There is a lot of complexity to the world of business. With a few notable exceptions, however, the vast majority of firms have the same simple aim. That is to make as much profit as possible and thus to grow and develop.
As any GCSE business studies student will tell you, a firm’s profits are what’s left of their turnover after taking away their costs. Cutting costs or increasing revenue are the best ways of improving profit.
A fundamental factor that impacts turnover is how much you charge for your products or services. How you price your offerings is affected by a variety of different factors.
They include things like the prevailing market conditions or the cost of resources and/or materials. Customers’ perceptions of the value of your products or services is also crucial.
The ways by which firms choose how to price their products or services are also diverse. If you’re looking to boost your profits, this is something you ought to pay close attention to. Revising your pricing model can help to get your bottom line looking much healthier.
What is a Pricing Model?
A pricing model is also sometimes known as a pricing strategy. It is the method by which businesses decide what prices to charge for their products or services.
The pricing model you use is crucial to the success of your firm. Adopting the wrong model will result in lost profits. You might scare customers away with high prices or operate on such thin margins you struggle to make a profit.
What pricing model a company may choose depends on an array of different factors
These can include things like:
- The industry in which the business operates
- Whether the firm provides products, services or a combination of both
- The perception customers have of the value provided by a company’s products or services
- How many competitors a business has. How strong they are and whether the firm holds any competitive advantages
- The company’s wider business strategy and what it is they are trying to achieve (market penetration, growth etc.)
There is no one ‘right’ pricing model, therefore. Each business’s unique circumstances determine which model might work best.
In some circumstances, you may even want to adopt more than one different model. That’s often true of firms that are diversified. One model may work well for one of your products but not so well for another
What you’re looking for, then, is the ideal model for you, rather than the ‘right’ model for everyone. This leads to the rather obvious question, when is a good time to revise your pricing model?
Revising Your Pricing Model
If your profits aren’t where you’d like them to be, you have a number of options. These boil down to measures you can take to either cut costs or boost revenue.
For the latter, you might look toward increasing customer numbers. Alternatively you may choose to focus on improving your margins on the business you already have.
There are lots of things you can do on both fronts. You might look to launch new, improved promotions. You could seek to enter a new market.
Revising your pricing model, however, might be your best bet. It’s one measure which can positively impact both customer numbers and margins.
Adopting the right pricing model is about setting the right prices. These should align with what customers are willing and able to pay. The cost shouldn’t don’t put off potential customers, but instead attract them from your rivals.
It should also ensure you have the healthiest margins possible. Whatever your products and services.
In order to find the pricing model which best suits your business, you need to know your options. That’s where this post comes in.
Pricing Model Alternatives
The following are a range of different pricing model options. Some will not suit your firm at all. Others might be the models that you already use. The hope is, though, that there may also be an alternative there which can help you to boost your profits.
Some of the following models are best suited to firms selling products. Others are better for service-based businesses.
In the same way, some will suit startups and others better established firms. As we run through each model, we’ll talk about which types of firms may be best served by adopting them. That’s alongside explaining how each model works.
This is the simplest and most traditional pricing model. It’s also known in various places as ‘cost plus pricing’. That’s because it’s pricing based on the cost of producing a product ‘plus’ a chosen markup to provide a profit margin.
Businesses using this model work out what it costs to produce each unit and what margin they want to make. That defines the prices they charge to consumers. The strategy doesn’t need extensive market research. That’s because it takes no other factors into account.
This model can be useful if you have no knowledge of what customers are willing to pay. It will give you a starting price point that you can then adapt as you move forward. It’s not efficient, however. Either in ensuring customer satisfaction or the best possible margins. This is more likely to be a pricing model that you may be looking to move away from.
The penetration model is a strategy best suited to start-ups or firms seeking to enter a new market. It involves setting prices at a low initial level in order to attract customer attention.
Those prices may damage or even remove entirely the company’s profit margin on a product. The main thing is that they must be lower than what well-established rivals are charging.
The penetration model is all about taking a long-term view. Firms adopt it in order to get an initial footing in a new market. They do so in the hope that they’ll later be able to raise prices and when they do benefit from a large customer base.
It is a risky model as a business has to be able to absorb the initial hit to their profits.
The factors most important to setting prices in a value-based model are customers’ interest in and perception of a product.
Value-based prices are set according to what customers are happy to pay. The aim is to create a feeling amongst customers that they are getting excellent value for money.
That makes this model ideal for improving customer opinion and developing brand loyalty. Both of those things can have a profound positive effect on profits in the long term.
The model, however, does need accurate, up-to-date customer insights at all times. It may also involve you charging less than you could possibly get away with.
The Premium model is the polar opposite to the value-based pricing model.
It involves setting prices deliberately high. That’s so as to present an image of luxury or exclusivity. Customers are essentially persuaded to desire your products because they’re more expensive.
This model is all about the concept of ‘perceived value’. You aren’t selling your product on price, you’re using a high price to convince customers of its value. This model is ideal for high-reputation businesses or firms in the tech or fashion niches.
This pricing model applies to businesses with multiple products and/or services.
It involves bundling some of those offerings together. They can then be sold as an overall package. The price of this package needs to be set. That price can and should be lower than what a customer would pay for if they purchased all the products individually.
The best bundles or portfolios are made up of products and services with varying mark-ups. Some should have small margins and others larger ones. This ensures that value perception will be higher in the eyes of your customer.
They will feel like they are getting more for their money. That’s without your overall margins suffering. This model is also ideal for selling old or less popular inventory.
The ‘Freemium’ model of pricing is a comparatively modern strategy. It’s a model reserved only for companies offering services, and is most often seen in the digital world. The idea behind the model, however, is quite simple.
Companies offer a basic version of their service for free. Any charges are introduced later. There is commonly a premium version of the service with more features. Hence the model’s name; ‘freemium’ = free + premium.
This model is most often employed by SaaS and other software companies. It can be very effective at generating a customer base but can be tough to profit from. Your premium service must differentiate itself from the free version. It has to be recognisably better.
The price for it, however, needs to be low enough so as not to represent too high a barrier to entry. That’s a tricky tightrope to walk for any business.