Correctly establishing the price of products and services is one of the most complex tasks that any marketer faces. The ability of the company to generate income and obtain a good return will largely depend on a good price structure.
Fortunately, those of us who are dedicated to marketing have a multitude of pricing models that can help us better understand and define the most appropriate prices for a specific target audience.
And to go deeper into this matter, let’s start at the beginning.
What is a pricing strategy?
It is a methodology that is used to establish the best possible price for a certain product or service.
This working model takes into account factors such as the target market, brand positioning, economic trends, competitive prices, the level of consumer demand and, of course, the properties and characteristics of the product or service in question.
A common resource to establish the price of a good or service is to calculate it from its production cost and the desired profitability. If we add to this a small study on the prices of the competition, we will arrive at one of the methods most used by a good part of the companies. However, we will now see that by applying this model we lose much of the perspective that is needed in an economy dominated by digitization.
So let’s see how to determine the best pricing strategy for a company.
How to establish the best pricing strategy?
Before identifying and implementing a specific pricing strategy, we need to handle a concept that, in my opinion, is key to knowing to what extent we should apply or not certain actions and types of pricing strategies that lead us to strengthen our position in a specific market.
The concept I am referring to is the elasticity of demand. This concept will help us to know how a change in prices affects consumer demand. In this sense, it is worth distinguishing between inelastic goods and services, that is, those that continue to be demanded when faced with an increase in price (such as fuel consumption, for example), and elastic goods and services, which are none other than those that they are consumed to a lesser extent if prices rise and much more is consumed if prices fall.
Knowing if a product or service is sensitive to price fluctuations is essential for making decisions about the best pricing strategy for marketers to establish. An ideal scenario would be the one that shows us an inelastic profile, but I am afraid that it is not the scenario that most of us face when we must set an efficient price policy, so it is time to calculate the elasticity of demand.
The elasticity of demand is calculated from the following formula:
% Variation in quantity / % Variation in price = Price elasticity of demand
If the coefficient of elasticity is less than 1, then we are dealing with an inelastic good and service, while if said coefficient is greater than 1, the demand for said good or service is said to be elastic.
Normally, essential products are inelastic, so the type of need will determine the elasticity of demand and, therefore, will help us establish a pricing policy that allows us to get closer to the consumer using the most appropriate strategy.
Another aspect to take into account is whether there are substitutes for the goods and services that the company sells, since, under this premise, in the face of a price increase, consumers can find cheaper alternatives that meet their needs. If there are many substitutes, the demand will be elastic, while if the consumer does not have too many alternatives in the market, we are faced with inelastic demand.
Finally, we must take into account that the demand curve is not linear, but can vary. For example, we can find the same product or service that has an elastic demand for high prices and, on the other hand, for low prices the demand is inelastic.
Well, once we handle the concept of elasticity of demand, we are going to see the types of pricing strategies that we can apply to our products and services.
What is the most appropriate pricing strategy?
Let’s see the most relevant types of pricing strategies, bearing in mind that they are not exclusive, that is, we can apply a combination of several types to better define our global pricing strategy.
Types of pricing strategies.
- Cost-based pricing strategy.
- Competition-based pricing strategy.
- Dynamic pricing strategy.
- The freemium model.
- High and low price strategy.
- Skim pricing strategy.
- Penetration pricing strategy.
- The premium model.
- Geographic pricing strategy
Cost-based pricing strategy.
We begin with one of the most used methodologies in companies, those that lead us to determine the sale price based on the costs of production, marketing, etc.
In this case, a percentage is normally applied to the cost price that represents the benefit that the company wishes to obtain and the resulting value will be what determines the final price of the product or service to be marketed.
The consumer products and retail sector is the ideal environment to apply this type of strategy. Traditionally, the retail chain sells products at prices set or established by manufacturers and large distributors, obtaining a profit percentage that is determined by wholesale purchase prices.
On the other hand, if a company sells services, this strategy is not highly recommended since normally the provision of said services represents a value much greater than its own cost of production.
The cost-based pricing strategy works well as long as the competition works with the same model, so before implementing it, the company will have to do a market study and carefully analyze the prices of its competition, since we can find the circumstance that the competition is prioritizing the acquisition of new clients to profitability, a circumstance that will drag you towards much less attractive prices from a profit point of view.
Competition-based pricing strategy.
If the cost-based pricing strategy is one of the most used, the second on the list is undoubtedly the one used by the competition’s prices. Normally, companies look askance at their competitors to determine their prices based on those exhibited in the market by those brands that are direct competitors.
This strategy does not take into account cost or consumer demand. However, it must be said that, as I have already mentioned before, companies can and should normally combine different types of strategies since they are not mutually exclusive. In this case, it is common for companies to combine a cost-based pricing strategy with a competition-based pricing strategy.
Normally those who use this type of price strategy based on competition are those companies that operate in highly saturated markets. Sometimes a minimal price difference can determine whether a consumer opts for one option or another. This price difference can be downward (normally it is downward), but it may also be convenient to apply a slightly higher price to give added value to our proposal compared to that of our competitors.
