The concept of pricing may be easy to grasp, but it’s not so easy to implement.
With the ever-increasing market competition, consumer behaviors shifting faster than ever and the explosion of data in constant evolution of digital technologies, businesses must carefully consider their pricing strategies to stay competitive and profitable.
The times when pricing decisions were based on the simple cost-plus pricing model are gone. The internet and price comparison tools mean consumers can easily compare prices across different vendors, so it’s essential for businesses to price their products strategically.
Modern companies need to adopt more sophisticated approaches to pricing and remain constantly adaptive to the changing market conditions. Choosing the right pricing strategy is critical for a business's success as it directly impacts revenue, profitability, market positioning, and customer perception.
In this blog post, we'll explore various pricing strategies and their applications, helping you understand how to choose the most appropriate approach for your business in today's competitive marketplace.
What is a pricing strategy?
A pricing strategy is an approach to determining the optimal price for a product or service. It's a crucial component of a company's overall marketing and business strategy, as it directly impacts revenue, market positioning, and customer perception.
Different pricing strategies can be used to achieve different business objectives, such as maximizing profits, gaining market share, or establishing a particular brand image.
A business’ pricing approach can and often does combine different pricing models to address various market segments, product lines, or business objectives. A comprehensive approach will guarantee better results.
Pricing strategies vs pricing models
Companies frequently use multiple approaches to address various market segments, product lines, or business objectives. We’ve prepared a separate article where you can read up on the different pricing models.
In fact, an effective pricing approach will combine pricing strategies with pricing models. For instance, as part of your penetration pricing strategy, you could use geographic pricing where you would offer a freemium pricing model.
I encourage you to take a look at both pricing strategies and pricing models in the articles we wrote on this topic. It should give you enough inspiration for the right combination that will help you fulfill your objectives.
1. Geographical pricing strategy: adjusted to customer locations
Geographical pricing strategy is also known as spatial pricing or location-based pricing. The name is self-explanatory: in this pricing approach, companies set different prices for their products or services based on where their customers are located.
This strategy takes into account factors like local market conditions, competition, consumer purchasing power or distribution costs and optimizes pricing accordingly for each specific region.
How does geographic pricing strategy work?
A business divides its target market into distinct geographical areas. Next, they need to assess local economic conditions, competition, consumer behavior and any other factors they deem necessary in each area. Then, they calculate distribution and operational costs for each area and set prices for each region based on the findings and strategic goals.
There's no single formula for geographical pricing, but to set pricing that works for each region, there are several factors that businesses should take into account:
- base price of the product or service
- transportation and distribution costs to the region
- local taxes and tariffs
- currency exchange rates (for international pricing)
- local market conditions and competition
- regional consumer purchasing power
Pros:
- maximizes profitability in different markets
- allows for competitive pricing in various regions
- enables price optimization based on regional demand
- accounts for differences in operational costs across locations
Cons:
- can be complex to implement and manage
- may lead to customer dissatisfaction if price differences are discovered and regions are chosen too narrowly
- can be perceived as unfair or discriminatory
- requires significant market research and ongoing analysis
Geographical pricing strategy works best for:
Geographic pricing is particularly relevant for digital products and services due to their global nature. It also works for:
- multinational corporations operating in diverse markets
- companies with significant variations in regional distribution costs
- businesses facing different levels of competition across regions
- products or services with varying demand elasticity in different areas
Example:
A streaming service could implement a geographical pricing strategy by offering different subscription tiers and prices based on the country or region. Additionally, they could adjust their content libraries to match local preferences and licensing agreements. Price subscriptions lower in developing markets to encourage adoption and offer region-specific promotions or bundles. Also, implement payment methods popular in each region.
Netflix and other popular streaming services are already doing exactly that.
2. Penetration pricing strategy: tap into the new markets
Penetration pricing is dedicated specifically for new products or services which a business may want to initially sell at a lower price to attract a large customer base and establish its market share.
The goal is to rapidly penetrate the market, establish a strong presence, and potentially increase prices later once the product or service has gained widespread adoption.
How does the penetration pricing strategy work?
