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Dictionary
Debitoor's accounting dictionary
Pricing strategy

Pricing strategy - What is a pricing strategy?

Pricing strategies are methods that a business uses to price their products or services.

Add discounts to individual products or services with a click in Debitoor invoicing software. Try it free for 7 days.

Companies use a pricing strategy to calculate at what price they should sell their product or service. Pricing strategies generally take into account production, labour and advertising expenses and then add on a certain percentage so they can make a profit. There are several different pricing strategies, but the main ones are explained in this article.

The different types of pricing strategies

There are several different pricing strategies that your business can make use of. Each strategy is used in different circumstances to maximise your revenue. The main pricing strategies I’ll discuss in this article are:

  • Cost-plus pricing
  • Value-based pricing
  • Penetration pricing
  • Price skimming
  • Product life cycle pricing
  • Competitive-based pricing
  • Temporary discount pricing

Cost-plus pricing strategy

The cost-plus pricing strategy is simply calculating your costs for a product or service and adding a markup. For example, a business is selling a customised hat for £10, and it costs £5 to make and advertise the hat. The business put a £5 markup on the unit’s cost and is, therefore, making a £5 profit.

Value-based pricing strategy

Value-based pricing is setting the price based on the value it gives your customers. Customers often change their buying habits based on the product price. Simply, it is about finding the price that your customer is willing to pay for the product or service. Some questions to think about when selecting a price are:

  • What is the customer prepared to pay for this product?
  • Does the customer care more about price or quality?
  • Is my product worth more than the cheaper competitors?
  • Does the customer care more about price or prestige?

For example, if I needed a pair of running shoes, I could go to a second-hand store and buy a pair for £10, or I could go to a Nike store and buy a pair for £50. If I only cared about the price, the second-hand store would win, but since I care about my fashion sense and comfort, Nike wins. My willingness to pay is based upon the value I place into the shoes I want and need.

Penetration pricing strategy

The penetration pricing strategy involves setting the price low with the goal of attracting customers. This strategy is mainly used by small businesses who are just entering the market. The objective of this strategy is to gain a new customer base through low prices and retain them by using marketing strategies.

For example, a small web development business is just starting out. Their competition is advertising £50 per website page. Since they are just entering the market, they decide to advertise at £35 per website page. This brings in many new clients, to whom they email new product offers every month. The company will work hard to serve those customers to build brand loyalty among them.

Price skimming strategy

Price skimming is a strategy in which a business sets its prices high to quickly recover expenditures for production and advertising. In this method, fewer sales are needed to break even, as you are sacrificing high sales to gain a high profit (i.e. "skimming" the market).

Price skimming is mainly used for the launch of a new product or service which has little to no competition in the market. This method is usually temporary as competitors will come in at a lower price.

Product life cycle pricing

The product life cycle pricing method is relative to the life cycle of the product or service. If the product is in the early stages and sales are high, then the company will generally set the price high. If the sales have dropped, and interest is declining, then the company will set the price lower. This is also known as ‘time-based pricing’.

For instance, when the new iPhone comes out, the price will be set high as the sales will be booming. After several months, the price will be set lower as the interest and sales have diminished.

Competitive-based pricing

Competitive-based pricing is the act of lowering your price to meet the prices of competitors. This is used when there is little difference between products or services in the industry.

For example, let’s say someone was looking to purchase new bed sheets, and there were two options, one for £12, and the other for £15. They were the same colour and same thread count, but different brands. The majority of buyers would choose the cheaper option. Therefore, the business selling the £15 sheets would likely lower their prices, or lose potential sales.

Temporary discount pricing

This strategy uses temporary discounts to increase sales. Temporary discount pricing can be in the form of coupons, seasonal sales, sales racks, promo codes, quantity discounts, etc. The goal is to increase customer volume, clear old inventory, and grow sales. This strategy rewards customers who purchase in bulk and builds customer loyalty for repeat customers.

Pricing strategies and Debitoor

With an invoicing software, it is easy to update your product prices and customise them with a picture and description. We understand that your business needs and prices will often change and we make it simple to customise everything as the market fluctuates.