However, many companies choose to identify a price range to establish their price within that range and thus also differentiate themselves by price. For example, imagine that the price of a SAAS (Software as a Service) solution ranges between €99 per month and €150 per month. Many companies will be more attracted to set a price of €119 per month for their SAAS to differentiate their platform from the rest by also applying a psychological price close to €120 per month.
In my opinion, consumers are not always looking for low prices, but rather they try to identify value propositions capable of satisfying their needs. If your business offers something that other competitors can’t, value versus low pricing may be the best way to gain market share. This value proposition does not necessarily have to be inherent in the product or service itself but can be linked to exceptional customer service, a good returns policy or even an attractive loyalty program.
Dynamic pricing strategy.
It is a type of strategy that finds its way of operating in the market in price flexibility. A clear example of this type of strategy is found in the tourism sector where prices fluctuate depending on whether we are in high season or low season.
Therefore, if prices vary according to the market or customer demand, then we must think of a dynamic pricing strategy to adapt our offer to the needs and expectations of consumers.
Carrying out a dynamic pricing strategy is not easy. Usually involved complex algorithms that take into account the prices of the competition, demand and other factors of reference. In this sense, there are technological platforms that greatly facilitate this task since they allow us to analyze the markets and the competition through artificial intelligence and machine learning environments.
Working with this type of algorithm allows companies to adapt their prices as the market evolves over a given period. Let’s think, for example, of an airline that must establish the prices of its tickets based on all the parameters that I have already mentioned. Their prices are obtained by carefully analyzing a multitude of variables and as consumers, we can verify that it does not represent the same cost to purchase tickets a certain time in advance or at a specific time of year. Finding the exact moment in which to complete the transaction will mean the difference between paying a higher or more competitive price for the same plane ticket.
A dynamic pricing strategy entails great wear and tear on the company’s marketing department since the battle to achieve the perfect level of balance between price and the product or service to be provided represents the difference between appropriate profitability or a competitive environment. losses. Something highly recommended in this type of strategy is to continuously carry out A/B tests of dynamic prices to try to maximize profits.
The freemium model.
In recent years, the combination of the free and premium concept has been the main protagonist, especially when it comes to the provision of services and the hiring of technological platforms.
Offering a basic version of a good or service to retain users and push them little by little, based on functionality, to contract a payment method is what is known as a Freemium model (in English, the combination between Free and Premium).
The main objective of this strategy is to generate confidence in the consumer, a user who, through basic knowledge of a solution, can determine its suitability to optimally meet their expectations.
In this case, the prices should not be significantly different between one contracting modality and another but should be raised gradually as the client acquires new functionalities and benefits.
A strategy based on a freemium model has its sights set on the long term since normally the initial (free) hiring does not represent significant benefits for the company, but, instead, it gives it access to a client that it can attract and build loyalty over a much higher life cycle thanks to the fact that you can become familiar with the use of said good or service and may be reluctant to change your option if you feel comfortable within the parameters of price and functionality that we offer you.
Let’s remember that creating a critical mass of customers loyal to the brand is one of the primary objectives of any marketing department, so the freemium model helps to create a link and a relationship of incalculable value.
High and low price strategy.
This type of strategy is used by those companies that initially sell their products at a high price and later, at a given moment, radically reduce their price.
The best example is found in companies that sell seasonal products, such as, for example, in the field of fashion. When brands launch a collection, it usually has a certain price and when that collection is no longer in force, its price is lowered considerably. However, I must add that this does not happen in the luxury sector, since fashion does not understand discounts in this sector, so the surplus garments are directly eliminated and destroyed.
Finally, we must not forget the specific promotions that push prices to the limit to attract the attention of consumers. I am referring, for example, to campaigns such as Black Friday and other special days in which madness seems to take over everyone.
My recommendation is to apply this type of strategy as long as the company can conveniently evaluate the popularity of its products and services. That is, as long as you have the necessary information to know which are the most successful products and which are, on the other hand, the products that need a special push to leave our warehouse. Even during certain periods, that is, months in which it costs more to sell, a low price strategy will always be a resource to take into account to avoid the dreaded seasonality.
Skim pricing strategy.
This type of strategy is used by those companies that initially sell their products at a high price and later, over time, gradually reduce their price, normally as the product loses relevance because it no longer represents a novelty.
The big difference between this type of pricing strategy and that of high and low prices lies precisely in the fact that in the skimmed pricing strategy the price reduction is gradual.
The best example of this strategy is found in the video game sector. Most of the titles that are launched in the market have an initial sale price, a price that as time goes by will decrease with offers, promotions, and other significant discounts that considerably reduce their value in the market. When a game is a novelty, it has a price, but when it ceases to be in force in the market, it enters into another price dynamic that leads it to be on sale and in a special promotion to continue to maintain its attractiveness from a purchase point of view. But that offer is not always the same, but the price continues to gradually reduce as the years go by.
