15 Best Pricing Strategies for Businesses in 2021
Justin finally made the decision. After months of saving his cash and putting his plan together, he was ready to open his retail store. He had very strong opinions that other retailers were ripping off the public, so he made it clear to anyone who listened that he would offer fair prices.
He opened his door in a very good retail section with high rents. He did a fine job decorating, and his signage was excellent. The grand opening was very successful, and he had plenty of traffic almost from day one. He was broke and out of business in 6 months.
Justin had failed a very basic lesson of business. Gross profit (sales minus cost of sales) minus overhead determines your profit. If you don’t have enough sales, you will lose money. If you have plenty of sales, but your profit margins are too low, you will lose money. If you have great sales and good margins, but your overhead is too high, you will lose money.
How do you determine your Selling Price and the Best Pricing Strategy
in order to stay profitable?
Moreover, How can you increase profits using Pricing Strategies?
Finally, what can you do in certain scenarios when your current pricing strategy is not working or is facing major headwinds such as costs increasing, sales decreasing, or new competition?
PRICING STRATEGY #1
Your Strategy Starts with Your Costs
Whether you are selling goods or services, the first step in your profit analysis is to take a hard look at your costs related to sales. If you don’t know your costs, how can you begin to figure out an appropriate amount to charge.
If you are selling products, you likely have a source of those goods, and that source is now or is willing to sell you blue widgets for $10 each. As a retailer, you know that a $10 item generally needs 50% margins, aka 100% markup or keystone. So, you sell the item for $20.
Here are some of the problems with that pricing strategy:
Freight in. The item is heavy, bulky, and ships from across the country. Freight per unit is $3. Your real cost is $13.
The widget comes with the assembly required. Your competitors do the assembly for the consumer, so you do, too. The cost to assemble is $2. Now your real cost is $15.00
You might think, “Okay, I raise the price to $30.” Unfortunately, all your competitors are at $19.95 and sometimes discount to $17.50.
Your employees sometimes offer the product for $17.50 for fear of losing the sale.
What are you to do? Unless all of your competitors have lost their minds, something is wrong here. Some possibilities include:
They have negotiated a better price with your supplier
They have a different supplier who sells the item for much less
They have a better freight agreement with the supplier or with a freight carrier, so pay less or nothing for freight.
They are buying more at a time, resulting in a discount and possibly lower freight.
They have found a way to do the labor of assembly for much less
In other words, all pricing strategy starts with the cost of the sale. You need to know the cost. You need to be prepared to find ways to lower the cost. You need to be sure you are not going to be undersold due to your competition having a substantial advantage that you can’t duplicate.
PRICING STRATEGY #2
Circumventing the Competitors Edge
Your competition might have a cost of sales edge that you can’t overcome. But that is only one competitive advantage they might enjoy on any individual item or service. They might have a brand that you can’t acquire or own certain rights to repair or service items.
There are many ways that you can navigate over, under, around or through such competition.
Buy the product from an inexpensive overseas supplier. You may have to buy large quantities to take advantage of this option, but it might be worth it.
Arrange for a custom version from your supplier. Maybe you could buy the item in bulk instead of packaging, then sell it without a package, or repackage it with your own brand. In bulk, the item should cost you less.
Add something to the product or service. A guarantee or something free or at a discount to improve the performance.
Create a new version of the product. That might be as simple as a different color but could include a different shape, size, or new improved functions. Differentiate what you sell so that the selling prices can’t really be compared.
PRICING STRATEGY #3
When you move beyond a specific product or service, you can differentiate your entire business by only selling the best in any given market. This will generally mean the selling price will be higher, the margins will be greater, and the potential for repeat business is excellent.
However, it also generally means that your overhead will be higher in order to present a more expensive look, better sales and customer service people, and potentially more expensive advertising venues.
In considering this approach, you will often be faced with how far down in perceived quality you can go. Will your reputation be hurt if you offer items that are not as trendy or just not as high quality to go with your more expensive products or services?
Selling Top-of-the-line will generally result in more loyalty from existing clients and a greater likelihood of referrals. Unfortunately, trendy items or businesses can be last week’s trend, and then the business can suffer.
PRICING STRATEGY #4
Instead of being a Top-of-the-line company, you might choose to go the lowest price route. Clearly, this is a very popular approach with companies such as Walmart, Target, and many others. This approach can be applied at retail, but it also works for wholesalers, importers, and manufacturers who are selling to other resellers. There are also plenty of service providers in this space.
In order to be profitable as a discounter, you need to have the ability to keep costs down and volumes up. There’s a funny old saying: “I don’t make any money on the individual sale, but I make it up in the volume.” There’s a bit of truth in this idea.
