Creating the best pricing strategy is important for your clients and your business. Learn how to set fair and profitable prices for your services here.
Though small businesses are vital to the US economy, maintaining healthy revenue is one of the great challenges of being a small business owner. Companies with no employees bring in an average of just $47,000 a year in revenue, and 82% of failed businesses claim that cash flow was a primary determinant.
Of the many factors at play in a small business’s revenue potential, pricing strategy is one of the most critical.
Understanding the different pricing strategies and learning how to charge your clients fairly is essential for maximizing your revenue potential and building your client base. Hoist wants to show you how to do just that!
"Pricing strategy" is an all-encompassing term describing the many different ways small businesses establish prices for products or services.
Market conditions, account segments, input costs, trade margins, production costs, competitor behavior, consumer behavior, and many other metrics factor into pricing strategy.
While pricing strategies help companies maximize profit margins, there is more to them than that. Say, for instance, you want to keep your portion of the market share by providing your service at a low price. Doing so could keep your rivals from stealing some of your territories.
If that was your situation, you could prioritize competitive pricing and sacrifice profit margins in the process. However, any time you take this sort of action, understand that you must proceed with caution.
It may help your company in the short term, but it could spell bad news in the long run. Remember that your customers may stop purchasing your services if you price them too high, but your business cannot cover expensive expenses if prices are too low.
It's common for new businesses to offer services for free or at discounted rates in the early stages. This can be an excellent way to get the word out about your company and gain clients. However, you will need to start determining your fees and charging full price sooner than later. Otherwise, you'll have trouble turning a profit.
The goal is to set prices that are fair to your customers but profitable for your company. This can be more challenging than it seems on the surface. Each service business must figure out a strategy that works for it.
Retail stores come with a clear starting point for product pricing. For instance, say you have an item that costs $3 to manufacture, and the vendor sold it to you for $4. Simply factor in your markup, overhead, and profit margin, and you get your price.
Pricing your services isn't that simple.
Not only do you have to consider the variable labor costs with your employees, but each project could require unique materials. You must be able to give accurate job quotes to keep customers satisfied and maintain cash flow.
As one example, if you own a painting business and you show up at a house with a detached garage, you might have to bring extra paint to the job. Or, perhaps the customer wants you to finish the project faster than you normally would, requiring you to pay for additional labor.
Then, you must consider that material and labor costs change in the market, meaning you must adjust your service prices accordingly. In other words, now is the time to set fees, but you must remain adaptable and regularly reevaluate your rates so that you can modify them as needed.
As you start working on your pricing strategy, don't stress about the actual number you're charging. What's more important in determining the range your services fall within, such as whether you offer a $100 service or a $1,000 service.
Try not to spend too much time deciding whether to charge $320 or $330. The key in the early stages is to build a firm foundation. Here are a few tips to help you do just that:
Many factors go into a pricing strategy, but you will be in a good spot as long as you get your value metric. Essentially, your "value metric" is whatever you are charging for.
You could be charging per transaction, per seat, per visit, and so on. When you determine your value metric, it automatically helps you achieve lower churn and higher expansion revenue.
The Benefits of Value Metric Pricing
A value metric-based pricing strategy helps you avoid charging a small customer the same fee as a large customer.
You can miss out on a lot of revenue if you charge a flat monthly fee. Having a value metric provides you with infinite price points, which can minimize the gray area and maximize revenue potential.
Another advantage of using value metrics is that it bakes growth directly into your pricing strategy. The customer pays more as the amount of value or usage increases, and they pay less when they consume less, helping you avoid churning.
Companies using this strategy often grow twice as quickly with half the churn and double the expansion revenue compared to those that charge a flat fee.
Determining Your Value Metric is Simple
It might sound complicated but determining your value metric is relatively easy. All you have to do is figure out the ideal essence of value for your service. In other words, what value does a customer get when they purchase directly from your company?
If you run a B2B business, your value metric is probably time and money savings, operational efficiency, more revenue, etc. For DTC, such as a home services business, it will likely be the time and stress you save customers and the top-notch quality of work you provide.
Once you know your value metric, it's time to figure out your customer profiles and target segments. Developing customer personas is one thing, but when you quantify personas and segments, they can prove very valuable as you create your pricing strategy.
Use a spreadsheet and divide your targeted customer profiles into columns to create quantified personas. Detail is essential at this stage.
The more specific you are about who you're targeting and how you can monetize and retain them, the better. Instead of trying to be everything to all people (which is impossible), learn exactly who you're targeting to make better decisions.
