What is (and isn’t) a Pricing Strategy?

There is a lot of confusion about pricing strategy.

There are three core elements of successful price management within a company. They are:

1.        Deciding on your pricing strategy; or, more likely, strategies.

2.        Managing short-term pricing tactics, such as a sale or Buy-One-Get-One-Free offer.

3.        Understanding the psychology behind how customers decide a price is fair, and adjust price communications accordingly.

This is one reason why confusion arises – companies think that all three things are all to do with pricing strategy. For example, many academic resources include Psychological Pricing as a strategy, and I fundamentally disagree. I think the psychological side of pricing is simply about successfully communicating the price. It’s not a strategy because 100% of all businesses are employing psychological pricing 100% of the time, whether they realise they are or not… because they are selling to other humans, and every single aspect of how they communicate has an impact, either positive or negative. Psychological pricing is simply becoming aware of those hidden psychological factors and deliberately presenting your prices in a way that helps you. That’s just good comms.

So let’s define what we mean. A pricing strategy is a method or approach used by businesses to determine the best price for their products or services in order to achieve their business goals.

And that’s the second area where confusion arises – too often pricing strategy is defined as the approaches a business takes regarding prices to maximise profit. But not all businesses are trying to maximise profit. The business goal might be to maximise growth, because scale means they’ll get bought out by a tech giant like Google for $zillions even if they are not making a profit. So a pricing strategy needs to help the business achieve its corporate objectives; and those goals can change, so the pricing strategy needs to change at the same time.

This also means that, for any business, ‘pricing strategy’ is seldom singular. There might be two or three strategies overlayed on each other, such as premium pricing with geographical differences.

Given all of that, let’s look at some common pricing strategies.

1. Cost-Plus Pricing

Definition: Cost-plus pricing involves adding a fixed percentage or amount to the cost of producing a product or delivering a service to determine its selling price.

How It’s Used: This method is straightforward and ensures that all costs are covered with a guaranteed profit margin, but it misses out on potentially higher margins by ignoring the value delivered. It is commonly used in retail, manufacturing, and construction. 

Example: A furniture manufacturer calculates the cost of materials, labour, and overheads for a chair, and then adds a 20% markup to set the price to its retailers (who often also add a fixed markup to the final consumer).

2. Competition-Based Pricing

Definition: Competition-based pricing sets the price based on what competitors are charging for similar products or services.

How It’s Used: This strategy is useful in highly competitive markets where there is medium/low differentiation between products/services, prices are reasonably volatile, and price is a key differentiator. It is commonly used in B2C markets like electronics or fashion. 

Example: A web retailer uses a technology solution like Pricefy to track competitor prices, and automatically adjusts each price to achieve a goal, such as to be the cheapest by 1p or be the 5th cheapest on the market.

As a side note, this also tends to be the default pricing strategy for many companies that have not considered their pricing strategy and price management – the easiest thing to do is assume that all your competitors know something you don’t, that they have figured out the right price, and so all you have to do is match them.

3. Commodity Pricing

Definition: Commodity pricing refers to setting prices based on the market price of the commodity, which fluctuates due to supply and demand conditions; and a commodity is something where there is no differentiation at all (i.e. all products or services are completely fungible), and the lowest price always wins. 

How It’s Used: Commonly used in markets for raw materials like oil, wheat, or metals, where individual producers have little control over prices.

Example: A bulk electronic component reseller producer prices its product according to the current market price for those components, which can change frequently. Each buyer can get exactly the same component from multiple resellers, so buys from the cheapest.

4. Economy Pricing

Definition: Economy pricing involves setting a low price to attract price-sensitive customers, often with minimal marketing and promotional expenses. 

How It’s Used: This strategy is often used by discount retailers or budget airlines that target cost-conscious consumers, and by doing so they hope to increase the size of the market by bringing in consumers who couldn’t afford a higher price.

Example: Ryanair has headline prices which aim to be the cheapest in the marketplace.

5. Skimming Pricing

Definition: Skimming pricing involves setting a high initial price for a new or innovative product and then gradually lowering the price as competition increases or demand decreases. 

How It’s Used: This strategy is effective for products with a high perceived value and low competition, such as cutting-edge technology.

Example: A tech company might launch a new gadget at a premium price to capitalise on early adopters, then reduce the price over time to reach a broader market or as more and more competitors enter the market.

6. High-Low Pricing

Definition: High-low pricing alternates between offering products at high regular prices and then discounting them during sales or promotions, e.g. due to seasonality.

How It’s Used: Retailers often use this strategy to create a sense of urgency and excitement around sales events, or to sell products that are now out of season.

Example: A fashion retailer may sell clothing at full price for most of the season but offer significant discounts during clearance sales.

7. Penetration Pricing

Definition: Penetration pricing involves setting a low price to enter a new market or attract a large customer base quickly, with the intention of raising prices later.

How It’s Used: This is common in markets with established competitors where gaining market share is critical. It is also used with new innovations where there is an early mover advantage (i.e. a short window before competitors follow the innovation) and the company wants to achieve scale as fast as possible.

