Practical Pricing Strategy That Will Boost Profit
Why you should stop using low prices to make sales and what to do instead.
Most business owners worry about being undercut by competitors. And why shouldn’t they? Price is a hot topic in every sales conversation.
The COVID-19 pandemic made it even harder for businesses to set prices. As a result, consumers have become cautious spenders. The Internet gives people more options to choose from and makes it easier to compare brands.
This trend will continue.
Setting prices has become a complex business problem. Companies must now have a pricing strategy to make a profit and thrive.
In this post, you will discover how to choose the right pricing strategy for your business.
You will also learn:
the real reasons many companies struggle with pricing
why “value” won’t help you make sales and what to focus on instead
how the right strategy will help you overcome price pressure once and for all
Let’s get started by exploring the two common pricing problems businesses have.
Pricing Problem #1: Chasing Competitors to the Bottom
Many business owners believe price is the primary factor in the buying decision. After all, one of the first questions customers have is how much something costs. This is why many companies set prices in line or slightly under the “going rate”.
Underselling the competition seems like a logical pricing strategy. But what happens when competitors find out you are charging less?
They lower prices and undercut yours.
Now, you must reduce your prices again to maintain the same competitive position. It becomes a race to the bottom that no one wins.
I want to challenge the belief that people buy on price alone. They don’t.
More on that in a minute.
Is It Too Good to Be True?
Did you know a cheap price reduces the value of your product or service in the customer’s mind?
Think about it. When we buy a cheap product, a voice in our head tells us we should probably lower our expectations. So are we surprised when the thing quits working, the terms change, or the company we bought it from won’t call us back?
Price is an indicator of quality. Studies show the direct correlation between the perceived quality of a product (or service) and its cost. The link between price and quality matters more when comparisons between brands are difficult to make.
Your customers expect to get what you promise. Even if they pay less. But you can’t meet their expectations if you can’t afford to do so. In other words, you must get paid to do your best work.
There is another reason to avoid using your competitors’ prices as a baseline for yours. They almost always guess at prices. Instead, prices should be set using data.
Most small, and even some mid-sized and large businesses, set prices on opinion. They decide what they think people will pay based on going rates and charge accordingly.
The last thing you want to do is tie your company’s financial future to someone else’s opinion.
Of course, competitor pricing affects the market. But you don’t have to let the market hold you hostage. Instead, you can take a different approach by providing proof that supports price levels.
You will learn how to provide proof in a section that follows.
Pricing Problem #2: Value Is Subjective
A lot of businesses talk about “providing value”. But value is subjective. I may value something that you do not. Value subjectivity creates a disconnect between the organization and the target market.
Here is the disconnect: the business knows its product is worth more than its price. But they don’t believe people will pay more because competitors’ prices are lower. However, they are letting competitors determine the value of their product or service.
Does it make sense to charge $700 for a product that is worth $1,000?
Before you answer, think about this question from the other side. Would you pay $1,000 for a product that is only worth $700?
Prospects must believe your product offers more value than the price paid. Since value is subjective, you must focus on building perceived value instead.
Before I go any further, let’s pause to understand more about the basis of value in the marketplace. Then, we will look at how to increase perceived value—the key to an effective pricing strategy.
Consumers will pay more if you show them why they should.
The Employee Revenue Equation
An employee provides a service to a company for a wage. To get the job, the employer approves of the employee’s ability to fill the role. In other words, the employer perceives the value an employee offers the company.
A variety of market factors weigh into the salary paid, but the employer has the final say. Also, note that the employee receives money the day they start work.
Money received = Employer + Time Worked
The equation illustrates how an employee’s value equals a specific dollar amount. It is possible to find jobs that pay more or less than industry averages. Salary comparisons can help an employee determine fair market value.
But this equation does not apply to business owners. Instead, they must use another formula to determine their value.
The Business Revenue Equation
When you become a business owner, the way you earn money changes.
The customer is your employer. To earn money, you must create value for the customer. A product or service is used to deliver that value. This is how business owners get paid.
Here is the point: the more value you create, the more money you will make.
But you need a strategy to create higher value and increase profit. Businesses without a plan are usually forced to compete on price. This is why so many entrepreneurs end up owning a job instead of a company.
The Business Revenue Equation illustrates the transaction between a company and its customers.
Differentiation + Perceived Value = Money received
To create more value, you must show people that your product or service is unique. Unique products and services are not easily replaced. This makes them more uncommon, thus more expensive.
Consumers understand intuitively that less common products and services cost more.
