Also called: Price Strategy, Pricing Model, Price Structure, and Price Architecture
See also: Flat Rate, Leasing, Licensing, Pay Per Use, Pay What You Want, Subscription, Value Proposition Mapping, Captive Product Pricing
Relevant metrics: Customer Acquisition Cost, Customer Retention Rate, Average Order Value, Gross Margin, and Customer Lifetime Value
What is a Pricing Strategy?
Developing a Pricing strategy is the process of selecting the most appropriate price for a product or service. It involves analyzing the market, understanding customer needs and preferences, and assessing the competition. Pricing strategies can be used to increase sales, attract new customers, and increase profits. Common pricing strategies include cost-plus pricing, market-oriented pricing, value-based pricing, and promotional pricing.
“Price is what you pay. Value is what you get.” - Warren Buffett
Pricing has a direct impact on your company’s bottom line. It’s more than just a number; it’s a communication tool that conveys the value of your product. We’ll discuss the importance of strategic pricing for profitability, customer acquisition, and customer retention in the SaaS context.
How mastering an array of pricing strategies will help you
Mastering a wide range of pricing strategies will equip you with the necessary toolkit to maximize your product’s financial performance. Different strategies like freemium, tiered pricing, per-user pricing, and usage-based pricing, each serve distinct purposes and cater to diverse customer needs.
- A freemium model can drive user acquisition
- A tiered pricing model can facilitate upselling and customer retention.
Accurate and strategic pricing, backed by a solid understanding of the product’s value proposition and the customer’s willingness to pay, can boost revenue, profitability, and cash flow. This is why it’s essential that you align your product’s value delivery with its pricing, as this can directly influence conversion rates, churn rates, and customer lifetime value.
At the same time, a deep understanding of pricing strategies is vital for remaining competitive in a crowded marketplace. The right pricing strategy communicates the product’s value effectively to potential customers, distinguishing it from competitors. By frequently reviewing and revising pricing based on market trends, customer feedback, and competitive landscape, you can ensure that your offering remains appealing and competitive.
For example, a usage-based pricing model might make a product more attractive to small businesses than a competitor’s flat-rate model. In a market that’s increasingly product-led, having the flexibility to shift and adapt pricing strategies is a key factor in maintaining a competitive edge.
29 Pricing strategies, models, and tactics
As you venture into the digital product realm, the choice of pricing strategy can significantly impact your product’s market performance. Your decision should be shaped by your product nature, customer segments, and overall business goals. Here’s an overview of some core pricing strategies.
Pricing strategies are overarching methodologies that dictate the general approach to setting prices. They are informed by business objectives, market dynamics, competitive landscape, and consumer behavior, defining how you aim to position your product in the marketplace. Pricing strategies can include methods like penetration pricing, price skimming, or value-based pricing, providing a high-level plan that aligns with your business goals.
Pricing models, on the other hand, are the structural frameworks that determine how you charge for your product or service. They form the foundation upon which your pricing strategy is implemented. This could be a flat rate, usage-based, freemium, or any other system that dictates how the price is calculated and presented to the customer.
Pricing tactics are the specific actions and techniques you employ to implement your pricing strategy. They are generally more short-term and flexible, allowing you to react to changes in the market or consumer behavior. Pricing tactics can include offering discounts, creating bundle deals, or using psychological pricing approaches like charm pricing or decoy pricing.
Armed with an understanding of these concepts, let’s explore the various pricing strategies, models, and tactics that can be utilized in your product’s pricing framework.
Common Pricing strategies
Penetration Pricing
Price is set low to attract customers and gain market share, and then increased.
Penetration Pricing is an approach where you set an initially low price to attract customers and gain market share, with the intention of raising the price later. The focus of this strategy is rapid market entry, user adoption, and market share acquisition.
Also known as “market-penetration pricing” or “introductory pricing,” it’s often used in highly competitive markets or when launching a new product or service.
To apply this approach, start by setting a price that undercuts the competition. This low price serves to lure in customers and build your user base. Once you’ve acquired a significant user base or market share, gradually increase the price.
However, this strategy doesn’t take into account profitability in the short term. As you’re starting with low prices, there may be initial losses or low-profit margins.
Penetration Pricing is especially helpful when trying to introduce a new product or service, or when you’re entering a new market segment where the goal is to quickly gain customer attention and market share.
It might not be the best approach when your product or service is perceived as high-value or luxury, as the low price could dilute the perceived value. It’s also not suitable for niche markets with few customers who are willing to pay more.
What’s particularly interesting about this approach is the psychology behind it. Customers are often more willing to try a new product or service when the financial risk is low, and once they see the value in it, they’re usually willing to pay more.
It’s worth noting that executing a successful penetration pricing strategy requires careful planning, understanding of the market, and the financial stability to endure low profitability in the initial phase. It’s also crucial to communicate effectively to customers when and why prices will increase, to maintain trust and satisfaction.
Example
A new coffee shop in town sets their prices lower than their competitors to attract customers and gain market share. They offer a small coffee for $1.50, while their competitors charge $2.50 for the same size. After a few months, the coffee shop gains a loyal customer base and increases their prices to match their competitors. They now charge $2.50 for a small coffee, but their customers continue to come back because they appreciate the quality of the coffee and the atmosphere of the shop.
Price Skimming
Prices start high and are gradually reduced.
Price Skimming is a strategy where you initially set a high price for a new product or service, then gradually reduce it over time. The focus of this strategy is to maximize profits with early adopters before targeting the broader market at lower price points.
Alternate names for this strategy include “skimming pricing strategy” or “market skimming.”
To implement price skimming, you first launch the product or service at a high price, targeting customers who are willing to pay more for being the first to access it. Over time, as this segment becomes saturated, and as competition emerges, you reduce the price to attract a wider, more price-sensitive audience.
The strategy does not take into account that it could initially limit your market size to only those willing to pay a premium. Also, if not properly executed, it could alienate customers who feel they were overcharged at the launch.
Price skimming is particularly effective when your offering is innovative, has unique features, or when you’re first to market. It works well when customers perceive the high price as an indicator of superior quality.
On the flip side, it might not work well in highly competitive markets where similar products are readily available at lower prices. It’s also less effective when customers are highly price-sensitive or when there’s no clear added value justifying a high initial price.
An interesting aspect of price skimming is how it allows you to capitalize on market segments with different price sensitivities. You start with those willing to pay more, then progressively cater to those who are more price-conscious.
The success of a price skimming strategy relies heavily on the perceived value of your offering and the existence of different customer segments with varying willingness to pay. If not carefully managed, the reputation of your product or service could be at risk, especially if customers feel the initial high price was unjustified.
Example
A new smartphone is released with a starting price of $1,000. The company uses price skimming by targeting early adopters who are willing to pay a premium for the latest technology. As time goes on and competitors release similar products, the company gradually reduces the price to stay competitive. After six months, the price is reduced to $800, and after a year, it is reduced to $600. This approach allows the company to maximize profits in the early stages of the product’s life cycle while still capturing market share as the price becomes more affordable for the mass market.
Prestige Pricing
Prices are set higher to give a perception of luxury or superior quality.
Prestige Pricing is a strategy where prices are intentionally set higher to create a perception of luxury, exclusivity, or superior quality. The focus of this approach is to position the product or service as premium and desirable, appealing to customers who associate higher prices with higher value or status.
This strategy is also known as “premium pricing” or “image pricing.”