Example: A streaming service might offer a low subscription fee to attract users and then gradually increase the price as the service becomes more popular.

8. Premium Pricing

Definition: Premium pricing sets a high price to reflect the high quality or exclusivity of a product or service. 

How It’s Used: This strategy is often used for luxury goods or services where price is a signal of status or quality.

Example: A designer clothing brand may price its products higher than competitors to maintain an image of exclusivity and luxury. In B2B a higher price for a product or service suggests higher quality, better solutions or lower risk.

9. Value-Based Pricing

Definition: Value-based pricing sets prices based on the perceived value to the customer rather than on the cost of the product or competition.

How It’s Used: This strategy requires a deep understanding of the customer’s needs and how much they are willing to pay for the perceived benefits.

Example: A software company might charge a premium for its product if it saves users significant time or money compared to alternatives.

10. Elective Pricing

Definition: Lets the buyer choose the price they are prepared to pay, often with guidance (such as ‘our costs are…’; or ‘most customers pay at least…’; etc).

How It’s Used: Often seen in personal service industries where there is a 1-2-1 relationship with the client and where value is keenly felt by the customer. The principle is that the grateful customer will often pay more at the end of the service (once they have experienced it) than they would have agreed to up front.

Example: In B2B, a coach/mentor working with C-Suite clients might suggest a minimum fee but leave it to the client to decide the actual fee. In B2C some restaurants have tried suggested minimum prices, or city tour guides have asked for donations at the end of the tour.

11. Geographical Pricing

Definition: Geographical pricing involves setting different prices for the same product in different regions or countries based on factors like local demand, taxes, and market conditions.

How It’s Used: Companies use this strategy to maximise profits in different markets or account for varying costs.

Example: A pharmaceutical company might charge different prices for the same medication in the UK, the US, and India based on local market conditions.

12. Captive Product (Two-Part) Pricing

Definition: Captive product pricing involves setting a low price for a main product and then charging higher prices for the complementary products or services that must be used with it.

How It’s Used: This strategy is common in industries where a primary product is essential, but additional purchases are required for continued use.

Example: A printer is sold at a low price, but the ink cartridges needed to operate it are relatively expensive. Also think about razors and blades, or coffee machines and capsules.

13. Dynamic Pricing

Definition: Dynamic pricing involves adjusting prices in real-time based on demand, competition, and other factors.

How It’s Used: This strategy is commonly used in industries where demand fluctuates significantly, such as airlines, hotels, and ride-sharing services.

Example: A hotel might increase ticket prices during peak travel seasons or reduce them during off-peak periods; or might significantly reduce prices a day ahead to fill empty rooms.

14. Hourly Pricing

Definition: Hourly pricing charges customers based on the time spent delivering a service.

How It’s Used: Common in professional services such as consulting, legal, or freelance work where the time investment is a key cost factor. 

Example: A lawyer often charges clients based on the number of hours spent working on their case.

15. Project-Based Pricing

Definition: Project-based pricing involves setting a fixed price for a specific project or task rather than charging by the hour.

How It’s Used: This is common in industries where deliverables are clear and clients prefer to know the total cost upfront.

Example: A web development agency might quote a fixed price to design and build a website, regardless of how many hours it takes (though they will probably base their price on a forecast for how long the project will take).

16. Menu Pricing

Definition: Menu pricing offers customers a range of product or service options, each with its own price, allowing them to choose what mix best fits their needs. 

How It’s Used: Often used in service industries like restaurants or consulting, where different levels of service or product features are available.

Example: A restaurant offers a la carte pricing where each dish is individually priced, allowing customers to choose based on their preferences and budget.

17. Optional Product Pricing

Definition: Optional product pricing involves setting a base price for the main product and then offering additional, optional features or services at extra cost.

How It’s Used: This strategy is common in industries like automotive, where customers can customise their purchases.

Example: A car dealership offers a basic model at a standard price but charges extra for features like a sunroof, premium sound system, or leather seats. Budget airlines also use this, having an extremely low headline price but charging for each additional element such as priority boarding or an additional baggage allowance.

18. Freemium Pricing

Definition: Freemium pricing offers a basic version of a product or service for free while charging for premium features or additional functionality.

How It’s Used: Common in the software and digital services industry, this strategy helps attract a large user base, with revenue generated from those who opt for paid upgrades.

Example: A cloud storage service offers a limited amount of free storage but charges for additional space or premium features like enhanced security.

19. Price Discrimination

Definition: Charging different prices for different customers based on the value they get, which might be based on occasion, pack sizes, brand, what’s bundled in the solution, size of business using the solution, etc.

How It’s Used: Often used in markets with different customer segments, so the base product can be configured in different ways at different prices.

Example: SaaS businesses often offer good / better / best solutions for different sized organisations, where the features and the scale of each is appropriate for the target customers.

There is no ‘right’ or ‘wrong’ pricing strategy. Each has its merits and circumstances that make it appropriate, so every one of them is ‘right’ for some companies and ‘wrong’ for others. The key message is that it is important to consider which strategy (or strategies) will help you to achieve your goals, and to ensure that everyone with any pricing or customer responsibility understands what the company has decided.