How to Choose a Pricing Model: Strategies and Techniques

With so many pricing models to choose from, finding the right one for your product or service can be challenging. Choose the right model, and you could potentially unlock more revenue, market share, and customer satisfaction. But price your items incorrectly and you could damage your brand, ruin your profit margins, and create cash flow and operational issues.

In this article, we’ll give you pricing strategies, tips, and techniques to narrow down the pricing model possibilities and set your business up for success.

What you’ll learn:

What is a pricing model?

A pricing model is used to calculate the price for specific products or services. It helps you align an item’s price with your target market, the type of product or service, and your long-term business goals. Factors like production cost, customers’ perceived value of the product, and competitor pricing all play a significant part in determining the right price. Ultimately, the goal is to find the sweet spot between maximizing revenue and profits while offering a price that your customers are happy to pay.

Pricing models vs. pricing strategies

A pricing strategy is the overall approach a business takes to set prices for its products and services. Think of the pricing model as the “what” and the pricing strategy as the “how” behind the pricing.

Some pricing strategy examples include:

• Penetration pricing is used when a business launches a new product in a highly competitive market. This strategy sets lower prices to attract customers and help the company quickly scale, create buzz, and build market share.
• Price skimming sets a high initial price for a new product and then gradually lowers it over time. This signals to customers that a product is superior and creates demand among those willing to pay more for the perceived benefits.
• Competitive pricing is when a business sets its prices at or below the prices of its competitors. Using competitors’ pricing helps align prices with the market instead of focusing on production costs or consumer demand.

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Types of pricing models

Pricing models can range from simple to complex. It may depend on whether a business offers a single product or service for a fixed price or there are multiple elements to pricing, such as usage of a service. Both types of pricing models — cost-plus and value-based — provide straightforward ways to determine the sales price of a product or service.

• Cost-plus pricing, also known as markup pricing, is when a fixed percentage is added to the total production cost for one product unit, yielding its selling price. To set your selling price, add up your production costs. Then, determine your desired profit margin (or markup) and add that to the production cost. Here’s the formula: (Total Production Cost) × (1 + Desired Profit) = Selling Price
• Value-based pricing is based on the buyer’s perceived value of a product or service rather than just on its features. This pricing model emphasizes the benefits and positive outcomes a buyer gains from using the product and highlights how it can meet their needs and resolve their pain points. Value-based pricing can be a good option if you’re in an industry where quality and exclusivity add perceived value, such as luxury products or upscale cars.

Cost-plus pricing has the benefits of being very simple to calculate, and will protect your business’ margins at all times. However there’s a risk that the cost doesn’t correlate to customer value and you under-price (reducing revenue) or over-price (reducing number of sales). It’s best used in small-scale, commoditised or low-margin business environments such as trade supplies or professional services.

Value-based pricing allows you to maximize revenue based on customer-willingness-to-pay, but it can be more complex to calculate as it requires a true understanding of the customer and market. It’s best used in high-margin businesses and/or highly differentiated markets such as software, technology and luxury or custom goods.

There are several types of pricing models beyond the ones we have mentioned here.

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Advanced pricing models for your business to consider

One of the reasons why product pricing matters is that the right price can entice prospects and create a strong value proposition. Advanced pricing models provide several pricing options that can be tailored to a customer’s and business’s specific needs, including:

Subscription-based pricing

Subscription-based pricing is a pricing model where customers pay a recurring fee on a monthly or annual basis to access products and services. Rather than a one-time purchase, payments are made over time, which lowers the cost to entry and creates recurring revenue.

Example: A financial services firm offers its clients a subscription-based financial planning service where clients pay a monthly financial advisor fee.

Usage-based pricing

Usage-based pricing is a pricing model where customers pay according to how much they use a product or service. This allows customers to only pay when they are utilizing and gaining value from the product or service.

Example: A pay-as-you-go telephone company charges for its services by how many minutes, SMS messages and gigabytes of data the customer uses

Dynamic pricing

Dynamic pricing, also known as surge or demand pricing, is a pricing model in which businesses set flexible prices for their products or services based on changing market demands. Prices can be adjusted in real time based on demand, supply, competition, or customer behavior.

Example: A rideshare company raises its prices based on demand during busy times of the day, such as rush hour.

Price anchoring

Price anchoring, also known as ‘high-low pricing’ establishes an initial high starting price or nominal value (the “anchor”) for a product or service before offering it at a discounted price. The pricing model is meant to influence customers’ perceptions of a product’s value and make it look like an affordable option.

Example: An electronics retailer initially prices a laptop at $300 and then marks it down to $200. An in-store sign shows the original and the discounted price.

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Step-by-step guide to choosing a pricing model

Determining the right pricing model is crucial to influencing prospects’ and customers’ purchasing decisions. According to the Salesforce Small & Medium Business Trends Report, one of the top factors for evaluating new tech is price. Price your product or service too high and your customers may not be willing to pay for it. If the price is too low, it could make your business seem cheap or like the quality isn’t there. It’s all about finding that sweet spot!