A traditional retailer might shoot 50% margins (keystone) on items that sell between $5 and $40, with lower margins above $40, and higher margins below $5. The theory here is that the 50% margin is enough to pay for retail space, salespeople, credit card charges, other overhead, and still net about 20% for the owner’s income.
If a discounter drops the retail by 20% that would mean there is nothing left for the owner, so why bother. Therefore, the discount shop owner needs to find ways to reduce expenses. This could mean volume purchases that allow for lower costs per unit, lower freight per unit, and potentially other negotiated savings (no freight charges, rebates, advertising allowances, and more. Maybe this adds up to 10% of the 20%.
Next, the discount business would look at overhead. Possibly there would be savings in rent, self-service instead of salespeople, and general overhead spread over higher volume. Potentially, the discount approach results in more profit to the owners as a percent of sales, but even if the percent is less, the dollars might be more due to volume.
PRICING STRATEGY #5
Margins in the Supply Chain
A traditional supply chain in the US consists of a manufacturer or importer selling proprietary products, a wholesale distributor, a retailer, and the consumer. Other potential players in the supply chain are OEM purchasers, jobbers or brokers, mass-market retailers, feeders, and co-ops. Each of these groups depends on various margins in order to be profitable.
We will start with the manufacturer who sells to this supply chain and look at how he would strategize his pricing. The importer who is buying products that are proprietary (they have the importers brand or some other distinction to make them unique) holds the same position in the supply chain as the manufacturer.
The manufacturer has many options as to where to sell products. They might sell to consumers through mail order, their own website, Shopify, Amazon, Etsy, or other eCommerce solutions. They might also sell retailers who sell consumers. They also could sell wholesalers, who sell to retailers. You get the picture.
How does the manufacturer arrive at pricing for all these positions in the supply chain?
Generally, they would use industry-established margins for each level. Here is one such pricing setup.
Landed cost on the floor with all packaging, inner pack, the master pack included. $5.00
Sales to OEM’s who must have margins to sell to wholesalers. $6.00 – 20% margin
Sales to wholesalers who must have margins to sell to retailers. $10.00 – 50% margin
Sales to mass market accounts who sell to consumers at a discount. $12.50 – 60% margin
Sales to traditional retailers. $15.00 – 66.6% margin
Sales to consumers. $30.00 – 83.3% margin
One might look at this chart and wonder out loud, “Why not always sell only consumers or retailers? Why ever sell to OEM’s or wholesalers.
This is a critical element in understanding the “math” of business. Margins matter! Middlemen are not just raking in unearned profits. They provide value and functionality that must be replaced if levels in the supply chain are leapfrogged. Thus, a manufacturer who sells to consumers must take on the entire burden of advertising, rather than sharing it with hundreds or even thousands of retailers. The manufacturer is now selling items one at a time to thousands of customers. Thus, the transaction costs are higher, both to sell units rather than 12 or 144 at a time, and by the need to deal with individual consumers. Even the freight is higher per unit.
While it is true that each level in the supply chain provides functions that have value, it is also true that each level must extract a profit. A wholesaler wants a 35% margin when selling to a retailer. The true value of that activity is probably closer to 25% with 10% going to profits. On the other hand, the manufacturer may not want thousands of retailers as customers and prefers to have 25 wholesalers who buy pallet loads at a time.
PRICING STRATEGY #6
Service Business Pricing Strategy
Lawyers, Doctors, CPAs, Auto Mechanics, and Plumbers also have traditional pricing systems based on normal expectations of overhead and cost to deliver the services.
For most business groups selling services, a 3X cost of service approach works great.
Therefore, if I am able to determine that my total outlay for a given employee is $30 per hour (including all taxes, benefits, vacation time, etc.) then I am probably safe to charge $90 per hour for the product produced by that employee. This formula assumes that there is a $30 cost of overhead for the employee (space, equipment, management, customer acquisition), and that would leave a $30 profit for the company. Or mathematically, 33% for the cost of service, 33% for overhead, and 33% for the net profit.
Some will say that this is not enough to cover all expenses and opt for 4X cost of service. This would include a higher cost of acquisition and allows for the employee having hours when the work being done is not billable (not enough work, equipment downtime, administrative time, training, etc.)
These two formulas will not work for all service companies but are a very good starting point.
An alternative, but the more complicated formula is to take the total cost of fixed overhead, including the owner’s desired total compensation, then determining how many hours at what profit per hour will it take to cover the overhead.
