Pricing policy - a few words about

What is a pricing policy? Why is it so important in every organization? How to approach the pricing of products and services in your company? In this article, we will answer all of these questions.

A few words about pricing – table of contents:

Introduction

Price is an important but often overlooked element of an offer. Yet it is of paramount importance in building a company’s value. Kevin Hale, a former partner of the prestigious Y Combinator startup accelerator program, said in one of his presentations that there are three ways through which companies can grow. These ways are the acquisition of new customers, retention of current customers, and the way of settling with them.

Which is the most effective? At first glance, it would seem that the fastest-growing businesses are those that acquire more customers. But a study of 500 SaaS companies shows that’s not true.

Kevin Hale believes that if you spend 1% more on acquiring customers, you will see a 3.32% return on that investment. If you bet on customer retention, the return will increase to 6.7%. On the other hand, if you decide to optimize your pricing and the way you bill your customers, the return will jump to 12.7%. This is why pricing is so important in any business. So let’s explain what pricing is and how you can use it to grow your company.

What is a pricing policy?

A pricing policy is nothing more than a strategy for setting prices for products and services. In other words, it is a set of actions through which business owners can determine the level of offered prices, how they are set, and the rules for granting discounts.

As you already know from the introduction, a pricing policy contributes to the overall growth of the company. And this is possible because taking care of your price list achieves three important goals.

Maximizing profit

Pricing policies have a direct impact on a company’s profitability. Let’s take a look at the fast-food restaurant chain McDonald’s. Through its “value menu”, McDonald’s burgers became attractively priced and accessible to the masses around the world. This was certainly one of the strategic elements that helped this U.S. company achieve economies of scale and contribute to increased profits.
Increasing market share

Pricing can help companies reach new customer segments and increase overall market share. For example, GetResponse, a Polish email marketing company, makes its platform available in multiple pricing options to meet the needs of its customers. We see a similar practice in many other industries, such as the automotive industry. Mercedes, for example, offers sports and luxury cars in addition to standard and expensive passenger cars – see AMG and Maybach.
Building a brand image

Pricing is also used to position a brand in the market. Apple, for example, successfully uses this mechanism by selling both laptops and smartphones at a higher price than its competitors. As a result, the U.S.-based technology giant is perceived as a premium brand, which is effective in reaching more affluent customers. Does that translate into business results? It does. In the fourth quarter of 2022, Apple’s share of the global smartphone sales market was as high as 24.1%.

Types of pricing strategies

As you already know what goals you can achieve by appropriately selecting a pricing policy for your products or services, let’s now look at the types of pricing strategies. There are several of them. However, we will focus on three basic ones, namely a low pricing strategy, a neutral pricing strategy, and a high pricing strategy.

Low pricing strategy

This strategy involves offering products or services at lower prices than the competition. The premise is simple: if I offer customers the same good product as my competitors, but at a lower price, then customers will come to me and buy from me. This is often a valid assumption. Is it always? No. Let’s look at when to use it.
- When to use a low pricing strategy? When you want to enter the market quickly and dominate your competitors. Low prices attract consumers, especially when it comes to fast-moving goods or when the market is saturated with similar products or services.
- When not to use a low pricing strategy? Low prices work better for selling products than services – the service has to be done, and that takes time. What’s more, it’s not a good strategy if you want to reach customers with deep pockets and build a premium brand image – that’s where value matters.
What’s more, setting low prices is a mistake if you do it solely out of fear of the customer’s reaction to a higher price. Beginning entrepreneurs often fall into this trap. One example is a former Google and Twitter employee, Larry Gadea, who now runs Envoy, a startup that offers a platform to help other companies register visitors to their offices.

In any case, when Larry Gadea was starting this business, he decided that monthly access to his system would cost customers $20 per location where that system was implemented. With this conviction in the back of his mind, he met with his potential customer – a large hotel chain.

When Larry Gadea’s prospective client expressed interest in working with Envoy and asked about the price, Gadea quickly replied, “$20,” then thought about it and corrected himself: “Sorry, I meant $200.” The client agreed without hesitation.

Menlo Ventures, which recounted the story on its blog, said that in that time Gadea learned an important thing. Namely, that raising the price even by 10 times does not rule out the sale. So it’s worth thinking twice before giving a customer too low a price.
Neutral pricing strategy

At the heart of the neutral pricing strategy is the belief that products and services should be offered at prices similar to those of competitors. Companies that follow this strategy do not compete on price. Instead, they look for added value that differentiates them from the competition.
- When to use a neutral pricing strategy? When you want to avoid a price war and build a competitive advantage by understanding your customers’ needs and the value of your solution.
- When not to use a neutral pricing strategy? Neutral prices may not work in dynamically changing markets when production costs fluctuate widely, and when sales are affected by seasonal factors.
High pricing strategy

A high pricing strategy involves offering products or services at prices much higher than competitors do. Companies using this strategy seek to achieve higher profit margins by focusing on customers who are willing to pay more for exceptional quality or value. Within the high pricing strategy, we can distinguish two tactics:
- Milking strategy – it is benefiting from a market segment that values quality, exclusivity, or innovation.
- Prestige pricing – it goes a step further and is based on creating an image of luxury and prestige. It is based on social status.
Using both tactics:
- When to use a high pricing strategy? When we want to build a premium brand or a luxury brand. Then setting prices at a high level affects the perception of the product or service and attracts customers with hefty wallets.
- When not to use a high pricing strategy? When we want to achieve economies of scale that are understood by a large number of customers. There is no doubt that high prices are a barrier to most customers. With such prices, you will not reach the masses.

Pricing methods

Let’s move forward and consider how we can approach pricing. Three methods will be helpful here. The first one is based on cost, the second on competitors’ prices, and the third on value.

