Whether you have experience in online sales or not, you probably know that pricing is often one of the most important criteria for the customer. Of course, we all like a good deal, but pricing also affects our perception of a product. We previously talked about low-cost pricing and premium pricing strategies. But pricing is more complex than that, and getting the price right is one of the most important things in maximizing sales and profits. Different businesses have different products, customers, and competitive environments, so they need the best strategy for their business. Let’s talk about the seven main pricing strategies that apply to Ecommerce and online sales.
Seven Ecommerce pricing strategies
Cost-plus pricing is the most basic strategy. You decide what margin you want to earn on the sale and add that percentage to the cost. Easy, right? This is what most newbies think when asked how to price an item.
The problem with that strategy is that it does not consider the market, customers, or competitors. If you want a margin of 80%, but your competitors are okay with 20%, it will be hard to be competitive and win the sale. Or, if your price is way under what the customer is willing to pay, you’d be leaving money on the table.
There is, however, one big advantage with this method: it is easy. It does not require extensive knowledge of the market or environment and is quick to calculate. For a retailer that sells large quantities of very different items, it would be very difficult to have the perfect pricing strategy for each product, so using cost-plus pricing could be a solution.
The name here is self-explanatory: the idea is to decide on a price based on what competitors are doing. There are two main approaches:
A cooperative pricing strategy means the company will align its prices with what its competitors are doing. If your competitors raise their prices, you raise yours. If they decrease their prices, you decrease yours. It’s as simple as that.
This is another strategy that is easy to apply. However, it means your competitors will dictate your strategy, and you may make suboptimal choices due to unplanned competitors’ moves. For example, let’s say a competitor has to get rid of some of its inventory due to approaching expiration dates and cut its prices by 30%. Unless you experience the same issue at the same time, you won’t mitigate the risks of having unsellable inventory and may end up selling good inventory at a much lower profit margin. In other words, your competitors will have a temporary competitive advantage as a result of making business decisions based on what is good for them, not solely based on competition. It also requires constant competitor monitoring, and your competitors have to sell very similar products for this strategy to make sense.
On the other hand, an aggressive pricing strategy means you’ll always try to price your product under your competitors’ prices. You won’t change your prices if your competitors increase theirs, and you won’t decrease them if they drop their prices. The goal isn’t only to gain market share by offering lower prices; it is also to send a message to the competition.
This strategy works best in industries where customers are the most cost-sensitive or when selling commoditized products since offering the lowest price will significantly increase sales. The drawback is the risk of triggering a price war and, as a result, seeing the whole industry’s profit margins shrink.
The Case of Dismissing Pricing
In some cases, companies will not even look at their competitors’ pricing before pricing their products. For example, this happens when their product is so unique they have no direct competition, or when customers value their brand so much they’ll barely compare their products to their competitors. However, customers’ behavior and competitive landscape can change over time, so it is never a bad idea to keep an eye on competitors and substitutes.
Price skimming means the company will charge a higher price when introducing the product, then lower the price over time. This happens a lot with new technologies that are sold at a very high price when first introduced—companies like Apple tend to use this strategy with their smartphones. The early adopters, those who really want the product as soon as possible and will set up a tent in front of the store the day before launch, will pay the highest price. Then, once these early adopters have spent their money, or when another newer version of the product is released, the company lowers the price so another group of customers, who were a bit less enthusiastic, will buy it. When they purchase the product at the reduced price, the company will lower their price even further to reach more customers, and so on.
Price skimming is a way to maximize profits by selling at the maximum price each segment is willing to pay. It also helps identify the early adopters, who have the potential to turn into the brand’s most loyal customers and are likely to spend more than the rest of the customer base. If they buy the product early enough and love it, they’ll advertise it to the next customer segment.
However, this strategy does not work if the market is too competitive. And even if there are few competitors, it isn’t easy to predict when they will enter it if the market is profitable enough. Besides, the high prices will attract competitors who will see an opportunity to compete on price. Finally, dropping the price too low too soon can upset your early adopters, who paid the full price. If that happens, these upsets customers will feel ripped off and most likely will not buy from you again in the future.
A penetration pricing strategy aims to quickly gain market share by offering low prices when introducing the product, then raising the price. It aims to get as many customers as possible to try the product and build a relationship with them to hopefully keep them loyal once prices are raised.
Many dating apps used this strategy in the past. There aren’t many things more useless and depressing than a dating app with no users. In order to quickly get new people to join the app, the company has to offer many free features and low-cost memberships. Then, once the app is booming and becomes a realistic way to find love (if that is ever a thing online), the company can start charging more for their services. It also works with physical products; for example, with new food that companies introduce to the market: they charge a low price initially, so people try it. Once enough customers try and like the product, the company raises its price. I personally almost always buy the same stuff and only discover new food items when I try them first with free samples or heavy discounts.
The advantage is that low prices are usually a good way to convert customers, especially when prices are highly elastic. This strategy can be used by new companies or for new products to quickly gain market share. Sometimes, the higher volumes generated by the low prices can help generate economies of scale.
However, this strategy has a few disadvantages. First, it is costly, and sometimes the products are initially sold at a loss. There is also a risk of starting a price war with existing competitors, which makes it very difficult to increase prices in the future. And even if the company gradually increases its prices, this move can upset existing customers and contribute to losing market share. It can’t be a long-term strategy, and increased prices make the company vulnerable to a new entrant with a lower penetration price.