For example, if employees are paid $30 per hour (all in), and the billing rate is $100 per hour, and if the employees are billing 80% of hours worked, you would have a $50 per hour profit on that employee. If the overhead plus what the owner wants to make is $10,000 per month, you would need 200 hours of billable work to cover the $10,000. (10,000/50 = 200).
PRICING STRATEGY #7
Market-based Pricing Strategy
Many business owners use a market analysis to figure out what to charge. They do online research; check with suppliers, trade associations, and customers; do field research in stores; try to pick up price lists at trade shows, and otherwise work hard to find what the going rate might be for products and services they offer or plan to offer.
While this is a very wise way to evaluate competitive positions and can provide a method for arriving at general strategies for pricing, it is kind of a backward approach to the issue. Having said that, here is how one might use this approach in light of the accounting principles mentioned above. (For a more detailed look at the accounting, please pick up a copy of “Making Money Out of Thin Air” on Amazon.
Maybe you find out through your efforts that the going price for a widget is $100. You decide that you want to sell things right about the market. No discounting, no added value. You understand that the margin required on $100 items in a retail store should be no less than 35% and preferably 40% or higher. You call one or more suppliers and find that no one will sell you the product for under $70. What are you to do?
Continue to research suppliers. Negotiate with them. Make it clear that your research indicates a selling price of $100. How can other retailers be at $100 if the cost is $70? Do you need to buy a certain quantity to get the $65 price?
If you truly believe you’ll have excellent sales on the item, look into importing the product directly. You might be able to buy 100 at a time for $50 landed.
Check online resources. Sometimes there are online sellers who are selling below the cost you can buy from traditional wholesalers.
Consider alternative strategies such as selling the item for $120 with a full-year service warranty or bundle the item with higher-margin products.
PRICING STRATEGY #8
Amazon Pricing Strategy
There are multiple ways to sell products on Amazon. You can be a seller using Fulfilled by Amazon (FBA) seller, or you can be a seller where you fulfill your own orders. Each has certain benefits and detriments, but that’s for another article.
If you are selling other peoples’ brands, whether you are buying those from manufacturers, wholesalers, or retailers, you will likely want to opt-out to fulfill the shipping yourself. Your pricing strategy is the hard part of this approach. It is likely that you have multiple other companies, including the manufacturer of the product, competing for the sale. Therefore you are only going to get sales if you are pricing the item better, shipping it faster, or have a great reputation, where the others don’t.
If you choose to try and gain the buy box (where you have the best price), you may not have enough margin to make money after paying Amazon’s fees and the shipping cost. Some sellers will show a low product price and a high shipping price, and the final total cost is about the same as others. Some consumers must fall for this, as it shows up on almost all products.
Alternatively, you may prefer to sell your own brand. This can be achieved by buying the item directly from a manufacturer in bulk or with your packaging, or you can buy the product with the manufacturer’s packaging and strip off the packaging. Finally, you can bundle two or more products together to create your own product.
When you use one of these methods to create your own brand, you can now opt for either fulfilled by the seller or fulfilled by Amazon. In either case, it has been my experience that you will need around 80% margins to be successful. Amazon will take approximately 15%. Shipping will range from 10% to 20%. You will need to advertise on Amazon to get any traction. That will cost anywhere from 15% to 25% or more. You may be able to drive traffic through your website, social media, YouTube, etc., but these all have potential costs in the same range.
Finally, you have costs related to product acquisition, shrinkage, returns (Amazon customers love to return stuff), and handling. If you buy the item for $5 and sell it for $24.95, you will likely make money.
PRICING STRATEGY #9
Retail Clothing Pricing Strategy
Clothing is a special case as there is generally greater shrinkage, seasonality, and style changes. As a result, retailers generally want to charge 3X the landed cost of the garment. The rule here is that 33% is the cost, 33% is for shrinkage and discounting at the end of the season, and 33% is for the gross profit before overhead.
PRICING STRATEGY #10
Loss Leader Pricing Strategy
Almost every business is looking for some strategy to get the first sale from a new client. A loss leader is a time-honored approach.
Let’s say you have a doughnut shop. You know you have amazing doughnuts, but no one knows that. You need folks to try them.
Further, let’s assume that most glazed doughnuts in your area go for $1 each or $7.99 per dozen. A loss leader strategy would price those doughnuts at 75¢ each or $5.99 per dozen, including a huge sign out front to get folks to stop.
Once the customer arrives, you want to have other options available that will raise your overall margin. So, if a mixed dozen is normally $9.99, you might have those at $8.99. Specialty doughnuts would be at full price.
PRICING STRATEGY #11
Sales Funnel Pricing Strategy
Many entrepreneurs are looking for a big win with so-called “passive” income. They want to create a course or an app or a system that they can sell, where the money keeps rolling in with no more work required.
