:

• Above the competition: This method uses higher-than-competition pricing that’s justified to customers by additional or unique benefits, such as convenience. Let’s say four gas stations are all located in the same area. The gas station that has the easiest access and is closest to the freeway on-ramp charges $0.15 more per gallon than the other three, but customers seem happy to pay the higher price for the convenience.
• Below the competition: Also known as the loss leader strategy, this pricing scheme deliberately sets an item’s price point below the average market rate. Businesses that use this version of competitive pricing often seek to gain a larger overall profit by encouraging customers to purchase additional items. Printers are a great example of this strategy. A lower-cost printer might attract customers, but those same customers will also need to purchase paper and ink cartridges. This increases the total initial sale while also leading to repeat purchases when ink and paper run out.
• Matching the competition: When a company sets prices equal to its competitors, the focus can shift from the price point to the product or service itself. This often happens in industries that are heavily regulated by the government. For example, before deregulation in 1978, U.S. airlines differentiated themselves from the competition by offering perks such as free champagne or gourmet meals.

Who benefits: Tech companies have long used price skimming when introducing unique products to the market.

Price skimming example:

When an entirely new or innovative product is released, the initial price can be quite expensive. That’s because the company is often the only one offering this new product or innovative features. They first target a smaller pool of customers willing to pay for early access. Once the company captures all the buyers possible at its launch price, it begins to lower the selling price over time. Doing so captures more price-sensitive customers while putting pressure on other sellers that inevitably begin to enter the market with similar products.

Who benefits: Internet or cell service providers and software as a service (SaaS)

Penetration pricing example:

A cell service provider makes a splash with low prices, but after gobbling up market share and earning more brand recognition, they move to competition-based pricing. Businesses that use this disruptive strategy may incur early losses, but they wager that the customers initially attracted by a bargain will stay loyal once the price creeps up.

Who benefits: Luxury products such as brand-name leather handbags, upscale automobiles, and high-end makeup brands

Value-based pricing example:

Luxury brands use marketing to convey that their products have high value. Over time, they come to represent status symbols to consumers. When this is successful, buyers are willing to pay a premium. A common throughline is knowing your industry, manufacturing costs, and audience. By doing your research before you jump in, you can create a customer-centric strategy that exceeds the demands of the marketplace.

Choosing the right pricing strategy could be the difference between your product or service succeeding or failing. Identify your product or service’s point of differentiation, understand your customers’ pain points, learn what it takes to build your product, and study your competition. Investing time and resources in investigating, testing, and optimizing your pricing strategy is crucial to your business's health.