So far this week we’ve looked at how to choose the right business model for your startup. Now, we’ll be looking at how to find the right type of pricing strategy to sell a new product.
Whatever business model you decide on, you must ensure that it can support the costs of the business. Don’t price yourself too low otherwise you may struggle to generate the volume of sales needed to be profitable.
Choosing your pricing strategy
The main things to consider when choosing your pricing strategy are:
- How much do you need to earn? Don’t price yourself out of business!
- How many products or services can you actually sell?
- How does your pricing match with your competitions?
The business’ income should equal the fixed and variable costs that the business needs to meet, plus the profit you are aiming to make once you’ve covered these costs.
With an idea of how much money your business needs to make every month, you’ll have a figure to aim for when considering how much you need to sell and how to price your individual products and services.
It’s going to be difficult to calculate accurately at this point as your costs are still a moving target. You’ll need to keep playing with the numbers and refine your figures as you progress. In Week 6 we’ll go through marketing and sales where you’ll get a better idea of how you can reach the volume you’ll need and what it will cost to get there.
For now, let’s look at identifying how you’re going to compete. We’ll also examine some of the most popular pricing strategies and decide how appropriate they are for your approach.
How are you going to compete?
When choosing your pricing strategy there are a number of factors you should consider about your competitors.
- Competing in an existing market on price
- Competing in an existing market on quality
- Competing in an existing market on convenience
- Competing in an existing market through specialising in a niche
- Creating an entirely new market
- Making an existing type of product appropriate to a new market
If you don’t have the answers, head back to the market research to find out what your competitors’ approaches are. This should hopefully give you the information you need to choose a pricing strategy that allows you to effectively compete in your market.
In order to make an informed decision about your pricing strategy, you also need to answer the following questions about your customers:
- How sensitive are they too price?
- How loyal are they to existing brands?
- How happy/unhappy are they with existing products?
- How educated are they about the market and available products?
- How likely are they to adopt new products?
Check out last week’s article on customer research techniques to help answer these questions.
Types of Pricing Strategies
You’ll probably have noticed through your market research that your competitors may have quite diverse price ranges. They may be using a variety of pricing models to achieve the profit they need and the market penetration they’re after.
Let’s look at the most common pricing strategies:
This is where a business bases their pricing on how much it costs to create their product and then adds a margin on top of that figure to arrive at their price. This method is simple and it ensures that your product lines are profitable.
At this point you may be thinking, surely this is the simplest pricing strategy – why would you use any other one?
Well, as you’ll see as we go through the different pricing strategies, each one has its own advantages. How appropriate they are for your business will depend on your market proposition, financial needs, and business objectives.
Market penetration pricing is where you deliberately undercut the competition to gain market share and raise prices later once you have an established customer base.
Can you afford to price low to get a foot in the door? This can be a risky strategy.
If you are selling into supermarkets then your profit margin will be squeezed and you’ll need to price low and sell a high volume of stock. This has been the downfall of many small businesses.
In other contexts, it can cause a race to the bottom of the barrel in terms of pricing, which is hard to come back from. Getting people to pay more for your product or service after using an initial market penetration strategy can be hard as they tend not to see the value in it.
You might have one product line or one service that you are happy to use as a loss leader – a product or service deliberately priced so low that you won’t even make a profit from selling it – you actually lose money from each sale you make. But – making this initial sale at a loss opens the door for you to sell your higher priced products or services to the same customer.
This is a high-risk strategy and is not for the faint-hearted unless you are extremely well funded because you can very quickly run out of cash with this tactic. You’ll need to do a lot of scenario testing to make sure you get your pricing just right if you are going to employ this tactic.
Economy pricing is also about setting a low price for your products. Unlike market penetration pricing, this is designed into the entire business model. You are creating a company with low costs and providing the bare minimum to your customers but for a much more appealing price.
You become the budget option in your market. This can be a great way to start competing because it is so easy to get across the benefits. It’s not some complicated new feature you have to explain, you’re simply more affordable – something anyone can quickly understand and buy into.
You just need to be careful to not sacrifice too much quality that might lead you to be associated with a bad product. It’s about finding just the right balance. Executing this well will mean you will have identified unnecessary extra features that your competition is providing which you can cut to save cost. At the same time keeping the core experience at a reasonable quality.