Then, list each profile's characteristics in rows to clearly differentiate between them. Examples of characteristics could include most valued features, least valued features, customer acquisition costs, and lifetime value.
You may not have all the data necessary to make a comprehensive segmentation, but you should still fill out your spreadsheet with your current information. You can then start validating the data and adding more information as you learn more about your customers.
After you’ve found your value metric and created your profiles and segments, it's time to get tactical. You will need to research your customer segments and try different strategies.
This process never ends because the goal is to find an optimal framework for translating your value. Since so many factors can move the goalposts, you will constantly need to reassess and experiment with different approaches.
Many companies experiment with monetization each quarter. As long as you find a growth framework that works for your team, experimentation should be a relatively simple process every time you do it.
If your service-based business caters to clients with varying needs, you will benefit from using a value metric-based pricing strategy.
For instance, say you charge a flat fee for your painting services. You would minimize your revenue potential because you would have to perform more work and buy more supplies for specific jobs, cutting your profits.
Charging by the value you’re providing each customer helps you make a profit while maintaining fair rates.
Let's talk about some of the many strategies small businesses are using today:
Competition-based or "competitive" pricing revolves around matching or beating the rates charged by your competitors. If another local painter charges a specific amount for their services, this would mean that you charge a bit less or at least precisely the same rate. Or, it could mean that you offer more flexible payment terms or a combination of both.
Many new businesses choose the competitive pricing strategy because it can help with building a client base and start generating revenue. However, it doesn't leave as much room for growth as some of the other strategies.
Ideally, you will build a reputation for being the best at what you do, so you wouldn't have to worry about what other companies are charging.
Perhaps the most straightforward pricing strategy is cost-plus pricing.
With this model, you figure out your costs and add a markup. It is easy for most business owners to calculate, and it ensures you make a profit.
The only downside to this strategy is that the calculated price centers solely on your company's needs. The price does not consider competitors or whether your target customers will be willing or able to pay it.
Cost-plus pricing is primarily used by product-based businesses, but many agencies use them to charge for services as well.
Demand is what drives a dynamic pricing strategy. Unlike strategies that use a fixed price, dynamic pricing is flexible and adapts to the demand for a good or service. If there is high demand or low supply, the price increases, just as the price decreases if there is low demand or high supply.
You will see this strategy used often in the travel and hospitality industries. The closer you get to the date, you will notice less availability and higher prices for seats and hotel rooms. If you choose this pricing model, you will need to monitor the market frequently.
High-low pricing is widely used because it lets a company charge more for a new product and then sell it at a lower price through promotional campaigns. These campaigns often include discounts, seasonal deals, clearance sales, and other bargains. Ultimately, businesses use high-low pricing to boost revenue.
Retail businesses everywhere use this strategy to sell mass-market products. When consumers see a product selling for half the regular price, they are more likely to visit a store or make an impulse purchase. In this situation, customers have a powerful sense of urgency to purchase an item whether or not they really need it.
If you ever use this pricing strategy, it's paramount that you and your customers understand the relative price for each product (the average market price). You must charge significantly less than the competition.
As with any strategy, there are pros and cons to high-low pricing. For example, you can expect an increase in your total sales volume, translating to more revenue.
This pricing strategy can also enable you to sell low-demand goods, such as excess inventory, old stocks, and slow-moving products. Using web push notifications, chatbots, and email campaigns to promote your deal can organically drive more traffic to your website and positively impact your search rankings.
It's also important to consider the drawbacks of a high-low pricing strategy. Customers become privy to when specific companies run promotional campaigns. This results in customers waiting to purchase products until a deal is available, which is not something you want.
High-low pricing can also cause customers to question the quality of your products. If other businesses sell bad products, they may question the quality of your brand, too.
Many service-based companies employ an hourly pricing strategy. Essentially, it means charging by the hour.
Depending on your company's needs and the type of jobs you regularly encounter, this could be an excellent or a horrible strategy.
Say, for instance, that you have a much more labor-intensive project than a similar job that is less taxing but takes the same amount of time to complete. You will not make a fair profit by charging a flat hourly rate.
That's why many businesses combine this pricing strategy with others, such as cost-plus pricing. With that being said, an hourly pricing strategy is an easy and effective way to price your services when most of your jobs are similar in nature and requirements.