A business sets an initial price significantly lower than its perceived value or its competitors. Once they attract the desired number of customers, they gradually start increasing the price.
Pros:
- rapid market entry and quick establishment of market share
- potential for economies of scale due to high volume
- creates barriers to entry for competitors
- builds brand awareness and loyalty
Cons:
- initial lower profit margins or potential losses
- challenging subsequent price increases, as they may cause customer backlash and hamper customer loyalty
- potential price wars with competitors
When this strategy works best:
Penetration pricing is most effective for:
- new products or services entering a competitive market, including tech startups and SaaS companies
- products with potential for high volume sales
Example:
Let's consider a new project management software company entering a market with established competitors like Asana, Trello, or Monday.com. The company identifies that most competitors charge around $9.99 to $14.99 per user per month for their basic plans.
The new company decides to launch its product at $4.99 per user per month, significantly undercutting the competition. Despite the low price, the software offers features comparable to or better than competitors' basic plans. As users become reliant on the software, the company introduces premium features and add-ons at an additional cost.
This penetration pricing strategy allows the new project management software to quickly gain market share, establish brand recognition, and build a large user base.
3. Skimming pricing strategy: for quick gains
Skimming pricing, also known as price skimming, is completely opposite to penetration pricing. In this approach, a company sets a high initial price for a new product or service and then gradually lowers it over time.
This pricing strategy aims to maximize profits by capturing customers who are willing to pay a premium for early access or perceived exclusivity.
How does the price skimming work?
A business sets an initial high price for a new product or service, targeting early adopters and those customers who are less sensitive to price. Then, the price is gradually reduced over time to capture more price-sensitive segments.
Pros:
- high initial profit margins
- quickly recoups development costs
- creates a perception of high quality or exclusivity
- allows for market segmentation based on price sensitivity
- flexibility to adjust prices based on market response
Cons:
- may limit initial market penetration
- risk of alienating price-sensitive customer
- can attract competition if margins are too high
- potential for negative publicity if price drops are too rapid or significant
- may not work well in markets with many substitutes or low barriers to entry
When skimming pricing strategy works best:
Skimming pricing is effective in case of products with a short life cycle or those that are updated and advanced quickly (think of the subsequent releases of iPhones), especially:
- innovative or unique products with little to no direct competition
- products with inelastic demand among early adopters
- markets with high brand loyalty or switching costs
Example:
Let's consider a new augmented reality (AR) fitness app that offers personalized workouts and real-time feedback using advanced AI and computer vision technology.
At the initial launch, the app could be priced at $19.99 per month, significantly higher than traditional fitness apps, but the cutting-edge technology and unique features justify the premium price. The initial marketing campaign targets tech-savvy fitness enthusiasts and early adopters willing to pay for the latest innovations. After 6 months, the price is lowered to $14.99 per month to attract more mainstream fitness enthusiasts. After another 6 months, tiered pricing structure could be introduced.
This skimming pricing strategy allows the AR fitness app to maximize profits from early adopters and tech enthusiasts who are willing to pay a premium for innovative features. As the market matures and competition increases, the gradual price reductions and tiered pricing structure help capture more price-sensitive segments while maintaining a premium option for those who value exclusivity and advanced features.
4. Premium pricing strategy: better, thus more expensive
With premium pricing, a company sets its prices higher than the market average or competitors' prices to create a perception of superior quality, exclusivity, or luxury.
This approach is based on the psychological principle that consumers often associate higher prices with better quality or value.
How does the premium pricing strategy work?
With this approach, your goal will be to position the product or service as exclusive. Set prices significantly higher than the market average and emphasize unique features, superior quality, or prestige. You’ll have to create a luxury brand image through marketing and packaging and provide excellent customer service that matches the product’s value.