To apply prestige pricing, you establish a price point that exceeds the average market price, signaling to customers that your product or service is of superior quality or offers unique benefits. This can be achieved through premium branding, high-end packaging, exceptional customer service, or other elements that contribute to a perception of luxury.
Prestige pricing is particularly helpful when you have a product or service that offers distinct features or a unique value proposition that justifies the higher price. It is effective in markets where customers seek status, exclusivity, or associate higher prices with quality.
It may not be suitable in highly price-sensitive markets where customers prioritize cost over perceived prestige. It is also less effective if the product or service lacks the desired premium qualities or if competitors offer comparable alternatives at lower prices.
Customers often associate higher prices with higher quality or prestige, and they may derive a sense of status or satisfaction from purchasing premium products or services.
When implementing a prestige pricing strategy, it’s crucial to ensure that the product or service lives up to the perceived value. Failing to deliver on promised quality or exclusivity can damage the brand’s reputation. Additionally, effective marketing and branding efforts play a vital role in creating and maintaining the perception of prestige.
Example
A high-end fashion brand sets the price of a limited edition handbag at $10,000, even though the cost of production is only $500. The high price creates a perception of luxury and exclusivity, attracting wealthy customers who are willing to pay a premium for the brand’s superior quality and prestige.
Dynamic Pricing
Prices change based on demand, supply, or other factors.
Dynamic pricing is a strategy where prices are adjusted in real-time based on various factors such as demand, supply, customer behavior, competition, or market conditions. The focus of this approach is to optimize pricing to maximize revenue and adapt to changing market dynamics.
Dynamic pricing is also known as “real-time pricing,” “flexible pricing,” or “demand-based pricing.”
To apply dynamic pricing, you utilize data and algorithms to continuously monitor and analyze relevant factors that influence pricing. Based on this analysis, you can adjust prices up or down to align with market conditions. For example, prices may increase during peak demand periods or decrease during low-demand periods to stimulate sales.
Dynamic pricing does not take into account the fixed or marginal cost of the product or service, but primarily focuses on maximizing revenue and may not always align with cost-based pricing.
Dynamic pricing is particularly helpful in industries with fluctuating demand, perishable inventory, or where supply can be adjusted in real-time. It works well when there is sufficient data available to make accurate pricing decisions and when customers perceive value in the responsiveness of pricing to market conditions.
It may not be suitable in industries with stable or regulated pricing, where customers prefer price predictability, or where the cost of implementing dynamic pricing technology outweighs the potential benefits.
Dynamic pricing comes with the ability to capitalize on demand fluctuations and optimize revenue. It can enable businesses to respond to market changes quickly and competitively. Additionally, dynamic pricing strategies are commonly used in online marketplaces, travel and hospitality industries, ride-sharing services, and ticketing platforms.
Implementing dynamic pricing requires sophisticated data analysis, pricing algorithms, and technology infrastructure. It also demands a careful balance to avoid pricing that is perceived as unfair or manipulative by customers. Transparency and effective communication around pricing changes are crucial to maintain customer trust.
Example
A hotel chain uses dynamic pricing to adjust room rates based on demand and supply. During peak seasons or events, the hotel increases its room rates to maximize revenue. For example, during a music festival in the city, the hotel increases its room rates by 30% to take advantage of the high demand for accommodations. On the other hand, during low seasons or weekdays, the hotel lowers its room rates to attract more customers and fill up empty rooms. For instance, on a Tuesday night, the hotel reduces its room rates by 20% to encourage more bookings. By using dynamic pricing, the hotel can optimize its revenue and occupancy rates.
Price Discrimination
Different prices are set for different customer segments.
Price discrimination is a strategy where different prices are set for different customer segments based on their willingness to pay, characteristics, or purchasing behaviors. The focus of this approach is to extract maximum revenue by tailoring prices to different customer groups.
Price discrimination can also be referred to as “market segmentation pricing” or “customer-based pricing.”
To apply price discrimination, you need to identify different customer segments and their distinct pricing sensitivities. You then set prices for each segment accordingly, taking into account factors such as their perceived value, purchasing power, price elasticity, or demographic characteristics.
Price discrimination does not take into account the potential ethical implications of charging different prices to different customers for the same product or service. It also assumes that customers within each segment do not have perfect information about the different prices being offered.
Price discrimination is particularly helpful in markets where customer segments have different price sensitivities or when certain customer groups are willing to pay more due to higher perceived value or unique needs. It allows businesses to capture additional value from customers who are willing to pay a higher price, without leaving money on the table from those who are more price-sensitive.
This strategy should not be used in contexts where transparency and fairness are paramount, or where price discrimination could harm customer relationships or lead to negative brand perception.
Price discrimination plays on the economic principle of capturing consumer surplus, where businesses aim to extract more value from customers who are willing to pay a higher price while still capturing the market share of price-sensitive customers.
Example
A fitness center offers different membership prices for different customer segments. For example, they may offer a discounted rate for students, a lower rate for seniors, and a higher rate for corporate memberships. This pricing strategy allows the fitness center to attract a wider range of customers and maximize revenue from each segment. For instance, a student may not be able to afford the full membership price, but they can afford the discounted rate, which still generates revenue for the fitness center. Similarly, a corporate membership may be more expensive, but it provides additional benefits and generates more revenue for the fitness center.
Loss Leader Strategy
Some products are sold at a loss to attract customers who will then buy other, more profitable products.
The Loss Leader Strategy is an approach where certain products or services are intentionally sold at a loss or with minimal profit margins to attract customers. The focus of this strategy is to entice customers with enticing deals or low prices on specific items, with the expectation that they will purchase other, more profitable products or services.
Alternate names for this strategy include “razor-and-blades strategy” or “bait pricing.”
To apply the loss leader strategy, you select specific products or services that have high customer appeal or are popular in the market. These products are then priced at a level where the profit margin is intentionally minimal or negative. The goal is to capture customers’ attention and incentivize them to make additional purchases of complementary or higher-margin products.
The loss leader strategy alone does not take into account the potential risks of not being able to recoup losses from the sale of other products or the potential for customers to solely purchase the loss leader item without additional purchases. It assumes that the increased traffic and customer loyalty generated by the strategy will compensate for any initial losses incurred.
The loss leader strategy is particularly helpful when the business has a wide range of products or services to offer, and there is a strong cross-sell or upsell potential. It can also be effective in competitive markets, where attracting new customers is essential for market share growth.
However, it should not be used when the business operates in a niche market with a limited product line, as there may be insufficient opportunities for customers to make additional purchases. Additionally, if not executed carefully, the strategy may lead to long-term negative profitability and erode the brand’s value perception.
The attractive pricing of the loss leader product creates a perception of value and encourages customers to explore other offerings from the same brand. This approach leverages the principle of reciprocity, where customers feel compelled to reciprocate after receiving a perceived benefit.
Before applying a loss leader strategy, you should carefully analyze the profitability of complementary products, closely monitor customer buying patterns, and effectively communicate the value of the entire product range. Additionally, strong customer relationship management and ongoing marketing efforts are crucial to capitalize on the initial customer acquisition and drive subsequent sales.
Example
A grocery store sells a gallon of milk for $2, which is below their cost of production. However, they know that customers who come in for the cheap milk will also buy other items at a higher profit margin, such as bread, eggs, and cheese. By using the loss leader strategy, the grocery store is able to attract more customers and increase overall sales revenue.
High-Low Pricing
Prices are reduced from a higher initial price, making customers feel they’re getting a deal.
High-Low Pricing is a strategy where prices are initially set at a higher level and then reduced to create a perception of offering a deal or discount. The focus of this approach is to attract customers by leveraging the contrast between the higher initial price and the subsequent reduced price.
