As a Product Manager, one of the key decisions you’ll make is determining the right price for your product. A well-thought-out pricing strategy can help you drive sales, increase customer satisfaction, and meet your business goals. In this article, we will guide you through the most fundamental pricing strategies with detailed explanations and real-life examples, so that you can start it right.
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The importance of Pricing
You might have already heard that pricing is a crucial business activity, but how important it is exactly you might wonder. In fact, there are several reasons to be mindful of your pricing:
First, price conveys the market positioning of your product. A high price tag screams “luxury” and “exclusivity,” while a lower price point positions you as the more “budget-friendly” option. The key is to find the sweet spot that perfectly reflects the value proposition of your product. This will attract your ideal customers and help you stand out from the crowd.
However, pricing isn’t just about making a quick buck. It’s the key to scaling your business and achieving long-term success. Every Product Manager needs to be a master of three pricing factors: revenue, cost, and profit. Finding the right price point ensures that as your sales and resource consumption (think staff, servers, machinery, etc.) grow, the money coming in will cover all your expenses and leave enough profit to keep your business flourishing.
Fundamental Pricing strategies
1. Cost-plus pricing
With cost-plus pricing, you define and sum up all the costs incurred for your product, including costs incurred during development, production and maintenance, then you add a markup percentage – your product’s desired profit margin – to get the final selling price.
Cost-plus pricing is a common method used by businesses such as manufacturing, construction, retails, and restaurants. However, its application is not limited to these industries but can be effectively implemented in a wide range of other sectors including SaaS, Cloud Service Providers (CSPs), etc.
Let’s look at an example: Everlane, an American clothing retail company founded in 2010. With each product, they show on their website the detailed cost breakdown, proving that they have implemented cost-plus pricing to set their price.
Pros:
- Straightforward and Easy to Implement: Cost-plus pricing is a clear and uncomplicated method. Businesses simply add a desired profit margin to their production costs to arrive at a selling price.
Cons:
- Limited Perspective: This method solely focuses on a company’s internal costs, neglecting crucial external factors like customer perceived value or how competitors set their price.
This downside can be addressed by combining cost-plus pricing with other methods, like competitive pricing. This creates a more comprehensive pricing strategy that takes both internal costs and external market forces into account.
2. Competitive pricing
Using competitive pricing means you follow competitors and change your price accordingly. Several common approaches to this method are:
- Co-operative: You match what your competitor is doing. A competitor’s one-dollar increase leads you to up your price by a dollar, and if they cut out two dollars, you do the same to maintain the status quo;
- Aggressive: You create a strong price differentiation by keeping your price the same when competitors increase theirs, or lowering your price even more than what competitors do.
A prime example of competitive pricing is Netflix vs. Disney+
- Disney+ had been steadily gaining subscribers, particularly attracting families with their lower priced ad-supported option at 8$/month (price in US);
- In May 2024, during their “Netflix Upfront 2024” presentation for advertisers, Netflix officially launched their ad-supported tier. This new tier price at just $6.99/month, offered a significantly lower price point compared to their ad-free plans, and lower than Disney+;
- Result: Netflix’s new ad-supported tier proved to be a success. By May 2024, it had already garnered over 40 million subscribers globally.
Pros:
- A Powerful First Impression: Pricing is often the first element that captures a customer’s attention, far outweighing features or support, which require time and experience to evaluate. Competitive pricing can effectively attract new customers and expand market share;
- Relative Simplicity of Implementation: Implementing competitive pricing is relatively straightforward. By researching competitor pricing, businesses can align their own pricing, reducing the risk of under- or overpricing.
Cons:
- The Pitfall of Price Wars: When competitive pricing becomes excessive, it can lead to destructive price wars, ultimately harming all involved parties.
- Overlooking Crucial Factors: Overemphasis on competitive pricing can lead to neglecting other critical aspects such as brand reputation, market positioning, and feature differentiation.
3. Price skimming
Price skimming is a pricing strategy where a business sets a high initial price for a new product or service and then gradually lowers the price over time.
Consumer technology industry is a textbook example of price skimming. Look at Apple: they typically launch their iPhones with a high initial price tag, targeting early adopters and those who value the latest technology and brand prestige. Over time, Apple lowers the price of older iPhone models as newer ones are released. This allows them to capture a broader market segment that might be more price sensitive.