Pros of premium pricing:
- higher profit margins
- attracts affluent customers willing to pay more
- creates a perception of quality and exclusivity
- can lead to increased brand loyalty
- less price sensitivity among target customers
- allows for greater investment in product development and customer service
Cons of premium pricing:
- limited market size due to higher prices
- risk of pricing out potential customers
- increased pressure to maintain high quality and customer satisfaction
- vulnerability to economic downturns
- potential for negative perception if value doesn't match the price
- attracts competition from other premium brands
When the premium pricing strategy works best:
This approach is designed specifically to target affluent or status-conscious consumers who value prestige and exclusivity. In particular:
- for products or services with unique features or superior quality
- for brands with a strong reputation for quality or innovation, including high-end electronics manufacturers
- in industries where high prices are associated with expertise or reliability
Examples:
Premium pricing is widely used by those businesses that have outstanding products, services or quality to offer. We can find notable examples in tech (Apple, Dyson), automotive (Tesla, Rolls-Royce), fashion (Rolex, Gucci), food and beverage (Dom Pérignon), hospitality (Four Seasons, Ritz-Carlton), professional services (McKinsey & Company), and many more.
These companies have positioned themselves as premium brands within their respective markets, offering high-quality products or services at prices above the industry average.
5. Psychological pricing: your customers are emotional
Psychological pricing is about using pricing techniques to influence consumers' perceptions and purchasing decisions. In contrast to other pricing strategies discussed so far, It’s based on emotional or irrational factors rather than purely economic ones.
It leverages cognitive biases and psychological principles to make prices appear more attractive to consumers.
How does psychological pricing work?
There are no calculations with psychological pricing, as you want to tap into consumers' subconscious minds and emotional responses to prices.
There are different techniques that you can use for this purpose. Here’s a sample:
- Visual price reduction: likely the most common tactic used in pricing – the "$4.99" rule – make prices appear lower than they are (it seems like 4 dollars instead of 5)
- Differentiate similar products: slightly vary prices for comparable items to encourage purchases, as identical pricing can lead to decision paralysis.
- Price lining: display expensive items alongside even pricier alternatives to make the target item seem more reasonable.
- Simplify price presentation: use fewer syllables and simpler formats (e.g., $1169 instead of $1,169.00) to make prices seem more attractive.
- Time-limited offers: run a 48-hour flash sale with 50% off selected courses, creating urgency and encouraging quick decisions.
These strategies leverage psychological principles to shape how consumers perceive and respond to pricing, potentially influencing their purchasing decisions.
Pros of psychological pricing:
- can increase sales and conversions
- improves the perceived value of products or services
- helps differentiate from competitors
- can lead to higher average transaction values
- effective in influencing impulse purchases
Cons of psychological pricing:
- may be seen as manipulative if overused
- can potentially damage brand trust if perceived as deceptive
- effectiveness may decrease as consumers become more aware of these tactics
- may not work for all types of products or target audiences
When psychological pricing works best:
This approach helps to convince price-sensitive consumers to purchase and for impulse purchase buyers. Retail and e-commerce environments typically benefit from it the most, but it could also be applied to subscription-based services.
6. Loss leader pricing: entice to visit the store
This particular strategy focuses on selling other products or services than the one you actually price. Loss-leader pricing strategy is about offering a product or service below its market cost to drive customers to visit your store or website – as the primary goal – in order to stimulate sales of other offerings.
The objective is to attract customers with an enticing offer and then encourage them to make additional purchases while they're in the store or on the website.
How does loss leader pricing work?
A business identifies a popular product or service, ideally one that a lot of people are potentially buying, and then prices it below cost or at a minimal profit margin (ideally at a lower price than your competitors). You advertise the low-priced item and use the increased traffic to sell other, more profitable items.
Calculating the effectiveness of a loss-leader strategy takes into account the loss on the discounted item, the profit from additional sales, customer acquisition costs and long-term customer value.
Here’s the formula:
(Profit from additional sales + Long-term customer value) - (Loss on discounted item + Customer acquisition costs) = Net benefit
Pros:
- attracts new customers
- increases store traffic or website visits
- boosts sales of other products
- helps clear out excess inventory, should you have it
- creates a perception of overall low prices
Cons:
- risk of attracting only bargain hunters
- potential for financial loss if additional sales don't materialize
- may upset competitors or lead to price wars
- some jurisdictions have laws against selling below cost, so research is required before implementing this strategy
Loss-leader pricing strategy works best for:
- retailers with a wide range of products
- businesses with high customer lifetime value
- companies looking to enter new markets
- seasonal businesses during peak periods
- subscription-based services
Example:
In the digital realm, many SaaS companies use a freemium strategy, which is a form of loss-leader pricing. They offer a free basic version of their product to attract users and then upsell premium features or expanded capabilities.