The contrast between the higher initial price and the subsequent discount triggers a perception of value and a sense of urgency to take advantage of the limited-time offer. Customers feel they are getting a special deal or exclusive opportunity.
Alternate names for this strategy include “promotional pricing,” “discount pricing,” or “price skimming and discounting.”
To apply high-low pricing, businesses first establish a higher price point for their products or services. Then, they periodically offer discounts, promotions, or limited-time offers to lower the price and create a sense of urgency or value for customers.
This strategy does not take into account customers who may feel frustrated or misled if they discover that the higher initial price was not truly representative of the product’s value. It also assumes that customers perceive the discounted price as a genuine deal.
High-Low Pricing is particularly helpful in creating excitement and encouraging immediate purchases. It can be effective in retail environments or during specific promotional periods where customers are more price-sensitive and motivated by perceived savings.
This strategy may not be suitable in cases where customers have easy access to price comparisons or when the initial higher price significantly exceeds the perceived value of the product or service. It should also be used judiciously to avoid eroding the brand’s value perception or training customers to wait for discounts before making a purchase.
Implementing high-low pricing requires careful planning of promotional campaigns, effective communication of the initial higher price to justify the discount, and monitoring customer response to optimize the timing and frequency of discount offers. Pricing should be adjusted strategically to balance the perceived value and maintain profitability.
The strategy can be a powerful tool to create excitement, drive customer traffic, and stimulate purchases. When used thoughtfully, it can effectively influence customer behavior and generate short-term revenue boosts.
Example
A clothing store initially prices a winter coat at $300, but after a few weeks, they reduce the price to $200. This makes customers feel like they are getting a good deal and encourages them to make the purchase.
Geographical Pricing
Prices are set based on location, considering factors like transportation costs, market conditions, etc.
Geographical Pricing is a strategy where prices are set based on the location or geographic region in which the product or service is sold. The focus of this approach is to account for variations in transportation costs, market conditions, and other factors that differ across different geographic areas.
Alternate names for this strategy include “location-based pricing,” “zone pricing,” or “regional pricing.”
To apply geographical pricing, businesses analyze various factors such as transportation costs, taxes, market demand, competitive landscape, and local purchasing power specific to each geographic region. Based on this analysis, they determine different price points for different locations to optimize profitability and competitiveness.
Geographical pricing does not take into account potential customer perceptions of unfairness or price discrepancies between different regions. It assumes that customers understand and accept pricing variations based on the cost and market conditions specific to each location.
Geographical pricing is particularly helpful when there are significant cost differences in transporting the product or service to different regions, or when market conditions, such as demand or competition, vary across locations. It allows businesses to account for these factors and adjust prices accordingly.
The strategy may not be suitable in situations where customers can easily compare prices across regions or when price variations are not justified by significant cost or market differences. It should also be used carefully to avoid negative customer reactions or negative impact on brand reputation.
Geographical pricing aligns pricing with local market conditions and cost structures, reflecting the economic realities of each location. It allows businesses to adapt their pricing strategy to maximize competitiveness and profitability in specific regions, but requires effective communication and transparency to help customers understand the rationale behind the pricing variations.
It’s worth noting that with the rise of e-commerce and global markets, customers can easily compare prices across regions, potentially leading to customer dissatisfaction if significant price differences exist without clear justifications.
Example
A company that sells organic food products online uses geographical pricing to set their prices. They charge $5 for a bag of organic apples in their home state of California, but charge $7 for the same bag of apples in New York due to higher transportation costs and market conditions. Similarly, they charge $6 for the same bag of apples in Texas, where the market is more competitive and transportation costs are lower. This allows the company to remain competitive in different markets while still maintaining profitability.
Common Pricing models
Cost-Plus Pricing
Price is derived from the cost of production plus a markup.
Cost-plus pricing is a straightforward pricing strategy where you calculate the cost of producing your product, including both direct and indirect costs, and add a markup to establish the final price. This markup is often expressed as a percentage of the cost and represents the profit margin you aim to achieve.
Also known as markup pricing or cost-based pricing, this approach is focused on covering your costs and ensuring a consistent profit margin. It’s commonly used because it’s simple to calculate and ensures profitability on each sale, provided you can sell all units produced.
To apply cost-plus pricing, you’ll first need to accurately calculate your total cost of production. This includes both fixed and variable costs, such as development costs, maintenance costs, labor, overheads, and any other costs associated with the product. Once you’ve determined this, you choose the percentage of profit you want to make, and add it to the cost.
Cost-plus pricing does not take into account market demand, competition, customer perception of value, or variations in value between different features or services. Because of this, there’s a risk of either overpricing, if your costs are high compared to the market, or underpricing, if your costs are low and customers would be willing to pay more for the value they receive.
This approach is particularly helpful in situations where the market is less price sensitive, where there’s less competition, or where it’s important to cover costs and ensure a predictable profit. It’s also often used in B2B contexts where it’s common to add a standard profit margin onto costs.
However, it’s not generally recommended in highly competitive markets, where price sensitivity is high, or where the perceived value to the customer is significantly different from the cost of production. It also may not be suitable for products with a high development cost but low production cost, as the high price may deter customers.
One interesting aspect of cost-plus pricing is that it can be more easily justified to customers if they question the price. You can explain that the price is based on the cost of providing the service plus a reasonable profit margin. However, care should be taken with this, as customers are typically more interested in the value they receive than the costs you incur.
Ultimately, while cost-plus pricing is a simple approach that can be useful in certain situations, it’s important to consider other factors like customer value and market conditions when setting your prices. Combining cost-plus pricing with other pricing strategies can often lead to more balanced and effective pricing
Example
A company that produces and sells handmade candles uses cost-plus pricing to determine the price of their products. The cost of production for each candle is $2, and they add a markup of 50% to cover overhead costs and generate profit. Therefore, the price of each candle is $3. This pricing strategy ensures that the company covers their costs and generates a profit while remaining competitive in the market.
Value-Based Pricing
Pricing based on the perceived value of the product to the customer.
Value-based pricing is a strategy that sets prices primarily, but not exclusively, according to the estimated or perceived value of a product or service to the customer rather than according to the cost of the product or historical prices. The focus of this approach is customer-centric, aiming to match the price you charge with the perceived value of your product in the customer’s eyes.
This strategy is also known as value-optimized pricing, customer-focused pricing, or perceived-value pricing.
In practice, to implement value-based pricing, you need to understand what your customers value and what they’re willing to pay for it. This could be through market research, customer interviews, surveys, or by analyzing usage data to understand which features or aspects of your service customers find most valuable. It’s important to continually revisit this, as customer perceptions can change over time.
Value-based pricing doesn’t consider your costs in determining pricing, so there’s a risk that if your costs are high, you might not cover them, especially if customer perceived value is lower than your costs. It also requires a deep understanding of your customers, which can be complex and time-consuming to acquire.
This pricing approach can be particularly effective when your product or service is differentiated from competitors and offers unique value, when you have a deep understanding of your customers’ needs and values, and when those customers are less price sensitive.
However, value-based pricing might not be the best approach in highly price-sensitive markets, where your product is similar to competitors’, or where you don’t have a clear understanding of your customers’ perceived value.
An interesting aspect of value-based pricing is that it incentivizes companies to constantly innovate and improve their offerings, as increased value to the customer can lead to higher prices. It aligns the interests of the company and its customers, as both benefit from increasing the value delivered.