Value-based pricing is a strategy that aims to decide on a price based on the customers’ perceived value of the product sold. In other terms, the price should be set to what the customer thinks the product is worth.
There is no scientific way to find the exact right price for a product, and every customer will have a different perceived value of a product. It is, however, possible to find the approximate price customers are willing to pay by building a relationship with the customer base and getting feedback from them.
For this reason, this strategy works better for brands that already have a strong customer base and the ability to easily get data from them. The product also needs to be unique or highly differentiated from its competitors and be worthy of customer attention. The more competitive a market is, the more difficult it is to use a value-based pricing strategy since customers will have many ways to compare prices.
An example would be Nespresso pods. When they first started, the product was pretty unique, and the company had more freedom to price it at a premium based on what customers were willing to pay.
It is an efficient strategy to maximize profits. It contributes to a good brand image and encourages communication between the company and the customers. Future products are then designed with customer feedback in mind, which is highly valuable.
On the other hand, it is very difficult and time-consuming to find the right price. It requires a lot of research and communication to find a price that will generate the most profits and include most of the customer base. It only works for unique products, and the entry of competitors into the market can make this strategy much more difficult to use.
Price bundling is selling two or more products at a lower price than if the products were bought individually in order to increase sales volumes while offering the customer more value. The most typical example of bundle pricing is getting a combo at a fast-food restaurant vs. buying the fries and the burger individually. Companies often bundle items that are great when used together (burger and fries, shampoo and conditioner, or camera and lens).
There are two ways to do it: Pure bundling and Mixed bundling. Pure bundling means only offering items through a bundle—for example, a computer with an operating system. Customers have to pay full price for the bundle even if they only want the computer. It maximizes the order value but can be frustrating for customers to buy the whole thing if they only want one item. Mixed bundling is when customers can purchase the items individually or buy them as a bundle to save money. It gives the customers more options but makes it harder to sell slow-moving items.
Bundle pricing increases the average order value by selling the customer more products; it also simplifies the customer experience. For example, a company could sell bundles of nutritional supplements based on the customers’ goals, like a “muscle-building bundle” with whey protein, creatine, and pre-workout. It makes it easier for newbies who don’t know what products they need. Finally, bundle pricing is a good way to sell slow-movers.
On the flip side, bundle pricing may decrease profitability and upset customers who would prefer buying items separately. It also causes legal issues in some places.
Loss Leader Pricing
Loss leader means the company will price a product so low they’ll lose money on it in order to increase sales of another, more profitable product. Unlike a penetration pricing strategy, the goal is not to increase the price over time but to keep selling the loss leader at a low price.
This is what companies like Nespresso or Gillette are doing. The machines or handles are cheap, but then the customer has to buy expensive pods or razor blades. Millions of people have received a Nespresso machine as a Christmas gift and had to spend a lot of money on pods to use it. For a long time, they couldn’t use an alternative pod brand; only the expensive Nespresso pods were compatible with the machine.
It works well to sell some products profitably and get customers to buy from a company for the first time. The main risk is if customers are only interested in the product sold at a loss, which annihilates any advantage of this strategy.
There are other strategies I will not discuss here since they mostly concern software or very specific industries. For example, Freemiums are free software with limited features that come with premium paid options. The transportation industry uses dynamic pricing models, so prices change with demand and supply. Investigating these other models can be interesting because they could lead to innovative Ecommerce business models. Maybe there are opportunities to come up with successful Ecommerce offers that use more exotic pricing strategies.
|STRATEGY||WHAT IT IS||PROS||CONS|
|Cost-plus pricing||Deciding on the price based on the margin we want||Very easy and quick to do||Not optimal because it does not consider customers or a competitive environment|
|Competitive pricing||Choosing the price based on the competitors’ price||Easy to set up and gives a good idea of what customers are willing to pay||Competitors dictate strategy|
|Price skimming||Starting with a high price and decreasing it over time||Maximizes sales from every segment of customers||May upset early adopters and does not work in more competitive markets|
|Penetration pricing||Starting with low prices, then raising them gradually||Makes it easy to initially gain market share and high initials volumes may generate economies of scale||Low profitability during early stages, doesn’t guarantee customers will stick, and is vulnerable to competition|
|Value-based pricing||Deciding on a price based on the customers’ perception of the product value||Gets a price close to the optional price, encourages communication with customer base, and uses feedback from customers||Difficult to gather all the data, works mostly for established businesses with differentiated and high-value items.|
|Bundle pricing||Selling products as a bundle at a lower price than if the customers were buying the items separately||Increases customers’ average order, simplifies customer experience, andhelps sell slow movers||May frustrate customers who prefer buying individually|
|Loss leader pricing||Selling a product at a loss or low margins in order to increase sales of another item||Works well to help sell more expensive products||Risky if customers only care about the product sold at a loss|
How to get the price right
Getting the price right requires using the best pricing strategy based on your industry, competitive environment, and value proposition. You’ll have to do your research and know your costs and environment well. Once the strategy is in place, you’ll also have to plan for the future, like when the competitive environment or the customer behavior will change, for example.
Most of the time, you should have a strategy for a whole product range or even a brand rather than a single product. For example, companies can use Good Better Best strategies to maximize their sales over multiple customer groups.
There are many strategies to choose from, and each has its advantages and disadvantages. Choosing the right strategy is one of the most important aspects of maximizing profits, and it requires a significant understanding of the product and environment. Finally, there are new opportunities with innovative pricing strategies, and looking at other industries can give ideas on what can be experimented with.