Finding the right pricing strategy
Cost-based, value-based, and promotion-based pricing are three models to consider for your small business.
Choosing the right pricing model can be a daunting task for small business owners, who face a variety of options when determining how much to charge for their product or service.
Should you base your price on your production or manufacturing costs? Or should you base your price on the value of the product perceived by your customer? Yet another pricing strategy is based on promotions such as a limited time discount or a special offer which you can combine with other strategies.
Regardless of the strategy you use, you'll want to consider factors such as what your competitors are doing and the pricing practices of your industry.
Consider these pricing options for your business:
Pricing strategy #1: Cost-based
Manufacturing or production costs serve as the basis for prices.1 A floor (lowest cost) and a ceiling (highest cost) are established. The price is somewhere in between, depending on the competition and how much profit you want. Industries that use cost-based pricing usually produce in mass, such as food products or building materials companies. They can take advantage of economies of scale, in which the average cost of producing an item falls as the volume of its output increases.
This method usually works best for larger competitors, which tend to have more resources in both money and staff. But this method is simple to calculate, does not require much market research, and enables you to project future revenue.2
Pricing strategy #2: Value-based
Value-based pricing considers the perceived value a product or service will bring to the customer, instead of production costs.1 For consumer products or services, such as fashion, cosmetics, or pharmaceuticals, the perceived value might include an enhanced image or improved health and well-being. For business-to-business products and services, such as computer software or manufacturing, the value may be based on improved efficiencies or increased revenue.
This approach tends to be a common choice for small businesses, which have an advantage when it comes to understanding customers on a personal level. In this case, businesses can create messaging that suggests a higher price point can be worth it for the value of the item.
Pricing strategy #3: Promotional
Promotional pricing features a limited-time discount or special offer on a product or service. It is often used to launch a new product, move inventory quickly (especially around the holidays), or generate new business (such as Groupon offers).
While promotional pricing can be effective in selling products quickly to cost-conscious consumers, it has some disadvantages. According to research by Washington University in St. Louis, loyal consumers stock up on goods when prices are low, hurting future, full-price sales.3
Finding the right pricing strategy can be challenging, but it is critical to developing a healthy profit margin for your business.
1 "The Differences Between Value-Based Pricing and Cost-Based Pricing." Houston Chronicle. http://smallbusiness.chron.com/differences-between-valuebased-pricing-costbased-pricing-23095.html
2 "Cost-Plus Pricing 101: The Necessities and Your Pricing Strategy." Price Intelligently. http://blog.priceintelligently.com/blog/bid/161014/Cost-Plus-Pricing-101-The-Necessities-and-Your-Pricing-Strategy
3"Why price promotions aren't the best marketing strategy." Washington University in St. Louis. http://news.wustl.edu/news/Pages/10839.aspx