While value-based pricing can be a powerful strategy, it should be combined with a good understanding of your costs and the market conditions to ensure profitability and competitiveness.
Example
A company that sells a project management software may use value-based pricing to determine the cost of their product. They may conduct market research to determine the perceived value of their software to their target customers. Let’s say they find that their software saves their customers an average of 10 hours per week and that their customers value their time at $50 per hour. This means that the perceived value of the software is $500 per week. The company may then set their pricing at $400 per week, which is lower than the perceived value but still high enough to generate a profit. This pricing strategy ensures that the customer feels they are getting a good deal while the company is still able to make a profit.
Competitive Pricing
Pricing based on what competitors charge.
Competitive pricing is a strategy that involves setting prices based on what competitors in the market are charging. The primary focus is on the external market environment, specifically on the price points established by your competition.
This approach is also referred to as market-oriented pricing or competition-based pricing.
Applying this strategy involves an ongoing process of monitoring competitor prices and adjusting your prices in response. This could be setting your price at the same level as competitors, slightly lower for a cost advantage, or slightly higher to signal superior quality. A key aspect is to ensure that, when comparing prices, you’re also comparing the features, benefits, and overall value of what’s being offered.
Competitive pricing does not directly take into account your own costs or the specific value your product provides to customers. Therefore, there’s a risk of underpricing if your costs are high or overpricing if your value proposition isn’t as strong as that of competitors.
This strategy can be particularly effective in markets where products are fairly similar, where customers are highly price sensitive, and where there’s a high level of price transparency, making it easy for customers to compare prices.
However, competitive pricing is less effective where products are differentiated, where customers are less price sensitive, or where you have a unique value proposition that customers are willing to pay a premium for.
An interesting aspect of competitive pricing is that it can lead to pricing wars, where competitors continually undercut each other’s prices. This can be damaging to profitability in the long run and may not be sustainable. It’s therefore important to ensure that competitive pricing is balanced with an understanding of your costs and the value you offer.
Overall, while competitive pricing can be a useful tool in certain market conditions, it’s important to use it as part of a broader pricing strategy that also considers costs and customer value.
Example
Let’s say you are a company that sells a popular productivity tool. You notice that your main competitor charges $10 per month for their basic plan. In order to remain competitive, you decide to price your basic plan at $9.99 per month. This way, potential customers who are comparing your tool to your competitor’s will see that you offer a similar product at a slightly lower price point. This competitive pricing strategy can help attract new customers and retain existing ones who may be considering switching to your competitor.
Freemium
Basic services are free, while premium features/services come at a cost.
The freemium approach is a popular pricing model that offers a basic version of a service for free, while charging for access to premium features or services. The focus of this approach is on acquiring users by reducing the barrier to entry, then converting them into paying customers by demonstrating value and incentivizing upgrades.
This model is also known as the “free-plus-premium” or “free-to-play” model.
To apply the freemium model, you should first clearly define which features or services will be available for free and which will be part of the premium offering. The free version should be functional and valuable in its own right to attract users, but the premium version should offer sufficient additional value to justify an upgrade. You’ll also need to communicate this value proposition clearly to users.
The freemium model does not take into account the cost of providing the free service. If the conversion rate to the premium version is low, it can result in high costs without sufficient revenue. It also requires careful balance to ensure the free offering is not so comprehensive that users see little value in upgrading.
Freemium is particularly useful when your product is digital or has low incremental costs, when there’s a large potential user base, when network effects are present (i.e., the product becomes more valuable as more people use it), and when there’s potential for a high customer lifetime value that justifies the initial cost of providing a free service.
However, the freemium model might not be suitable in markets with a smaller user base, where the cost of providing a free service is high, or where there’s a risk of devaluing the product by offering too much for free.
One of the intriguing aspects of the freemium model is how it plays on psychology. By offering something for free, it lowers the perceived risk and encourages users to try the product. Once users are engaged and see the value in the product, they’re more likely to pay for additional features.
While the freemium model can be an effective way to grow a user base and convert users into paying customers, it’s important to carefully consider the balance between the free and premium offerings, and to closely monitor costs and conversion rates.
Example
A popular example of the freemium pricing strategy is Dropbox. The basic version of Dropbox is free and allows users to store up to 2GB of data. However, if users want to store more data, they need to upgrade to a premium plan, which starts at $9.99 per month for 2TB of storage. This approach has helped Dropbox attract a large user base and convert a significant portion of them into paying customers.
Captive Pricing
Basic product is priced low while necessary ancillary products are priced higher.
Captive pricing is a strategy where the basic product is priced low or competitively, while necessary ancillary products, upgrades, or services are priced higher. The focus of this approach is to attract customers with the low cost of entry, then generate revenue from the subsequent necessary purchases or add-ons.
This strategy might also be referred to as the razor and blades model or the printer and ink model, referencing classic examples of this approach.
To implement captive pricing, you would offer a primary product at a low price or even at a loss, while ensuring that this product requires regular, ongoing purchases of complementary products or services. These ancillary items should be priced with a higher margin to compensate for the low or loss-making price of the primary product.
Captive pricing doesn’t take into account customers who only need or want the basic product and won’t need many (or any) ancillaries. There’s a risk that the revenue from the ancillary products won’t cover the low or loss-making price of the primary product.
This strategy can be particularly effective when the product requires consistent replenishment or renewals (like subscription add-ons or replaceable parts), when there’s a high switching cost for the customer, or when customers derive high value from the ancillary products.
However, captive pricing might not work as effectively in markets where ancillary products or services can be easily sourced from third-party providers, or where there’s a high level of competition in pricing for these ancillaries.
A particularly interesting aspect of captive pricing is how it can foster customer loyalty and create a more predictable, recurring revenue stream. However, customers may feel ‘trapped’ if they weren’t aware of the full costs upfront, so transparency is crucial.
When utilizing a captive pricing strategy, it’s important to strike a balance between an attractive entry price for the primary product and ensuring profitability through the sale of ancillary items. A solid understanding of your customers’ needs and usage patterns can help make this strategy a success.
Example
A company that sells printers may offer a basic printer model for $50, but charge $100 for replacement ink cartridges and $150 for a maintenance kit. This captive pricing strategy encourages customers to purchase the basic printer at a low cost, but then become locked in to purchasing the higher-priced ancillary products in order to continue using the printer.
Economy Pricing
Prices are set low to attract price-sensitive customers.
Economy pricing is a strategy in which prices are set low to attract price-sensitive customers. The focus of this approach is the cost-conscious customer who is primarily driven by price when making purchase decisions.
This strategy might also be known as cost-based pricing, low-cost pricing, or budget pricing.
To implement economy pricing, you need to have a keen eye on your cost structures. The goal is to minimize costs wherever possible to enable you to set low prices and still maintain profitability. This often involves operational efficiency, economies of scale, and a minimal approach to features and services.
Economy pricing doesn’t account for customers who are seeking premium or differentiated features or services. By offering a basic, low-cost product, you might not appeal to customers who value higher-end or unique offerings.
This pricing strategy can be particularly effective in highly competitive markets with price-sensitive customers, when your product or service has few differentiating factors, or when you can achieve cost advantages through scale or efficiency.
However, economy pricing might not be as effective in markets where customers value quality, features, or brand over price, or where costs cannot be reduced sufficiently to maintain profitability at low price points.
An intriguing aspect of economy pricing is that, while it targets cost-conscious customers, it can potentially attract a broad range of customers due to its sheer affordability. However, maintaining profitability can be challenging, and there is the risk of devaluing the product or brand in the eyes of some customers.