7. Economy pricing: minimizing production and marketing costs.
Also known as low-price strategy or no-frills pricing, the economy pricing strategy is about offering products or services at the lowest possible price point, while still maintaining a small profit margin.
This strategy aims to attract price-sensitive customers and gain market share through high sales volume rather than high profit per unit.
How does economy pricing strategy work?
With this approach, you want to sell at a small profit margin, but you do this while also minimizing production and operational costs. Reduce or eliminate non-essential features or services and set prices just above the break-even point. This approach prioritizes high-volume sales and targets price-sensitive customers.
Formula: (Production costs + Operational costs) / (1 - Minimum profit margin percentage) = Economy price
Pros:
- attracts mainly price-sensitive customers
- increases market share
- high sales volume can lead to economies of scale
- can deter new market entrants
Cons:
- low profit margins
- limited room for price adjustments
- may be perceived as low quality
- difficult to differentiate from competitors
- vulnerable to price wars
Economy pricing strategy works best for:
Economy pricing works best for companies selling commodities or staple products. In the digital space, it often relies on achieving a large user base and benefiting from economies of scale, so it works well for:
- businesses with low operational costs
- industries with intense price competition
Example:
A cloud storage provider could offer a basic storage plan with limited features at a very low price. This plan would provide essential storage functionality without advanced sharing options, collaboration tools, or customer support. The company would focus on automating processes and minimizing operational costs to maintain profitability.
A real-world example includes Mailchimp – an email marketing tool that includes a free plan with limited features and low-cost plans for small businesses, focusing on high volume and automation to keep costs down. Also, Google One and Microsoft OneDrive offer low-cost basic storage plans to compete in the crowded cloud storage market.
8. Captive product pricing: earning on the extras
Captive product pricing strategy, also known as captive pricing or razor-and-blade pricing. In this pricing strategy, a company sells a primary product (the "razor") at a low price or even at a loss, while selling complementary, proprietary products (the "blades") at a higher price, where significant profit margins are hidden.
This strategy is applicable only to products or services with primary and complementary components. It aims to create a long-term revenue stream from the sale of complementary products.
How does captive product pricing work?
Offer a primary product at a low price to attract customers and then price the complementary products with high profit margins. Ensure ongoing sales of the complementary products.
Formula: (Loss on primary product) + (Profit on complementary products * Expected lifetime usage) = Total profit per customer
Pros:
- creates a steady, long-term revenue stream
- builds customer loyalty and lock-in
- allows for competitive pricing on the primary product
- can lead to high overall profit margins
- enables market penetration for new technologies
Cons:
- risk of customer frustration with high-priced complementary products
- potential for negative brand perception
- vulnerability to third-party competitors for complementary products
- initial losses on the primary product
- requires ongoing innovation to maintain the captive market
Captive product pricing strategy works best for:
- products with ongoing consumable needs
- products with a long lifespan
Example:
A company could offer a free or low-cost project management software platform (primary product) but charge for premium integrations, advanced features, or increased storage capacity (complementary products). Users become invested in the platform and are more likely to pay for the additional features to enhance their experience.
Xbox and PlayStation, Apple iPhones and App Store purchases and Amazon Kindle e-readers and e-books are all examples of captive product pricing.
In the digital realm, captive product pricing is widely used, often in conjunction with freemium models or subscription services.
9. Product line pricing: Setting different prices for products within the same product line.
Product line pricing strategy is an approach where a company offers multiple related products at different price points to cater to various customer segments and preferences.
This strategy allows businesses to capture a wider market share by addressing different needs, budgets, and value perceptions within a single product category.
How does product line pricing work?
A business needs to have a range of products within the same category on offer. They differentiate products based on features, quality, or performance and set prices for each product to reflect its value and target customer segment.
With this strategy, it’s necessary to create clear distinctions between price tiers and to encourage customers to upgrade to higher-priced options.