Cost-plus pricing

The cost-plus pricing strategy involves analyzing the costs of producing and distributing a product or service and setting a price that not only covers all costs but also achieves the expected profit margin. To use it, follow the steps below:

Step 1. Determine production costs. The most important step is to accurately determine all costs associated with the production or delivery of a product or service. This includes the cost of raw materials, labor, energy, etc.

Step 2. Determine the margin level. Next, determine the profit margin you want to achieve. It should be expressed as a percentage of the revenue from the sale of the product or service.

Step 3. Calculate the price. Knowing the cost and margin, you can move on to the third step, which is setting the price.

Step 4. Monitor the price. An important part of the process is to constantly monitor costs and the market to offer an up-to-date price to maintain profitability.
Competitive pricing

The essence of this strategy is to learn about the prices and values offered by competitors and then adjust your offerings based on this information. In this case, prices can either be higher, lower, or at the same level as the competitors’. To use this strategy, go through the following steps:

Step 1. Conduct a competitive pricing analysis. First, make a list of all your competitors. You will need a spreadsheet to do this. Then gather information about what your competitors are offering, for how much, and on what terms.

Step 2. Identify your price positioning. Now think about how you compare to your competitors. What are you better at and what are you worse at? What do your customers value you for? How do you want to position yourself in the marketplace? As you answer these questions, determine if you want to offer prices similar to your competitors’ or if you want to be seen as a premium brand with high prices.

Step 3. Respond to changes. This approach requires constant monitoring of the competition and responding to changes in their offerings. So set up a process that will help you keep your finger on the pulse. How often will you analyze the competition? When will you do it? Where will you record the results of your analysis? You need to know the answers to these and other questions.
Value-based pricing

Instead of focusing on production costs or competitors’ prices, companies that base their price lists on value, analyze how much the customer is willing to pay for the provided solution. It is a perception-based strategy. To use this strategy, take the following steps:

Step 1. Understand the customer value. Talk to your customers, do a survey, or conduct market research to find out what customers value your or similar solutions for. What is a key value for them?

Step 2. Determine how much the customer is willing to pay. Once you know the value, you can ask two more questions. How much are customers willing to pay for that value, and how does that value make a difference in their lives? If you can answer the second question with numbers, even better.

Step 3. Test prices. The last step is price testing. For example, you can offer the same product at two different prices to see which price customers choose more often. That will be your price.

Testing prices

A/B price testing can be a bit troublesome. After all, the premise is this: you give one customer a lower price and another a higher price. But you run the risk of alienating the customer, who may be disappointed, to say the least, to find out that they paid more when they could have paid less. Can this be avoided, and if so, how?

Hiten Shah, co-founder of KISSmetrics and CrazyEgg, shared the solution to this problem using Wufoo as an example. Once upon a time, Wufoo ran an A/B test selling access to the same tool at two prices. One group of customers could buy access for $7 and the other for $9. And at that point, Wufoo did something interesting.

Instead of charging $9 to people who decided to buy at that price, Wufoo charged a lower fee – $7. By doing so, the startup not only avoided customers’ disappointment but also made itself known to its audience as a pro-consumer company. Customers must have loved it. And to top it off, Wufoo tested whether a $2 higher price would be attractive to its users.

Pricing mistakes

Finally, we would like to share with you four mistakes you should avoid making when pricing. They are as follows:

Overly complicated price list

An overly complicated and incomprehensible price list is a serious mistake – especially if you are just entering the market with an innovative product. As a result, customers may not understand your offer, or they may get lost in the maze of information about discounts and billing rules, and ultimately not make a purchase. It’s better to start with a simple and transparent pricing policy. Look at how Spotify does it, offering free or premium access to the service in four simple ways that target four different user groups.
Outdated price list and sticking to one price

Another common mistake is not updating prices and sticking to a fixed price for a long period. Companies do not change prices because they are worried about the customers’ response. However, this can lead to losing competitiveness. At the same time, it reduces the company’s profitability. The market does not sleep, it changes constantly – as do prices in the business environment, such as the prices of raw materials. Therefore, you should regularly review your pricing policy and increase prices.

Hubspot is well aware of this. For those who don’t know, HubSpot is a company that offers CRM. Its co-founder and CTO, Dharmesh Shah, wrote an article in 2020 in which he shared his experience with changing the way it billed customers. At the time, HubSpot charged for every contact that customers added to its marketing tool.

That was supposed to change the following year. How exactly? HubSpot was going to only charge for contacts that its customers actively run marketing activities for. A subtle change. But a change for the better. What motivated the HubSpot team to make this change?

Market observation. Dharmesh Shah said he learned three things while working on the new price list. What worked in the past may not work in the future. Pricing must benefit both the company and the customer. “Friction” in pricing can only be removed by a major change.
Offering discounts too frequently

Offering discounts and promotions can help attract new customers or retain existing ones. However, excessive use of discounts can reduce the value of the product or service in the customers’ eyes and negatively affect profit margins. That’s why it’s a good idea to establish rules for granting discounts. An interesting approach, for example, is the sales window used when selling online courses. At the beginning of the sales cycle, the course creator sells access to the course at a lower price, while after the first 24 hours, they raise the price by 10-15%.
Failing to match prices to customer segments

A final common pricing mistake is the failure to tailor prices to customer segments. Companies often treat all customers the same and apply uniform prices, overlooking differences in the needs and preferences of different customer groups. This can result in losing potential customers who expect personalized offers. To avoid this mistake, understand the differences between your customers and listen to their needs regularly.

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Author: Adam Sawicki
Owner and Editor-in-Chief of Rebiznes.pl, a website with news, interviews, and guides for solo entrepreneurs and online creators. In media since 2014.
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