In using an economy pricing strategy, it’s crucial to maintain cost efficiencies and monitor market conditions and competitor pricing closely to ensure profitability and market positioning.
Example
A local grocery store sets the price of their store-brand canned vegetables at $0.50 per can, which is significantly lower than the national brand canned vegetables priced at $1.00 per can. This economy pricing strategy attracts price-sensitive customers who are looking for a good deal on their groceries.
Flat Rate Pricing
One price for unlimited usage.
Flat rate pricing is a pricing model where customers pay a single fixed fee for unlimited access to a product or service. The focus of this model is simplicity and predictability, offering customers unrestricted usage for a known cost.
This model may also be referred to as “all-you-can-eat pricing”, “unlimited pricing”, or “fixed pricing”.
To implement flat rate pricing, you should offer a product or service that can be used extensively without additional costs to you. This model relies on the assumption that, while some customers will use the product or service heavily, others will use it less, balancing out the cost.
Flat rate pricing does not take into account variations in customer usage. For heavy users, this model provides exceptional value, but for light users, it may seem costly compared to pay-per-use models.
This pricing model can be particularly effective when your product has low incremental costs, when usage is difficult to meter, or when customers appreciate the simplicity and predictability of a single price.
However, flat rate pricing may not be suitable when usage varies widely among customers, when heavy usage could strain resources, or when your cost structure depends on usage levels.
An interesting aspect of flat rate pricing is its simplicity and attractiveness to customers who value predictability in costs. However, it can lead to overuse or “freeloading” by some customers, potentially straining resources or leading to degradation in service quality.
When implementing a flat rate pricing strategy, it’s crucial to monitor usage patterns and ensure that the flat rate covers your costs while still providing value to the majority of your customers. It may be beneficial to combine this model with other pricing options to cater to different customer segments.
Example
A gym membership that charges a flat rate of $50 per month for unlimited access to all facilities and classes. Customers can use the gym as much as they want without any additional fees or charges. This pricing strategy encourages customers to use the gym more frequently and get the most value out of their membership.
Tiered Pricing
Different packages with varying levels of features are provided at different prices.
Tiered pricing is a strategy where multiple packages with varying levels of features or services are offered at different price points. The primary focus of this strategy is to cater to a wide variety of customers with different needs and budgets, giving them the flexibility to choose the level of service that best suits them.
This strategy is sometimes also referred to as “package pricing” or “multi-tier pricing.”
To implement tiered pricing, you need to identify different customer segments and their varying needs. You would then create different packages of features or services to cater to these needs and price them accordingly. The key here is to ensure each package provides incremental value, justifying the higher price to the customer.
One thing tiered pricing doesn’t account for is customers whose needs don’t fit neatly into one of your predefined tiers. These customers may feel they’re either paying too much for features they don’t need or not getting enough from a lower tier.
Tiered pricing can be particularly useful when your product has a broad customer base with varying needs and budgets, when there’s a high customer lifetime value that justifies the upfront effort of creating and managing multiple tiers, and when upselling and cross-selling opportunities exist.
However, it might not be suitable in markets with a homogenous customer base where the same features and services suit all, or where the complexity of managing multiple packages outweighs the benefits.
One interesting aspect of tiered pricing is that it can guide customers to spend more by demonstrating the additional value they could get from a higher-priced package. However, the tiers need to be carefully structured to ensure customers see the value in higher-priced packages and aren’t just defaulting to the lowest-priced option.
When utilizing a tiered pricing strategy, understanding your customer segments and their needs, communicating the value of each tier effectively, and managing the complexity of multiple packages are key.
Example
A fitness app offers three different packages to its users: Basic, Premium, and Elite. The Basic package includes access to basic workout plans and tracking features for $9.99 per month. The Premium package includes access to more advanced workout plans, personalized coaching, and nutrition tracking for $19.99 per month. The Elite package includes all of the features of the Premium package, plus access to exclusive workout classes and personalized meal plans for $29.99 per month. This tiered pricing strategy allows the fitness app to cater to different types of users with varying needs and budgets.
Bundle Pricing
A set of products are sold together at a lower price than if sold separately.
Bundle pricing is a pricing strategy where a group of products or services are sold together at a lower price than if the customer were to purchase each item separately. The central focus of this approach is to enhance perceived value and encourage customers to buy more products or services together.
This strategy can also be referred to as “product bundling”, “package deal”, or “combined pricing”.
To apply bundle pricing, you need to identify products or services that complement each other or are often bought together. Once these are grouped, offer them as a bundle at a slightly discounted price compared to the total individual prices. The value perception of the bundle should be greater than the sum of the individual items.
Bundle pricing doesn’t consider customers who are only interested in one or a few items in the bundle. These customers might feel forced to pay for things they don’t need or want.
This strategy can be highly effective when customers value the convenience and value proposition of a bundle, when you have complementary products or services that enhance each other’s value, or when you want to move excess inventory or increase uptake of less popular items.
However, bundle pricing might not be as effective when your products or services don’t naturally fit together, when customers prefer to choose individually, or when the discounted price of the bundle significantly erodes your margins.
An interesting aspect of bundle pricing is its ability to expose customers to additional products or services they might not have considered, potentially increasing their engagement and satisfaction. However, there’s a risk of devaluing individual products or services, as customers might expect to always receive a discount when buying multiple items.
When using a bundle pricing strategy, it’s essential to carefully select which items to bundle together to maximize perceived value and ensure profitability, while also considering your customers’ needs and preferences.
Example
A company that sells a bundle of software tools for project management, including a task tracker, a team communication tool, and a time tracker. Individually, each tool costs $50 per month, but the company offers a bundle of all three tools for $120 per month, providing a discount of $30 per month. This bundle pricing strategy encourages customers to purchase all three tools together, increasing the company’s revenue and customer retention.
Usage-Based Pricing
Customers pay according to how much they use.
Usage-based pricing is a pricing model where customers pay according to their use of a product or service. The focus of this model is on fairness and flexibility, as customers only pay for what they actually use.
Alternate names for this approach include “pay per use”, “pay-as-you-go pricing,” “consumption-based pricing,” or “metered pricing.”
To implement usage-based pricing, you need a reliable way to track customer usage. This could be through metering, monitoring, or a tracking system. Once usage is recorded, customers are billed accordingly. This model requires clear communication around pricing tiers or rate structures, so customers understand what they’re paying for.
This approach does not take into account customers who value predictability in pricing. For some, the variable cost may be off-putting, as they would prefer to know upfront what their expense will be.
Usage-based pricing can be particularly useful in situations where usage varies significantly among customers, when usage is easy to track and measure, or when the product or service has low fixed costs and high variable costs.
However, it may not be the best choice when usage is challenging to measure accurately, when usage doesn’t correlate with the value that customers get, or when high fixed costs need to be covered.
An interesting aspect of usage-based pricing is that it aligns the value a customer gets with the price they pay, which can lead to high customer satisfaction. However, it may introduce unpredictability in revenue as customer usage can fluctuate.
Implementing a usage-based pricing model requires careful consideration of cost structures, value perception, and your ability to track usage accurately. If done right, it can lead to a high-value proposition for customers and profitable revenue streams.
Example
A ride-sharing company charges customers based on the distance traveled and time spent in the car. For example, a customer who travels 10 miles and spends 30 minutes in the car would be charged $15, while a customer who travels 5 miles and spends 15 minutes in the car would be charged $7.50. This usage-based pricing model allows the company to charge customers based on the value they receive from the service, while also incentivizing customers to use the service more frequently.