Value-Based & Premium Pricing
Essentially these strategies mean pricing your products or services based on the value or experience you bring to your customer. It relies on your customers recognising the value you’re providing and being happy to pay a fair or even premium price for your product or service.
With this type of pricing, you must set the right tone across all your marketing efforts and understand those consumers or clients who are price sensitive will never buy from you – and that this is OK.
If your marketing is on point, your consumers or clients will likely equate your higher prices with quality – increasing the desirability of the product or service.
There are of course pros and cons to this pricing methodology – value or premium pricing allows you to offer introductory offers or run good promotions – you can afford to give sizable discounts given the profit you will make from each sale. A note of caution here is that you need to make sure that you do not train your potential buyers to only make their purchase when discounts are available.
This pricing scheme goes hand in hand with the razor, razor blade business model. There are plenty of examples from printers and print cartridges to coffee machines and coffee pods. It involves locking in a consumer to a one-off purchase that the continual purchasing of an associated product alongside it.
People buying your product because they have to is great for generating revenue. However, being locked into one brand by necessity can be off-putting for a consumer if the company abuses their position. It’s important you ensure people are buying your product because they really want to, not just because they are forced to in order to keep using the device they purchased.
Price Discrimination Pricing
This is a methodology used by many service providers and Software as a Service (SaaS) companies to target different types of customers within their marketplace.
For instance, you can see with Brixx that we use this strategy because we recognise that start-ups, small businesses and accountants need and use very different feature sets within our software.
It makes sense for our pricing and feature sets to scale along with the needs of the type of business using it.
We also chose to offer a free version of our software because we believe that every business should have access to basic and accurate cash flow forecasting software.
This strategy involves charging the highest possible price you think customers will be willing to pay for your product. Gradually, you’ll lower it overtime to open it up to more customers. This has some of the advantages of premium pricing, as your product will hopefully be associated with quality due to its price point.
Price skimming can allow a firm to quickly recover high product development costs. This approach is great in markets with little competition. You’ll need to be confident you can communicate exactly why your product is worth buying at that price though.
It is usually applied to innovative
In markets with a lot of competition and variety, it will prove more difficult and you might want to choose a different option or you’ll find yourself slashing prices quicker than you’d planned.
Using your financial forecast to inform your pricing strategy
The pricing strategy you eventually choose will be heavily influenced by the vision you have for your company. Many people start out with a goal to create a premium product (for example) right from the ideation phase.
It’s important to have this vision but you also need to validate that your idea works financially.
A premium pricing scheme obviously fits with a premium product but many business ideas can work with quite different approaches.
As we saw in the previous article about choosing your business model the approach you choose can radically change the shape of your developing business. This can have an impact on every area, from the type of costs you take on to operate your business to the methods used to deliver your products or services.
Not all paths will be profitable. Not all methods will lead to financial success.
To help find the correct path you should continue to experiment with your financials, looking at rough numbers for the first few years of business.
Brixx is the perfect tool for loose experimentation at this stage of planning. You can play around with different costs, price points and unit volumes that will change depending on which pricing strategy you choose. Modelling a range of scenarios is the key to making the right choices.
We’ve covered quite a lot of strategies here! It might be a bit overwhelming working out which one is for you, and that’s okay. Take your time to think through each strategy and see which one matches up with your business idea the most. It may take some tweaking to get right, but one of these will likely do the job.
A quick recap of the strategies we talked about:
- Cost Plus – price to make + margin
- Market Penetration – deliberately undercut the competition to build a customer base, then raise prices
- Economy Pricing – a product with fewer features at a cheap price, with the aim of being the cheapest in the market.
- Value-Based & Premium Pricing – Priced based on experience and value offered. Need to drive home value of the product through marketing.
- Captive Pricing – Sell main product at a loss or thin margin and price supporting products higher, i.e coffee machines & pods or printers & printer cartridges
- Price Discrimination – Give your customers more choice by offering packages or options to suit more types of customers
- Price Skimming – Initially charge a high price for a product then gradually lower it over time. Common in the tech industry where R&D costs are high.
Remember, your pricing strategy is never set in stone and adjustments might be necessary over time, so feel free to experiment with each.
In week 5 we’ll look at how to identify USPs and use them to create and test a minimum viable product (MVP) for your startup.