You need a process that helps you create unique value.
The process of creating perceived value is called brand differentiation.
I will use two imaginary landscape companies to illustrate brand differentiation.
GVB Landscaping thrives with 40 employees, company vehicles, and a robust customer base. They have a website and are active on social media. They share landscaping tips through blogs and videos. GVB targets affluent residential neighborhoods and commercial resorts.
Meanwhile, Billy’s Lawn Care is a five-person operation that struggles to survive. They have less overhead than GVB, but their prices are 15-20% lower. They work for a variety of customers and rely on word-of-mouth marketing.
Billy’s had a five-year business plan. Not anymore. The plan fell to the wayside after the first year.
Both companies manage their money well and are skilled landscapers. GVB started small, like Billy’s, and grew into an enterprise.
Now, how can one landscaping company be so much more successful than the other?
In our example, GVB has done a better job of creating perceived value by differentiating with a brand.
A brand communicates an organization’s unique qualities to the audience.
Now, let’s pick up where we left off. I will show you how to build a brand and choose the right pricing strategy for your business.
Branding and Pricing Strategy
Thanks to the Internet, consumers have more choices than ever. Unfortunately, for business owners, this means more competition. As a result, most companies now compete in a saturated market.
Market saturation makes it difficult for consumers to see how your product is unique. So, you must show them what makes you different.
Your brand is the impression people have of your business. It is how they identify it and helps them compare you to competitors.
Whether you know it or not, your business already makes an impression. And that impression pulls customers closer to you or pushes them away.
Most businesses let their brand “happen”. By that, I mean the brand evolves, and the company has no intentional strategy. But companies with a brand strategy take control of the impression they make on the audience.
The purpose of branding is to build more perceived value for your product or service. Higher perceived value reinforces the prices you charge.
There is a connection between the strength of a company’s brand and the degree of perceived value. Starbucks, BMW, and Disney, are examples of strong brands with high perceived value.
Consumers must believe the value of your product or service exceeds its price. When they do, you can charge more without the stress.
Pricing Strategies for Small Businesses
Now, let’s explore specific pricing strategies that will boost profit.
Though there are several, I will cover the most common ones. The pricing strategy you select should align with business goals and industry standards.
This pricing strategy is the most popular. Competitors’ prices serve as a baseline. Other factors, such as demand and brand value, are secondary.
This pricing strategy is the easiest to follow. It is effective if you don’t have a specific target customer profile or sell at high volumes.
But, as we have seen in previous sections of this post, using this strategy has its disadvantages.
To use this simple pricing strategy, the company adds a percentage to the cost of goods and services. For example, if a product costs $50 to produce, and the goal is to make a 20% profit, the product’s price would be $60.
This method is better for businesses that sell low-cost goods and services.
Hourly pricing is also popular. It is a favorite among service providers such as attorneys, plumbers, and consultants. Prices are set at an hourly fee and based on average market rates.
The provider’s opinion of their services (quality, expertise) comes into play. Often, this will affect whether prices are above, below, or on par with market averages.
This pricing strategy can be challenging because a “fair hourly rate” is subjective.
Penetration pricing strategy is popular among startups. The concept is to charge below-market prices at launch to get customers. Then, prices increase as the business grows.
There is a significant obstacle to clear using this strategy. It may be difficult to raise prices later. If you have positioned your business as a low-cost brand, people may resist any price changes.
With project-based pricing, the company creates a fixed price for work within a specified timeframe.
Be careful when estimating the time and work required for a project. It is common to invest more time and money than planned. In most cases, this creates considerable losses and regret. Companies that ask the customer to pay for their mistake should be ready for an argument.
Research and data help define the value of the product or service with this strategy. Prices are then set just below their actual worth. Thus, this strategy creates a perception that the value received is higher than the price paid.
This pricing strategy leverages psychology and a brand strategy. Premium prices must be supported with a strong brand identity and niche targeting.
Some key takeaways from this article are:
- Not everyone buys on price. Instead, look for customers who appreciate the quality of work you do and the value you offer.
- Avoid chasing competitors’ prices and focus on creating perceived value.
- Leverage your brand to create differentiation, which increases value.
- Research the pricing strategy best suited for your business goals.
Want to raise your current prices but are afraid of losing customers? Do you want to know which pricing strategy is best for your business model?
We can help.
For a free consultation, email me personally at firstname.lastname@example.org.
Until next time,
P.S. Are you getting tired of looking like everyone else that does what you do? We can help. Click this link to schedule a short call with me to find out how.
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