Per Feature Pricing
Different features have individual prices. Customers pay for what they need.
Per Feature Pricing is a pricing model that assigns individual prices to different features of a product or service. The focus of this approach is to provide maximum flexibility and customization to the customer, allowing them to pay only for the features they need.
This approach is also referred to as “a la carte pricing” or “feature-based pricing.”
To apply per feature pricing, you need to identify distinct features of your product or service that can be unbundled and used independently. Each of these features is then priced individually, and customers can choose and pay for only those they need.
This model doesn’t account for customers who prefer simplicity and can get overwhelmed by too many choices. These customers might find it difficult to understand the value of individual features and decide what they need.
Per feature pricing can be particularly effective when your product or service has numerous features that can be used independently, when there is significant variance in feature usage across your customer base, or when customers value customization and flexibility.
However, it might not be suitable when your product’s features are interconnected and can’t be used independently, when customers prefer bundled packages, or when managing and communicating a large number of individual features becomes too complex.
One interesting aspect of per feature pricing is its potential to capture value from all types of customers – those who want just a few features and those who want many. However, it’s crucial to balance the desire for revenue maximization with a clear and understandable offer to customers. Too many choices can lead to decision paralysis, reducing conversion rates.
When implementing a per feature pricing strategy, understanding your customers’ needs and usage patterns, articulating the value of individual features effectively, and managing complexity are essential.
Example
A graphic design software company offers a range of features such as vector editing, photo editing, and typography tools. The company charges $10 per month for access to the vector editing feature, $8 per month for photo editing, and $5 per month for typography tools. Customers can choose to pay for only the features they need, resulting in a customized pricing plan. For example, a customer who only needs access to the typography tools would pay $5 per month, while a customer who needs access to all three features would pay $23 per month.
Per User & Per Active User Pricing
Customers pay per user or active user.
Per User and Per Active User Pricing are models where customers pay based on the number of users or active users of a product or service. The focus here is to tie pricing directly to the scale of usage, making it especially applicable to products or services that gain value through multiple users.
These approaches are also known as “per seat pricing,” “license-based pricing,” or “per active member pricing.”
To apply these models, you need to track the number of users or active users. A user could be anyone who has access to the product or service, while an active user is someone who is actively using the product or service. Customers are then billed based on these counts, often on a monthly or yearly basis.
Per User or Per Active User Pricing are particularly effective when the product or service is designed for collaboration or when each user gets independent value from the product. It aligns well with the growth of the customer’s business or team.
However, these models might not be ideal when user activity fluctuates greatly or when the product or service is used collectively and adding more users doesn’t increase the cost or value significantly.
An interesting aspect of Per User and Per Active User Pricing is the predictable revenue stream they provide. The more the customer’s team grows, the more revenue you generate. However, this can sometimes discourage customers from adding new users, limiting the spread and usage of the product within their organization.
Implementing a Per User or Per Active User Pricing model requires careful consideration of user activity, potential growth within the customer organization, and the value provided to individual users. Balancing the price per user with the perceived value will be key to the success of this pricing model.
Example
A company that provides project management software charges $10 per user per month. They have 100 customers, with an average of 10 users per customer. This means they have 1,000 total users. However, not all users are active every month. They track active users and charge based on that number. In a given month, they have 800 active users. This means they generate $8,000 in revenue for that month.
Subscription Pricing
Customers pay a recurring fee to access the product or service.
Subscription Pricing is a model where customers pay a recurring fee, typically monthly or annually, to access a product or service. This approach focuses on customer retention and recurring revenue. It promotes a long-term relationship with the customer, leading to predictable income and customer loyalty.
Alternate names include “recurring billing,” “membership pricing,” or “retainer pricing.”
Implementing subscription pricing involves deciding on the frequency and price of the subscription fee. You would also need to determine what features, benefits, or services are included in the subscription. Payments are usually automated, which means you’ll need a reliable and secure billing system.
However, this approach does not take into account customers who prefer one-time purchases or are hesitant to commit to recurring payments. It also requires constant value delivery to justify the recurring cost.
Subscription pricing is particularly helpful when your product or service offers continuous value over time, when you can provide frequent updates or regular new content, or when your customers value convenience and uninterrupted access.
It might not be the best choice when the product or service is transactional by nature, when the value proposition doesn’t justify a recurring cost, or when customers prefer ownership over access.
A fascinating aspect of subscription pricing is its potential to generate a steady and predictable stream of revenue. It also aligns well with the shift towards a “subscription economy,” where customers are increasingly comfortable paying for ongoing access instead of outright ownership. However, to sustain this model, you need to continuously deliver value and ensure high customer satisfaction levels to reduce churn.
While implementing a subscription pricing model, customer lifetime value, retention strategies, and regular value delivery are key considerations. If well-executed, this model can drive long-term customer relationships and stable revenue.
Example
A gym membership that costs $50 per month for unlimited access to the gym and its equipment. Customers pay a recurring fee to access the gym and its services, and can cancel or renew their subscription at any time.
Common pricing tactics
Free Trial Pricing
Customers get to use the product free for a limited time.
Free Trial Pricing is an approach where customers are given the opportunity to use a product or service free of charge for a limited period of time. The focus of this strategy is to allow potential customers to experience the value and benefits of the offering firsthand before committing to a purchase.
By offering a free trial, businesses tap into the principle of reciprocity, where customers feel a sense of obligation to reciprocate the favor by converting to a paid subscription or purchase. It also allows businesses to showcase their product’s features, functionality, and user experience, potentially leading to higher conversion rates.
Alternate names for this approach include “trial period pricing,” “try-before-you-buy pricing,” or “freemium trial.”
To apply free trial pricing, businesses offer a time-limited version of their product or service with restricted features or access. Customers can sign up and use the product for a specific duration without any monetary commitment. At the end of the trial period, customers are given the option to convert to a paid subscription or purchase the full version of the product.
Free trial pricing does not take into account the potential costs associated with acquiring and supporting trial users, as well as the risk of customers who take advantage of the free trial without converting to paid customers.
Free trial pricing is particularly helpful in building trust, reducing customer hesitation, and allowing potential customers to assess the value and suitability of the product or service. It is commonly used in industries where customers benefit from experiencing the product firsthand, such as software, online services, or digital platforms.
However, it may not be suitable in cases where the product or service has a steep learning curve or requires significant time or effort investment from the customer during the trial period. Additionally, if the trial version does not provide a sufficient representation of the product’s value, it may fail to convert trial users into paying customers.
A shorter trial period may create a sense of urgency, while a longer trial period allows users to thoroughly evaluate the product. It’s also essential to have a clear and seamless conversion process in place to maximize the chances of turning trial users into paying customers.
Example
A company offering a project management tool provides a 14-day free trial for new users. During the trial period, users have access to all features and functionalities of the tool. After the trial period ends, users are prompted to upgrade to a paid subscription to continue using the tool. The company has found that this approach has increased their conversion rates and overall revenue.
Price Anchoring
A reference price is established, making the actual price seem more attractive.
Price Anchoring is a strategy where a reference price is established to influence customers’ perception of the actual price, making it appear more attractive by comparison. The focus of this approach is to leverage the power of cognitive bias to anchor customers’ expectations and influence their willingness to pay.
Price anchoring plays on the cognitive bias known as “anchoring and adjustment.” When customers are presented with a higher reference price, their perception of the actual price is influenced by this anchor, often leading them to perceive the discounted price as more favorable.