It should be noted that this strategy, which is necessary for this type of company (by the way), is widely known by a large part of consumers since one group will decide to buy the product just when it comes out on the market, while another group will decide to wait until the period of offers and promotions arrives to consider its acquisition.
A skim pricing strategy helps prolong the profit once costs are recovered during the launch stage and also contributes to prolonging the life cycle of a product that continues to find a market among “laggard” consumers who only buy if the price is reasonable. attractive, thereby accessing new markets and opportunities.
Penetration pricing strategy.
On many occasions, companies adopt a strategy that consists of offering extremely low prices to enter and position themselves in a specific market to outperform better-placed competition and thus attract the attention of consumers and users.
It is what we know as a penetration pricing strategy, a type of policy that in my opinion is very unsustainable in the long term, so it should be applied for a short period. It is therefore very risky and may not be as effective as desired.
What moves companies to adopt this type of strategy is the hope of keeping those initial customers when they finally decide to raise their prices, but in my opinion, the added value provided by the product or service must be very clear to avoid purchasing a critical mass of customers who only respond to low prices.
Normally it is start-ups and even brands that want to enter new markets who venture with this type of strategy. However, we can also see this policy in companies that market a wide range of products and services and that make use of hook offers in the hope of attracting attention to other offers that have a higher price.
My advice to be able to implement this type of long-term strategy is to focus the message and attention on the values of the product or service compared to the price so that the latter becomes secondary and so when it goes up, the customer can continue to appreciate your products. Benefits.
The premium model.
It is a type of pricing strategy that luxury brands usually use, for example, since elements such as prestige or exclusivity come into play. In this case, companies set high prices to present an image of high value that differs substantially from the real production value of the goods and services they sell.
It is a function that gives vital importance to brand perception, brand awareness and, of course, the status it grants to those who satisfy its needs through the purchase of these premium goods and services.
The possibility of establishing a premium price is largely determined by the market’s perception of the good or service. There are many ways to influence this perception, but I would perhaps highlight the collaboration with influential people, who will be the best prescribers of the brand and the control of supply that allows limiting the availability of products and services, which will contribute to increasing demand.
Geographic pricing strategy.
Sometimes companies must decide to market their products and services at different prices depending on the geographic location of consumers.
Social, economic and sometimes even political factors will force us to design a variable pricing strategy based on the market we are targeting.
Therefore, we must bear in mind that the same product can be sold at different prices in the different countries that make up the global market.
However, in a global economy such as the one we have, companies that adopt this type of strategy must define very well the different markets in which they operate to prevent consumers who reside in countries with greater purchasing power from acquiring those products at much higher prices. competitive in countries with less economic capacity. Therefore, they must avoid selling products to people who are not residents of the geographical areas in which they operate so that each market is limited exclusively to its target audience.
Well, now that we have defined the types of pricing strategy, let’s see how we should design that strategy.
How to design a good pricing strategy?
There are mainly four elements that must be taken into account to design a pricing strategy that can work.
Analyze pricing potential.
A company must know the approximate price of the product or service at which it can be marketed in a specific market, mainly taking into account cost and demand.
The main factors affecting pricing potential are:
- The demographics of the market.
- fluctuations in demand.
- The competitive advantages.
- The production and distribution capacity of the company.
- The costs of the operations.
Determine the Buyer Persona.
The price has to be determined by the type of person who is potentially going to acquire our product or service. Who is looking for said product or service will be defined as the ideal client and to determine the most suitable buyer person we must take into account the following:
- The customer’s willingness to pay for our product or service.
- The weak points of the potential client.
- The life cycle of the customer relationship.
Thorough market research helps you understand what your potential customers want, information that you should check with your own sales team (since they are the ones working in the field), to determine the characteristics of a market that is often complex and changing.
Find a balance between value and sales goals.
When designing a pricing strategy, we must ensure that we cover the needs of the two parties involved in the commercial exchange, that is, our company and the clients. This, which seems like a truism, is not usually applied in most cases in companies and some elements tend to prevail over others in favour of some objectives that must be fulfilled inevitably.
However, as marketing managers, we must focus above all on the following aspects, but looking for a balance that helps to operate in the most efficient way possible. The aspects to consider are the following:
- The achievement of the highest possible profitability.
- A good rate of market penetration.
- The possibilities of expanding the market share.
- The conversion ratio of potential customers and its sustained increase over time.
Observe the prices of the competition.
We have already seen that we must take into account the prices of the competition and that these in one way or another are going to influence our decision-making and the type of pricing strategy to adopt.
When we have analyzed the market we will have to decide what to do in a price situation for certain products and services.
On the one hand, we can be in better conditions than our competition to introduce more competitive prices and thus gradually obtain that market share that we so desire.
On the other hand, we can focus on the value of our offer of products and services compared to their price, which will lead us to raise said price concerning that of our competition as long as we can provide tangible benefits that differentiate our proposal. compared to others on the market.
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