Pros:
- Capture Early Market Value: A high initial price allows you to capitalize on strong launch excitement and limited competition, maximizing profits before the market cools;
- Premium Brand Image: Setting a high initial price can create a perception of superior quality and exclusivity for your product. This can lead to increased brand loyalty and potentially higher margins even after price reductions;
- Early Adopter Feedback: Price skimming attracts early adopters who are willing to pay a premium for the newest technology. These customers can provide valuable feedback that helps refine the product and inform future marketing strategies;
Cons:
- Accessibility Challenge: Not all companies have the resources or brand reputation to implement price skimming effectively;
- Competition Catalyst: High initial prices can attract competitors who jump in with comparable products at lower prices,eroding your market advantage;
- Justifying the premium price tag: Convincing customers to pay a premium requires crystal-clear communication and demonstration of the product’s unique value proposition, which might pose some challenges.
4. Penetration pricing
Penetration pricing is a pricing strategy where a business sets a low introductory price for a new product or service to achieve rapid market share growth.
Sony implemented this strategy back in 1994 when they joined the Gaming console industry. The original PlayStation launched that year at a significantly lower price (at around $399 USD) than its competitors the Sega Saturn (at around 449$) and the Nintendo 64. This aggressive pricing strategy helped Sony gain a substantial market share (by 2000, estimate over 60% of the global console market) and establish the PlayStation brand as a leader in the gaming industry.
Pros:
- Dominate the Market Quickly: A low introductory price acts like a magnet for new customers, allowing you to rapidly gain brand awareness and market share. This is especially beneficial for new businesses entering a competitive market;
- Gather Valuable Customer Insights: Penetration pricing can attract many early adopters. Their feedback can be invaluable in refining your product and developing future marketing strategies.
Cons:
- Price-Driven Loyalty: Customers attracted solely by the low price may not be loyal to your brand eventually. They might switch to competitors offering even lower prices.
- Value Perception Challenge: Low introductory prices can create the feeling that your product is less valuable than competitors’ offerings. This can make it difficult to raise prices later without losing customers.
5. Value-based pricing
Finally, value-based pricing. This is the strategy that focuses on the perceived value your product/service delivers to customers. The core concept of this is Higher Value, Higher Price, meaning:
- Products with a clear value proposition that solves customer problems or offers significant benefits can command a higher price point;
- Customers are more likely to be receptive to a premium price if they perceive a strong return on their investment;
A prime example of this pricing strategy is SaaS businesses implementing the “Freemium” business model. Companies like Dropbox, Grammarly, and Zoom offer a Free tier with simple features that address customers’ basic needs. The free tier also serves as a springboard for potential customers to experience the core value proposition of the product, encouraging them to upgrade to a Paid tier with more advanced features, support and benefits.
Pros:
- For customer: price is a better fit with the customer’s perspective;
- For your business: brings in higher profit, allowing you to acquire more resources and grow your business.
Cons:
- Subjectivity of Value: Quantifying customer value can be challenging. Extensive market research and customer surveys are often necessary to gain a deep understanding of what customers perceive as valuable in your product or service. This can be time-consuming and resource intensive.
- Differentiation Dilemma: Value-based pricing relies heavily on proving a clear differentiation from competitors. Companies with minimal product or service differentiation, particularly those competing primarily on price (e.g., commodity T-shirts), may find it difficult to justify a premium price through value-based pricing alone.
Additional points to keep in mind
1. B2B vs. B2C pricing strategies
There’s a significant difference between B2B and B2C pricing strategies. Here’s why:
- B2C: Due to high competition and price-sensitive customers, B2C companies often have thinner profit margins. They are likely to set their prices as low and competitive as possible to stand out from many other similar companies;
- B2B: A lot of B2B companies (especially Sales-led growth ones) tend to set their prices with a certain percentage of “buffer” over cost and profit, so that they can leverage it into exclusive discounts with each customer to create a special relationship, and eventually win deals.
2. Consult stakeholders in price setting
Even though price setting mostly falls into the Product Manager’s scope of responsibility, you’re likely to not have all the facts and input needed. Then, remember to consult other related departments for valuable insights:
- Sales & Marketing: Can provide information about customer needs, competitor pricing, willingness to pay, data on market trends, target audience preferences, and brand positioning;
- Finance & Accounting: Can help with cost analysis, profitability calculations, and financial forecasting.
Pricing is a continuous process, not a one-time decision. As your product evolves through its life cycle and market conditions change, be prepared to adapt and refine your pricing strategy based on these critical factors. Selecting the most effective approach is crucial, and it will evolve alongside your product.
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