We have found that approaching pricing models means considering model options with rationale, criticism, and questions. Here are the steps to choose a pricing model for your business:

1. Analyze your cost structure and evaluate competitor pricing

Your goal here is to narrow your pricing model options and determine whether your customers would pay more for your product or service by identifying where you have pricing power and where you’re struggling.

• Begin by analyzing your company’s current pricing structure based on price performance and value creation to understand your baseline starting point. Consider your production, labor, and materials costs.
• Look at buying signals such as usage patterns, purchase frequency, and if customers are heavily negotiating to lower a product’s price.
• Review your main competitors’ pricing and how it relates to your own pricing.
• Look at the market landscape and industry trends. Use an AI-powered customer relationship management (CRM) platform to automate your research and surface insights from real-time data.

Create a few scenarios for potential pricing models and analyze the pros and cons of each. Use the results to narrow it down to three potential pricing models.

2. Check if your business has the capabilities for implementation

Make sure your company can execute your three potential pricing models. Do this early in the process so you don’t get to the implementation stage and find out that you can’t execute the model. Consider these business capabilities:

• Timelines to ensure pricing models roll out in the right amount of time
• Infrastructure, such as buildings and office space, are a consideration if a pricing model means expanding into new market locations or increasing the amount of space for employees
• Technology abilities, such as software and hardware, to track and monitor pricing
• Production and manufacturing, such as machines and supply chains, since pricing may impact product demand and inventory
• Staffing and resources to determine if you need to recruit or train current employees

If you are not able to implement the pricing model options, you’ll either need to find the time and budget to grow your capabilities or swap out another pricing model option.

3. Conduct customer research

Gather research data from your customers to uncover how they perceive the value and price of your product or service based on your three potential models. There are two areas where you should conduct market research to understand your customer base:

• Customer interviews: Start with small groups or one-on-one interviews with your existing customer base. Questions should be open-ended and not inadvertently influence a customer’s response. Listen attentively and ask follow-up questions for clarity.
• Customer surveys: Next, conduct quantitative research with surveys given to a large group of customers. Use the responses from the customer interviews as the basis for the survey questions. The survey questions should be closed-ended like multiple choice, ranking, or rating on a scale. For example, provide five of the product benefits mentioned during the interviews and ask the survey respondents their willingness to pay for each.

You can also automate your customer research by using an AI-powered CRM to curate customer insights from sales activities or call summaries.

4. Select a pricing model

Analyze all of the information, including your customer research and insights, competitors’ pricing, and the market landscape, and examine how they might impact your three potential pricing model options. Consider these elements to guide your final decision:

• Zero in on the data about what customers will pay for and where they see value in your product or service.
• Explore how each pricing model aligns with your short- and long-term business goals and plans. Map out the likely profits from each pricing model based on customer input and market behavior.
• Consider the benefits and drawbacks of each pricing model on your revenue, profitability, and competition.

5. Implement and monitor

Implementing your chosen pricing model is not a one-and-done exercise. You must continually monitor it and adapt your pricing as needed based on market changes. These are pricing model areas to continually check on:

• Internal sales metrics and conversion rates, such as dips in profit or revenue, can be monitored with your CRM’s reports and dashboards
• Changes in competitors’ pricing, products, or services
• Changes in your customer base, such as by region or income
• Economic shifts, such as inflation or supply chain issues

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Tips and best practices for choosing your pricing model

Choosing the right pricing model depends on your industry, target market, and product or service. Here are some best practices to follow to ensure yours will resonate with your customers:

• Establish a pricing model point person. Pricing models should be an ongoing process, not a project that is given attention every few years. Appoint a person or team or create a system that is responsible for pricing and consistently monitors it.
• Don’t overcomplicate pricing. Keep your pricing model simple. Your sales team should easily understand your pricing model and be able to clearly communicate it to their prospects and customers. Otherwise, you risk confusing customers, which impacts their decision to buy your product.
• Explore hybrid pricing models. Consider combining pricing models if you have multiple products or services targeting different customers or industries. For example, some cloud computing businesses create a hybrid pricing model that combines subscription-based pricing, for access to the core product, and usage-based pricing, where a customer only pays for the products or services they use.
• Test your pricing model options. If you’ve narrowed down your pricing models to two top options, conduct A/B testing to evaluate the best one for your business. A/B testing is where you present two or more versions of your pricing model to determine which performs the best with customers. You can also try pilot testing or offer customers a trial.

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If the price is right, the future is bright

Implementing the right pricing model is one of the most important elements in a business’ growth because it directly impacts revenue and profitability. By following the steps we’ve outlined and conducting thorough analysis and research, you can narrow your options and identify your ideal pricing model. Continuously monitoring and adapting to market changes will set your business’ pricing model up for long-term success.