Businesses use price skimming to maximize sales of their new products or services. This is the strategy at work when you see high rates during the initial phase of a good or service. After that phase has run its course, the price gradually falls as similar products from competitors start to hit the market.
Price skimming is an excellent way to attract early adopters and new customers. The benefits are two-fold:
If you need to recoup your development costs, price skimming will help your small business do it.
Plus, it can help create an air of exclusivity and quality as your product first enters the marketplace. Technically, price skimming is a dynamic pricing strategy.
On the other end of the spectrum, small businesses use penetration pricing to attract buyers to new products and services through lower prices.
Charging less than your rivals as you first introduce a good or service can help it become more well-known.
For example, if a competitor is selling a specific product for $150, you would sell it for $140. You might take a minor hit on the sale, but it could help your business "penetrate" the market by drawing attention to your brand and away from others. It could also boost brand loyalty and even lead to long-term business from customers.
The biggest drawback of penetration pricing is that it can cause a significant loss of income upfront. If the loss is big enough, it can be difficult for your small business to overcome.
Nonetheless, if your business builds enough awareness through this pricing strategy, it can help set you apart from the crowd and drive more profits in the long run. Once the initial phase is over, your company can raise prices to match the market more closely.
If your business is offering a product or service that no other brand can compete with, you might consider the premium pricing strategy. With this model, you would establish higher costs because your offering is entirely unique.
Know, however, that you should only use this strategy if you are confident in your competitive advantage and are not worried about another product or service on the market undercutting your efforts.
Most customers need to know that any high-priced product is worth the investment, which means that you must work extra hard to demonstrate value. The product itself must be of the highest quality, but your company must also go the extra mile on the packaging, the marketing strategy driving the product, and any other factors that will support the premium price.
One of the best examples of premium pricing is Tesla. Since no other manufacturers are currently offering luxury autonomous cars, they can charge higher prices.
You typically see project-based pricing used in place of an hourly pricing strategy in service industries. Charging by the project is preferable to many customers because they know they are paying a specific fee for the desired service.
The caveat to using this strategy is that your business must know how to accurately predict how many hours each project will require. Otherwise, you will struggle to make a profit. However, if there is a project that takes less time than you planned, it could work in your favor.
Choosing the proper pricing strategy for your company is critical, but here are a few other ways to position your business for success:
Determine what you hope to achieve through your pricing. Maybe you want to capture a larger chunk of the market or hire more employees. Maybe you want to focus on distinguishing your brand as offering the highest quality products or services possible. Figure out what you want, and it will help you set your prices.
You need to understand your market if you hope to make your brand stand out.
Regularly research the competition and market trends to stay ahead of the game. You will likely need to make frequent adjustments to your strategies.
To reach your target customers, you’ll need to learn about them.
This doesn't mean personally knowing each and every one of your customers, but it does mean getting an idea of their behaviors and willingness to purchase.
Understand how your product or service provides value to your customers, and you will be able to develop a better pricing and marketing strategy.
You can learn a lot from your competitors.
Search the web for information about the competition to determine how they structure their businesses and handle pricing strategies.
For example, one company might offer multiple price points while another company bundles products together. Observing how they interact with customers and their level of success can help you make decisions going forward.
Talking about pricing strategy is one thing; seeing it in action is another.
Here are a few examples of successful companies who have figured out how to price their products and services:
Salesforce emerged as the only cloud-based CRM available on the market.
In fact, no one referred to it as "the cloud" at the time. The company targeted large enterprises and used a set of ground-breaking deployment strategies that put it in a powerful position to go about things differently. Eventually, it lowered prices to allow for smaller businesses to use its products and services (price skimming).
Dollar Shave Club found success through an aggressive marketing strategy that revolved around economy pricing.
The company took an unusual advertising approach considering the pricing model, and it led to significant results. More and more customers flocked to the cheap, high-quality, easy-to-get razors. Unilever acquired the business for $1 billion in 2016.
Netflix and other streaming services (e.g., Hulu, Disney+, Amazon Prime, etc.) engage in competitive pricing. They employ market-based pricing, which is why they all charge similar rates for their services.
Pricing your product or service is a critical small business operating decision. Consider the strategies and tips above as you develop a plan that moves your company in the right direction.
Check out Hoist for more small business advice or comprehensive assistance with getting your business off the ground.
Sources:
Small Business Revenue Statistics (2021): Annual Sales and Earnings | Fundera Ledger
Cost-Plus Pricing: What It Is & When to Use It | HubSpot
Price Skimming Definition | Investopedia
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