It is really difficult to choose the right price for your products, isn’t it?
If you had a crystal ball to help you know what price clients were willing to pay, everything would be easier.
But since that is not the case, you are going to need a well defined price strategy and policy. No need to worry about that. In this post we are going to explain everything you need to know on the topic.
Though there is no definitive method, knowing the main pricing strategies and seeing some examples about how to apply them will help you design your own plan.
This price setting guide for e-commerce has been thought up just for people like you.
What is pricing?
Before we start analyzing the different strategies, it is important to learn a few concepts in order to understand how pricing works.
A pricing strategy is about anticipating a consumer’s buying response for a said price in order to maximize the amount of money earned.
Let’s see the first concept: consumer surplus.
The difference between the price we charge and the price consumers would have been willing to pay is known as consumer surplus.
You need to clearly understand this idea because the main goal of a pricing strategy is to reduce that number as much as possible. This means that you will be charging the highest amount that the clients would pay.
The second theoretical concept that will help you set good prices is elasticity.
The price elasticity of demand measures the effect of a price change on the amount of products sold.
In a hypothetical case, if elasticity were 0, changing the price would not affect the demand.
This is impossible for an e-commerce shop because this would only happen with a necessity good and only if your shop was the only one selling that product.
You don’t need to calculate it with the exact formula. You just need to understand the idea and think about how your price changes affect the demand.
Remember the pricing goal: to charge what clients are willing to pay. As you can imagine, lots of strategies have been tested. These are just a few.
Types of pricing strategies
There is no magic formula for price setting; each sector and each product is different, just as demographic differences are.
However, surely one of these models will fit your e-commerce shop.
1. Setting prices according to your expenses
The oldest strategy in the book. It’s about calculating the costs, applying a profit margin, and setting the price for clients.
- It’s easy to figure out on paper: it’s based on addition and multiplication.
- It’s applicable to all products: and that is really convenient.
- It works independent of strategies: you don’t need to worry about playing with prices because of any other factors. Cost + profit margin and that’s it.
- Reality is normally different from what you plan: life normally has other plans, especially when talking about unexpected costs.
- It doesn’t take the client into account: this method doesn’t take into account what clients are willing to pay. Now that you know what consumer surplus is, you can see why this is a mistake, can’t you?
- It diminishes your products’ value: if the perceived value is high, a price set by costs could undervalue your product.
Of course you need to know your expenses, but you don’t have to base your prices on them.
You can understand this strategy by having a look at Apple’s selling prices.
When a new iPhone or iPad is launched, the price is super high. Only fanatics line up in front of the Apple Store to pay that amount on the first day.
After some time, the price of that model decreases, which allows other buyers to get the device at a lower price.
What does Apple get from this?
They charge each client segment the maximum amount that they are willing to pay.
When the iPhone X is $1000, only a few pay for it. However, when the price is $800 or $600, new buyers get in on it.
This strategy is known as skimming.
3. According to the value
A price policy which is much more reasonable and advisable has to do with setting the price according to the value that the product adds to the client.
It has nothing to do with the costs, but rather with the result or benefit that buyers gain after buying the product.
It’s the opposite of the costs strategy… you’ll see it with this example.
Think about a person whose job is to advise companies about power consumption. If their services save the company $2,000 each month on their power bill, how much do you think this person could charge for that?
Setting the price according to the costs wouldn’t make much sense in this case, would it?
A. Perceived value vs. economic value
In the previous example, the obtained value is translated into dollars saved, but this is not always the case.
Why does a locksmith charge up to $200 or $300 just to open your door on a weekend night?
The value for the client cannot be measured in money.
B. Knowledge value
There is a very famous story about an electrical engineer who was hired by Henry Ford in order to solve a problem in one of his factories.
We are talking about the beginning of the 20th century and this man charged $10,000 to repair an electric generator.
His job was to use chalk to mark the exact point at which the generator’s coil should be cut. His diagnosis was 100% correct, but after sending the $10,000 bill, Ford asked him to break down the costs. This is what was sent:
- Drawing the line: 1 USD
- Knowing where to draw it: 9,999 USD
Knowledge and experience come after years of effort and dedication. If you are very good in your sector, you have to charge accordingly for your services while always taking the perceived value by the client into account.
4. Dynamic prices
This is the differential pricing strategy typically used by airlines and hotels, although we are seeing it more and more in online shops.
It’s the opposite of fixed prices and it consists of changing the price according to the demand in real time. When a lot of people are buying, the price increases; if there is a lull, the price decreases.
These constant changes to prices lead to many companies hiring a revenue manager. The main task of that position is to determine the best price at every moment in order to maximize income.
This has also lead to average price being included as one of the most important metrics for any e-commerce.
5. Penetration pricing
This is commonly used during the first few months of any business, both online and offline. The goal is to get a spot in the market and help people get to know you with a very aggressive price policy.
By selling your products at prices lower than the market minimum, you attract clients and they can try your products.
The main problem is that this cannot go on for too long. There is no cash flow that can balance out selling for a price lower than the cost price.
Amazon used this method of entering the market and has been criticized and even punished in some countries. Its financial muscle allows them to sell with losses for a long time until they defeat their competitors, at which point they can control the market and then set prices however they want.
6. Psychological pricing
More than just a strategy, this is a way of setting prices to the make the most of the cognitive bias of the human mind.
Haven’t you realized that it seems to be almost compulsory to have every price end in 7 or 9? Does it really work to make prices end like that?
It looks like it does for Apple.
7. High or prestigious pricing
Do you remember price elasticity?
This strategy aims to take advantage of the high demand that some products have when they increase their prices.
A high price is normally linked to quality and exclusivity, and there will always be people willing to pay for that extra premium.
It is not exclusive of luxury brands—it can be combined with other strategies within an e-commerce shop, for example.
Through extra services or cross-selling, you can provide certain clients with the opportunity to get more expensive products.
Let’s see this in real time.
The 3 Prices
Does this ring a bell when it comes to online services?
This is also called the good, the bad, and the ugly.
The three prices are:
- One that is really low and cheap: it includes minimal services and the shop is not interested in selling this one compared to the other two.
- The good: highlighted in red because it is the one most likely to be sold.
- The expensive: it is there to make the good one look even better. It also skims the market by offering the option of a more expensive plan or product with extra exclusive services.
Can you think of a way of adding this strategy to your e-commerce shop?
Homework: now you have to think about your pricing strategy
Defining your e-commerce pricing is as difficult as it is important. Knowing your ideal client will help you, so make an effort to get to know their buying habits and their consumer profile.
Don’t forget to also keep this in mind:
- Take into account all the possible circumstances and have a plan B full of offers and promotions ready.
- Plan which products and when exactly you are going to increase or decrease your prices ahead of time.
- Keep an eye on your competitors.
- Be meticulous when calculating your costs before setting a price.
And, of course, value your brand and your products—if you don’t do it, nobody will!