The art of pricing can be deceptively complex, as there are a myriad of factors to consider when choosing the prices for your products or services.
As an entrepreneur, it’s essential to price your offerings to strike a balance between what’s affordable for customers and what’s enough to grow your business sustainably.
That said, this is often easier said than done. With no surefire formula to follow, deciding how much to charge can feel like a guessing game.
If you want to get the pricing equation right on the first try, here are a few things to consider when setting your prices.
4 Types of Product Pricing Strategies
There are many types of pricing strategies that businesses use to charge their customers. Four of the most common ones include cost-plus pricing, competitive pricing, premium pricing, and demand-based pricing.
Let’s look into each of them and understand how they differ.
Cost-Plus Pricing
The most straightforward way to set prices is by applying the cost-plus pricing method. This concept involves adding a predetermined markup to the raw cost of production. This markup, in turn, serves as the profit margin for the product or service you plan to sell.
The formula of this pricing strategy is as follows: Labor cost + material cost + overhead costs + markup rate = selling price.
Cost-plus pricing is a no-frills approach that helps determine prices based on the actual costs of manufacturing and other operational expenses, as well as the desired profit margin.
That said, the markup rate can vary depending on your industry and the competition. Some may be able to get away with a larger profit margin of 2x to 3x the costs, while others may have to keep it relatively low to keep up with the competition and economic pressures.
Competitive Pricing
Competitive pricing takes into account the prices of similar products or services in your market as a reference when setting your own. This helps you establish a price range or benchmark, so you don’t end up undercutting yourself—or overcharging by too much.
While this is an easier method than most, it’s not always the most profitable. Depending on your business’s maturity, it may be difficult to compete with lower prices set by competitors. This can leave you with a thin margin of profit or even a loss per sale, so bear this in mind when you decide to set your rate.
Demand-based Pricing
Demand-based pricing uses customer demand and the perceived value of a product or service to set prices.
This is usually applied in industries like hospitality, airline, and transportation where prices are set according to the availability of services and supply.
In this method, prices are set higher when demand is high and lower when there’s an oversupply. This helps entrepreneurs maximize profits while still adapting to market conditions.
Premium Pricing
While some industries rely on low prices to stay competitive, others like fine clothing and technology find success by charging a premium. This is when businesses create an illusion of greater value and quality—even when the cost of making the product is relatively low.
While this pricing strategy looks promising for business profits, it’s important to remember that most customers aren’t willing to pay a premium for their purchases, especially if your offer has little value.
As this is the case, brand building is a highly important aspect of this strategy, as it will help you establish a loyal customer base that is willing to pay more for your products.
3 Types of Service Pricing Methods
If you’re a service-based business or a freelancer, you can apply the following service pricing methods to set your rates.
Hourly Rates
Hourly rates are a type of rate that’s based on the hours spent on a project. It’s common for long-term arrangements and projects that require continuous effort. This method is great for freelancers and agencies who bill their clients based on the number of hours they worked.
The hourly rate is usually determined by the contractor’s skill level and years of experience.
Fixed Fees
Fixed fees are a one-time charge payable by the client. This removes the need to track hours and is great for companies that have to stick with a rigid budget and a definite scope of work.
Fixed fees essentially remove any disputes over the cost of a project, as the rate has already been agreed upon by both parties beforehand.
Variable Pricing
Variable pricing is a type of pricing that’s dynamic and changes based on various factors. This method works great for customisable projects that don’t have a fixed scope.
This type of pricing gives room for customers to bargain for discounts and lower rates. One upside to this is that it allows businesses to make room for clients who only need smaller-scale projects done without committing a lot of labor and internal resources.
Extra Fees to Consider
When choosing a price, there are additional costs and fees to consider that may not be part of the initial quote. This could include taxes, shipping and delivery charges, payment fees, and other third-party charges.
With that in mind, it’s important to be transparent about these costs and show it when the time is right. This will ensure that the customer won’t get upset when the total price is higher than initially agreed upon.
The simple difference of whether or not you charge payment fees can make or break a customer’s decision to buy your product, after all. So if you want to convert customers, you’ll want to make sure they aren’t met with any unexpected surprises.