This strategy is also known as “anchored pricing,” “reference pricing,” or “contrast pricing.”
To apply price anchoring, businesses establish a higher-priced reference point, often through the display of the original or “list” price alongside the actual discounted price. The presence of the higher reference price creates a psychological anchor, leading customers to perceive the discounted price as a better deal or value proposition.
Price anchoring does not take into account customers who may perceive the reference price as misleading or artificially inflated. It assumes that customers will use the reference price as a benchmark for evaluating the attractiveness of the actual price.
Price anchoring is particularly helpful in creating a perception of value and incentivizing customers to make a purchase by highlighting the discount or savings they receive. It is commonly used in retail environments, e-commerce platforms, and during sales events to influence purchase decisions.
However, it may not be suitable in contexts where customers are well-informed about market prices or when the reference price is perceived as unrealistic or inflated. It should also be used ethically and transparently to avoid misleading customers or damaging the brand’s reputation.
Consider factors such as the choice of reference price, the magnitude of the discount, and the perceived value of the product or service. It’s important to strike a balance between creating a perception of value and ensuring transparency and fairness in pricing practices.
It’s worth noting that the effectiveness of price anchoring can vary depending on customer demographics, market conditions, and the perceived value of the product or service. Continual monitoring and experimentation may be necessary to optimize the impact of price anchoring on customer behavior.
Example
A clothing store sets the price of a new jacket at $200, but also displays a similar jacket from last season at $300. This makes the new jacket seem like a better deal in comparison, even though it is still a relatively high price.
Charm Pricing
Prices are set just below a round number (like $9.99 instead of $10).
Charm Pricing is a strategy where prices are set just below a round number, typically by a small amount, to create a perception of a lower price. The focus of this approach is to leverage customers’ psychological tendencies to perceive prices as more favorable when they are slightly below a whole number.
Charm pricing plays on the psychological phenomenon known as the “left-digit effect.” Customers tend to focus more on the leftmost digit of a price and perceive it as the significant factor in evaluating the price’s attractiveness. Thus, setting a price just below a whole number can lead to a substantial difference in perceived value.
Charm Pricing is also known as “psychological pricing,” “magic pricing,” or “odd pricing.”
To apply charm pricing, businesses intentionally set prices at values such as $9.99, $19.99, or $99.95 instead of rounding up to the nearest whole number. The small difference between the rounded-up price and the charm price is meant to create the perception of a significant discount or value proposition.
Charm pricing does not take into account the potential skepticism or consumer awareness of this pricing tactic. It assumes that customers perceive the charm price as significantly lower than the rounded-up price, even though the difference may be minimal.
Charm pricing is particularly helpful in creating an illusion of lower prices and enticing customers to make a purchase by triggering the perception of a bargain. It is widely used in retail, e-commerce, and various consumer-facing industries to influence consumer decision-making.
However, charm pricing may not be as effective in contexts where customers are price-savvy or when the price difference between the rounded-up price and the charm price is perceived as insignificant. It should also be used with caution in premium or luxury markets where customers may associate higher prices with higher quality.
Experimentation and A/B testing may be necessary to determine the optimal charm price that resonates with the target audience.
Charm pricing should not be the sole pricing strategy employed. Other factors such as the perceived value, competitive positioning, and customer satisfaction should also be taken into account to ensure a comprehensive pricing strategy.
Charm pricing is a widely used psychological pricing tactic that takes advantage of customers’ cognitive biases. When applied strategically and ethically, it can create a perception of lower prices and influence customer behavior. However, businesses should consider the context, industry, and target audience to effectively leverage charm pricing as part of a holistic pricing strategy.
Example
A clothing retailer sets the price of a t-shirt at $19.99 instead of $20. This pricing strategy is used to make the price seem more affordable and attractive to customers, even though the difference is only one cent. This approach is commonly used in retail and e-commerce industries.
Odd-Even Pricing
Prices are set at odd or even numbers to appear more appealing.
Odd prices are often associated with discounts, while even prices are associated with stability and roundedness.
Odd-Even Pricing is a strategy where prices are intentionally set at odd or even numbers to create a psychological appeal and influence customers’ perception of the price. The focus of this approach is to leverage customers’ preference for certain numbers and their perception of value based on number characteristics.
Odd-Even Pricing is also known as “psychological pricing,” “numerical pricing,” or “rounded pricing.”
To apply odd-even pricing, businesses choose whether to set prices at odd numbers (e.g., $9.99, $19.95) or even numbers (e.g., $10.00, $20.00) based on the desired effect. Odd prices are often used to convey a perception of discount or value, while even prices are used to convey stability and quality.
Odd-even pricing does not take into account customers who may be skeptical of this pricing tactic or have varying cultural or personal associations with numbers. It assumes that customers perceive odd or even prices as more appealing or reasonable based on their cognitive biases.
Odd-even pricing is particularly helpful in creating a perception of value, encouraging purchases, and reducing the price sensitivity of customers. It is commonly used in retail, e-commerce, and various consumer-driven industries to influence consumer decision-making.
However, the effectiveness of odd-even pricing can vary depending on cultural differences, market conditions, and the overall value proposition of the product or service. It may not be as effective in contexts where customers are highly price-sensitive or where the product’s quality or features are the primary purchase drivers.
Experimentation and A/B testing may be necessary to determine the optimal pricing strategy based on the target audience and market dynamics. Odd-even pricing should be used as part of a comprehensive pricing strategy, considering other elements such as perceived value, competitor pricing, and customer segmentation. You should be mindful of cultural nuances and individual customer preferences when employing this approach.
Example
A clothing store sets the price of a shirt at $29 instead of $30 to make it appear more affordable and appealing to customers.
Decoy Pricing
An additional pricing option is used to make the others seem more attractive.
Decoy Pricing is a strategy where an additional pricing option, known as the “decoy,” is introduced to influence customers’ decision-making by making other pricing options appear more attractive in comparison. The focus of this approach is to guide customers towards a specific desired choice by manipulating their perception of value and the relative attractiveness of different pricing options.
Decoy pricing plays on the cognitive bias known as the “decoy effect” or the “compromise effect.” The presence of the decoy option influences customers to perceive the other options as more attractive in comparison, creating a perception of value and nudging customers towards a particular choice.
To apply decoy pricing, businesses strategically introduce a third pricing option that is intentionally designed to be less appealing in terms of value or features compared to the other available options. By creating a less attractive decoy option, customers are more likely to be drawn towards the other options that the business wants to promote.
Decoy pricing does not take into account customers who may perceive the presence of a decoy as manipulative or misleading. It assumes that customers will make decisions based on the perceived value relative to the other options available, rather than evaluating each option independently.
Decoy pricing is particularly helpful in influencing customer preferences and driving them towards the desired choice. It can be effective in various industries and contexts where businesses want to steer customers towards specific products or pricing tiers.
Decoy pricing may not be as effective in contexts where customers are highly price-sensitive or have a strong aversion to perceived manipulation. It should be used with caution to avoid negative customer reactions or damage to the brand’s reputation.
When implementing decoy pricing, businesses should carefully design the characteristics of the decoy option, such as pricing, features, or bundle configurations, to ensure it serves its purpose of influencing customer decisions. A thorough understanding of customer preferences and willingness to pay is crucial for selecting an appropriate decoy.
Decoy pricing should be used ethically and transparently. Customers should be able to make informed decisions based on the true value and benefits offered by each pricing option.