These systems commonly use the sales funnel strategy, where the prospect is sent to a very long scrolling landing page that has page after page of testimonials and reasons to buy. All through the landing page are offered to “try it now,” or “special offer today only.” The offer is generally a stripped-down version of the eventual full product, and it sells for just $29.95, though it is worth $3000.
Once the prospect signs up for the $29.95 offer, they are immediately presented with a bonus opportunity where they can buy additional stuff for only $199.00. If the now client buys the $199-item they are then given a chance to buy the ultimate done-for-you or complete package for only $189 a month or a one-time charge of $1995.
If they don’t opt for these next two levels, they will receive follow-up emails asking how they are doing with the $29.95 deal and making it clear that an upgrade will change their life.
PRICING STRATEGY #12
Bundling Pricing Strategy
We all know what a bundle is. We probably have an Internet, Wifi, phone bundle of some kind right now. Or we have our car insurance and homeowners bundled for a nice discount.
The bundling idea works for almost any company with any product or service. If you can increase the total invoice per transaction, your cost per transaction drops. Moreover, if you sell the prospect any additional items while you have them in your domain, that item is not going to be purchased elsewhere.
Create items or services that make sense and give your customers clear online or hard copy materials that spell out the benefits of the bundled products. Show the savings in dollars and/or percentage amount. Your margins might be 10% less than normal, but the benefits are worth it
PRICING STRATEGY #13
Startup Pricing Strategy
When a company is first starting out or introducing a new product, product line, or entering a new territory or distribution channel, it is commonly necessary to offer some inducement to get folks to pay attention and/or try you out instead of their regular provider.
One way is to offer a deal. The cookie place in the mall offers free cookies. The new car dealer offers no down payment, and the manufacturer going into a new international market suggests free local language packaging.
How should you price your special offer? Way back at Strategy 1, we said that you need to know your cost. So, is there some way to get your supplier or suppliers to help out with your discount? Even if you are a manufacturer, the raw goods or packing suppliers can give you a one-time grand opening deal. (By the way, this strategy works for weekend sales, trade show offers, and even seasonal specials).
Call up your suppliers and start negotiating for free or super discounted products.
Next, set a total budget for the project. Will you spend $10,000 for the grand opening, $25,000 to enter that new market, $50,000 for a new product launch. Decide how much of the budget will go for advertising, promotion, and every other aspect of the launch. How much will go towards discounting?
Now figure out how many you think you’ll sell during the launch. Then do the math. So, you have a $100 item that normally costs your $60, but you talk the supplier down to $40. You think you could move 100 of these during the launch if they were a super good deal. You are willing to spend $1000 of your budget on discounting. You subtract the $10 from the $40, and your cost is $30. You can now sell this item for $50 with full normal margins.
PRICING STRATEGY #14
Deal-based Pricing Strategy
We’ve mentioned the cost of customer acquisition a few times above. Do you know what you are willing to pay to get a new client?
The shorthand way to determine this is to estimate what a normal client will spend with you per year, what the profit will be on that spend, and then how much you are willing to spend to achieve that many dollars in profit for one or more years.
Maybe your average customer would spend $200 a year with you and your profit would be $100. You realize that $40 of that is the owner’s compensation (combination of payroll, benefits, special owner benefits, and return on investment.) That means that $60 is there to pay for normal overhead.
What would you be willing to do to get that customer to spend the entire $200 on the first visit rather than spread it into the normal 4 visits? And this would also potentially result in that type of customer spending more than $200 per year.
You can now offer a deal. Maybe they get 10% off whenever they spend over $200. Maybe they get a $20 gift certificate for their next visit. How can you create a deal that makes the customer feel special, that generates more sales, and reduces the cost of the transaction?
PRICING STRATEGY #15
Razor Blade Pricing Strategy
Simple and straightforward – you give away the razor with the plan to sell that client blades for a lifetime.
Variations of this theme can be used in so many industries. A CPA does taxes for free if the business client gives them the monthly fee for all other accounting services.
A merchant services provider gives away the credit card machine, but all transactions for 5 years must go through their company.
An interior decorator creates the plan for a very low cost or free with a contract for a minimum of $10,000 in purchases.
How can you use the razor blade approach in your business?
It is possible, even probable, that you can increase your personal and corporate income through the application of better buying strategies and pricing approaches. A margin increase of just 5% on $500,000 in sales results in $25,000 per year of additional income but would require at least a 25% increase in sales to accomplish the same result. That doesn’t mean you should eschew the effort on increasing sales, only that the methods of lowering costs and making smart pricing moves may be easier.