Running a small business is a dream for a lot of people. You get to build it from scratch, be your own boss, and work on something you’re passionate about.
However, the reality of running a small business can too often turn into a nightmare. The US Small Business Administration (SBA) estimates that only half of all small businesses survive five years.
From overestimating market needs, failing to find capital, being unable to build an effective team or getting a pricing strategy wrong, there are many reasons for a small business to fail.
Pricing is one of the defining factors that determine the success of a small business. Unfortunately, in most cases, there isn’t one simple answer for choosing a strategy.
The trade-off between profit margin and attracting new customers is a balancing act every small business owner must deal with. Many small business owners have sleepless nights worrying about being undercut by a competitor or losing revenue from setting prices too low.
So what do you need to know for creating the best pricing strategy decision?
Things to think about when creating a pricing strategy
Pricing is so tricky because it’s the outcome of so many factors. Choosing easy pricing options and not doing proper work to understand your business and its products usually ends in failure.
You can copy from your competition, but every business is different, and you should be striving to offer something that differentiates you from the crowd. You can simply take your product or service expenses and then add the desired profit margin, but this method fails to understand that value is defined by your actions; it isn’t just a number slapped on top.
There’s a lot to consider when it comes down to pricing strategies, and that’s before you even get into the logistics of payments and ensuring you have a suitable payment platform that fits your needs.
Every small business has to take the time to study a range of different factors in order to find a pricing strategy that works for them. Things to consider are your businesses:
- Target customers.
- Business model.
- External market conditions.
- Current demand.
- Fixed expenses.
- Variable costs.
- Marketing & branding.
- Potential promotions.
Here’s a list of 5 popular pricing strategies that small businesses should consider when deciding what to charge.
- Penetration pricing
Penetration pricing refers to pricing a product or service low when entering a market to raise awareness of your business and attract new customers rapidly. By making the price artificially low (less than your competitors), you can quickly get your product into more customers’ hands. The strategy often means sacrificing today’s profits for tomorrow’s, accepting initial losses to build market share and creating greater profits down the line when you raise prices. This strategy is popular among tech startups, particularly those with VC funding who don’t need to be immediately profitable in order to stay in business. Specifically, in tech, there are benefits to getting the product out there and learning how consumers interact with it.
Penetration pricing can be a risky strategy, as you can quickly rack up losses, and there are no guarantee that consumers will stick with you when prices go up.
- Price skimming
On the other end of pricing strategies is price skimming. Generally, only applicable to new products and services, price skimming means setting prices initially high before competitors can come out with similar products.
Price skimming takes advantage of early adopters who are willing to spend big to be the first to get a new product. When successful, price skimming maximizes profits early and builds anticipation before prices drop and the customer base is expanded. It can help recoup the high cost of developing a product and increase its perceived value.
However, there’s always the risk that the price will be too high, which can lead to low sales and the product failing to find an audience.
- Value-based pricing
Value-based means setting the price based on the perceived value of a product or service. This method requires significant market research to determine how your target audience views your product and what they’ll be willing to pay for it.
Discovering the perceived value of a product and then setting the price just below that, can attract customers who think they’re getting a deal. Value-based pricing needs ongoing research in order to stay up to date with consumers’ price sensitivity and their perceived value of the product or service.
- Psychology pricing
Some businesses use ideas from psychology to create the illusion of extra value when setting prices. This method is called psychological pricing, and there’s a range of techniques small businesses can use to put it into play.
One of the most used techniques is called “charm pricing”; the adoption of small discounts to make the number appear smaller. For example, when a grocery store offers a loaf of bread for $0.99 instead of a $1 or an electronics store selling a TV for $499, rather than $500.
While we are all consciously aware that these are virtually the same price, subconsciously, consumers tend to place more emphasis on the price tag’s first number. The determining factor in purchasing intent is a complex mix of feelings and emotions in the consumers mind. So while we know what’s happening, the tiny change in price still has an effect on our purchasing preferences.
Applying psychology pricing tactics can be beneficial for your business, but they don’t necessarily give you an advantage over competitors, as they are out in the open and everyone can use them.
- Dynamic pricing
A newer technique available to online companies is dynamic pricing. This strategy offers unique pricing that depends on who makes the purchase or when they want to buy the product. This flexible approach looks to maximize purchase intent and profit in every transaction.
Dynamic pricing can consider various factors depending on implementation, from market forces (e.g. changes in supply and demand) to personal characteristics (e.g. purchasing history or estimated customer profile based on information provided).
This technique is common in eCommerce and transport industries but is restricted to certain types of businesses. An excellent example of dynamic pricing is airline tickets. If you’ve ever tried to buy a plane ticket, you’ll know airlines rarely have fixed prices. Dynamic pricing takes advantage of price elasticity, the idea that small price changes can significantly affect purchasing intent.
Making sure the price is right
Pricing strategy can be a difficult tightrope to walk on, no matter the business. By taking the time to understand all the market forces at play and how they affect you, you’ll have the best chance of finding the right balance. However, it’s also vital to remember markets aren’t static and you should continuously review and look for new competitive advantages when it comes to pricing your products.
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