Example
A coffee shop offers three sizes of coffee: small for $2, medium for $3, and large for $4. To implement decoy pricing, they add a fourth size, extra-large, for $5. This makes the large size seem like a better deal in comparison, and customers are more likely to choose it. The coffee shop sees an increase in sales of the large size and overall revenue.
Center Stage Effect
The middle option in a tiered pricing strategy is emphasized as it’s often chosen more.
Customers tend to view the middle option as a balanced compromise between the extremes. This effect taps into customers’ desire for a reasonable value proposition and can lead to increased conversions for the middle-tier option.
The Center Stage Effect is a pricing strategy where the middle option in a tiered pricing structure is intentionally emphasized to increase its appeal and likelihood of selection. The focus of this approach is to leverage customers’ tendency to gravitate towards the middle option when presented with a range of choices.
To apply the Center Stage Effect, businesses create a tiered pricing structure with multiple options, typically consisting of a basic, middle, and premium tier. The middle option is strategically highlighted, given more prominence in terms of visual presentation, positioning, or additional features. This intentional emphasis draws customers’ attention to the middle option, increasing the likelihood of its selection.
The Center Stage Effect does not take into account customers who may have different preferences or needs that align better with the lower or higher-priced options. It assumes that customers will perceive the middle option as a balanced choice, offering reasonable value and features.
The Center Stage Effect is particularly helpful in guiding customer decision-making and influencing them towards the desired pricing tier or option. It can be effective in various industries and contexts where businesses want to steer customers towards a specific price point while still offering other alternatives.
However, the Center Stage Effect may not be as effective if customers have clear preferences for either the lower or higher-priced options, or if the middle option does not align well with customer needs or expectations. It should be used thoughtfully and supported by a thorough understanding of the target audience.
When implementing the Center Stage Effect, businesses should consider factors such as pricing differences, feature differentiations, and customer preferences. A careful balance needs to be struck between emphasizing the middle option and ensuring that all pricing tiers offer clear value and benefits.
The Center Stage Effect should be used as part of a holistic pricing strategy, considering other elements such as market competition, customer segmentation, and overall product value proposition. As such, it is a strategic pricing tactic to influence customer choices by emphasizing the middle option in a tiered pricing structure. When applied effectively and aligned with customer preferences, it can drive customers towards the desired pricing tier and optimize conversion rates. However, businesses should be mindful of customer needs and market dynamics to effectively leverage this approach.
Example
A company selling a subscription-based meal delivery service offers three pricing tiers: Basic, Standard, and Premium. The Basic plan costs $10 per meal, the Standard plan costs $12 per meal, and the Premium plan costs $15 per meal. The Center Stage Effect is applied by emphasizing the Standard plan as the most popular option, with 60% of customers choosing it. This is highlighted on the pricing page with a larger font and a different color. As a result, more customers are likely to choose the Standard plan, increasing the company’s revenue.
Discount Pricing
Temporary reduction in price to increase sales, usually for a limited period.
Discount pricing has an ability to create a sense of urgency and excitement among customers. The limited-time nature of the discounts taps into customers’ fear of missing out (FOMO) and can generate increased demand.
Discount Pricing is a strategy where prices are temporarily reduced to stimulate sales and incentivize customer purchases. The focus of this approach is to create a sense of urgency and value for customers by offering a lower price than the regular or original price.
Discount Pricing is also known as “sale pricing,” “promotional pricing,” or “price markdowns.”
To apply discount pricing, businesses offer temporary price reductions on their products or services for a limited period. This can be done through various methods, such as percentage discounts, buy-one-get-one (BOGO) offers, bundle deals, or seasonal promotions.
Discount pricing does not take into account customers who may perceive regular or higher prices as inflated or misleading. It assumes that customers will be enticed by the lower price and motivated to make a purchase based on the perceived savings or value.
Discount pricing is particularly helpful in driving short-term sales, attracting price-sensitive customers, and clearing out excess inventory. It is commonly used during promotional periods, seasonal sales, or to coincide with specific events or holidays.
However, discount pricing may not be as effective in contexts where customers are price-insensitive or have a perception that discounted products or services are of lower quality. It should not be relied upon as the sole pricing strategy, as it may erode brand value if used excessively or without careful consideration.
When implementing discount pricing, businesses should consider factors such as profit margins, customer segments, and competitive landscape. Careful planning and analysis of pricing elasticity and customer behavior can help determine the most effective discount strategy.
The main challenge of this tactic is striking a balance between offering attractive discounts and maintaining profitability. Excessive discounting can erode profit margins and potentially devalue the product or service in the eyes of customers.
Example
A clothing store offers a 20% discount on all items for a weekend sale. The regular price of a shirt is $50, but with the discount, it is now $40. This temporary reduction in price is meant to increase sales during the limited period of the weekend sale. Customers are more likely to make a purchase when they see a discount, and the store hopes to attract more customers and increase revenue during the sale.
Examples
Amazon
Amazon has a dynamic pricing strategy that changes prices based on customer demand. This strategy allows Amazon to maximize profits by charging different prices for different customers. For example, Amazon may charge a higher price for a product during peak demand periods, such as the holiday season.
Apple
Apple uses a premium pricing strategy, which involves setting high prices for its products. This strategy allows Apple to maintain its brand image as a luxury product provider. Apple also uses a skimming pricing strategy, which involves setting high prices for its newest products and gradually lowering them as the products become more widely available.
Walmart
Walmart uses a cost-plus pricing strategy, which involves setting prices based on the cost of the product plus a markup. This strategy allows Walmart to remain competitive in the market while still making a profit. Walmart also uses a penetration pricing strategy, which involves setting low prices to attract customers and increase market share.
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What is the goal of the pricing strategy?
Hint The goal of the pricing strategy is to maximize profits while still providing value to customers. -
What is the target market for the pricing strategy?
Hint The target market for the pricing strategy will depend on the product or service being offered. -
What is the competitive landscape?
Hint The competitive landscape will involve researching competitors' pricing strategies and understanding the market dynamics. -
What are the costs associated with the pricing strategy?
Hint The costs associated with the pricing strategy will depend on the product or service being offered, but may include research and development costs, marketing costs, and production costs. -
What are the potential risks associated with the pricing strategy?
Hint The potential risks associated with the pricing strategy include pricing too high and losing customers, pricing too low and not making a profit, and not being able to adjust to changing market conditions. -
How will the pricing strategy affect customer loyalty?
Hint The pricing strategy can affect customer loyalty by providing value to customers and creating a sense of loyalty to the brand. -
How will the pricing strategy affect profitability?
Hint The pricing strategy can affect profitability by increasing sales and reducing costs. -
What are the potential long-term implications of the pricing strategy?
Hint The potential long-term implications of the pricing strategy include creating a competitive advantage, increasing customer loyalty, and creating a sustainable pricing model.
You might also be interested in reading up on:
- Scott Stratten @unmarketing
- Jay Baer @jaybaer
- Joe Pulizzi @JoePulizzi
- Ann Handley @MarketingProfs
- Chris Brogan @ChrisBrogan
- Pricing: Making Profitable Decisions by Philip Kotler (2011)
- Pricing Power: A Practical Guide to Pricing Strategy by Simon-Kucher & Partners (2017)
- Hidden Champions of the 21st Century: Success Strategies of Unknown World Market Leaders by Hermann Simon (2006)
- The 1% Windfall: How Successful Companies Use Price to Profit and Grow by Rafi Mohammed (2011)
- The Strategy and Tactics of Pricing: A Guide to Growing More Profitably by Thomas T. Nagle and Reed K. Holden (2013)
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