Pros:
- captures a wider range of customers
- encourages upselling and cross-selling
- provides options for different customer needs
- can increase overall revenue and market share
Cons:
- may lead to the cannibalization of higher-priced products
- requires careful management of product differentiation
- may confuse customers if the differences aren't clear
Product line pricing works best for:
- companies with diverse customer bases
- industries with varying customer needs and budgets
- products with clear feature or quality differentiations
- markets where customers value choice and customization
- businesses looking to expand their market share
Examples:
Tiered pricing models are one way to execute a product line pricing strategy.
A cloud storage provider offering multiple tiers of service could offer the following packages under different tiers:
- Basic: 100GB storage, limited sharing features
- Pro: 1TB storage, advanced sharing, and collaboration tools
- Business: 5TB storage, admin controls, and priority support
Each tier would be priced accordingly, allowing customers to choose the option that best fits their needs and budget.
In the digital realm, product line pricing is widely used across various industries. For instance, Salesforce offers Essentials, Professional, Enterprise, and Unlimited editions of its CRM platform. Netflix offers Basic, Standard, and Premium plans with different video quality and simultaneous streams.
10. Promotional pricing to offer temporary discounts
In promotional pricing strategy, businesses temporarily reduce the price of a product or service to stimulate sales, attract new customers, increase market share, or clear their inventories.
This strategy is based on the principle that a lower price can drive higher demand, at least for a short period. It's a form of dynamic pricing that aims to create a sense of urgency and encourage immediate purchases.
How does promotional pricing strategy work?
We all understand how promotional pricing works – a price is lowered for a limited time. However, businesses should think about how to use this strategy appropriately.
Start by selecting items that will attract customers and potentially lead to additional purchases. Decide on the level of price reduction, which can be a percentage off, a fixed dollar amount off, or a new lower price point. Establish a specific duration for the promotion to create urgency. Communicate the promotional price to target customers through various marketing channels. After the promotion ends, analyze customer behavior and consider strategies to retain new customers acquired during the promotion.
To ensure profitability:
Promotional Price > COGS + (Marketing Costs ÷ Expected Units Sold)
Break-even analysis:
Break-even Units = Fixed Costs ÷ (Promotional Price - Variable Cost per Unit)
Pros:
- attracts new customers and increases short-term sales
- creates buzz around products or services
- helps clear excess inventory or fill unused capacity
- encourages customers to try new products or services
- provides a competitive edge in crowded markets
Cons:
- may reduce the perceived value of products or services
- can lead to reduced profit margins
- risk of attracting only price-sensitive customers who may not return at regular prices
- potential for cannibalization of regular-priced sales
- customers may delay purchases, waiting for future promotions
- overuse may train customers to expect discounts regularly
Promotional pricing works best for:
- retailers with seasonal inventory or fashion-sensitive goods
- businesses launching new products or entering new markets
- companies looking to increase market share in competitive industries
- digital products or services with low marginal costs
- subscription-based businesses looking to acquire new customers
Example:
A SaaS company could implement a promotional pricing strategy with 50% off the first three months of an annual subscription to their premium plan. The offer would be limited to two weeks, targeting new customers and existing users on the basic plan. They would have to implement relevant marketing campaigns to ensure maximum visibility of the offer.
This promotion aims to attract new users and encourage basic plan users to upgrade, with the goal of retaining them as long-term premium subscribers after the promotional period ends.
Get the best pricing approach for your business
To wrap up this comprehensive exploration of pricing strategies, it's clear that the art of pricing is both complex and crucial for modern businesses. As we've seen, from geographical pricing to premium strategies, each approach offers unique advantages and challenges. The key is to align your pricing strategy with your overall business goals, market position, and target audience.
If you're struggling to develop an effective pricing strategy for your software development business, our team of data analytics and pricing experts would be happy to help. We have extensive experience working with modern data platforms and helping companies in your industry optimize their pricing to drive revenue growth and profitability.
Don't hesitate to get in touch with us through this contact form to schedule a free data strategy consultation. We'll review your business goals, market dynamics, and pricing data to recommend the best pricing strategy for your company. Together, we’ll ensure you're maximizing the value of your offerings and staying ahead of the competition.
