Pricing policy: Example and pricing strategies to develop your business

Understanding Pricing Strategy Fundamentals

Price Elasticity of Demand: Measuring the Impact of Price Changes

While it's difficult for most businesses to study, you need to understand this concept to begin thinking about your pricing strategy.

Price elasticity of demand is an economic concept that measures how sensitive demand is to changes in a product or service's price. It's generally negative, meaning that when prices increase, demand decreases. However, the magnitude of this variation depends on numerous factors, such as product uniqueness, the presence of substitute products, and the consumer's level of need for the product.

Price elasticity of demand is calculated by dividing the rate of demand change by the rate of price change. If elasticity is greater than 1 (in absolute value), demand is considered elastic, meaning a 1% price variation causes more than 1% demand variation. If elasticity is less than 1 (in absolute value), demand is inelastic: a 1% price variation causes less than 1% demand variation.

For example, if demand for a product is inelastic, a company could increase its prices without fearing a significant drop in demand, thus increasing revenue. Conversely, if demand is elastic, a price increase could lead to a substantial decrease in demand, reducing revenue.

Market Segmentation and Its Influence on Pricing Strategy

Market segmentation is a strategic approach that involves dividing a market into homogeneous subgroups of consumers with similar characteristics and purchasing behaviors. This segmentation directly influences product or service pricing.

Based on segmentation, a company can choose to offer different prices for each segment. For example, an airline might offer higher rates for business travelers (who often book last minute) and lower rates for leisure travelers (who generally book in advance).

Market segmentation can also influence the company's pricing strategy. For instance, if a segment is very price-sensitive, a company might adopt a penetration strategy (low prices to gain market share) or a skimming strategy (high prices to maximize margins).

Finally, market segmentation can help identify differentiated pricing opportunities. For example, a company might offer higher prices to a segment with strong purchasing power or lower prices to a more price-sensitive segment.

In all cases, a good understanding of each segment is essential for defining appropriate pricing and optimizing company revenue and margins.

Generally, differentiated pricing by segment also implies a differentiated product or service by segment.

Analyzing Customer Perceived Value: How to Evaluate and Use It for Pricing

Evaluating customer perceived value is a crucial step in setting fair prices. This value is based on the consumer's perception of a product or service's advantages and benefits. Product quality, convenience, competitive advantages, and brand reputation are key factors in this evaluation.

To measure this perceived value, you can directly survey your customers, use polls and questionnaires, or analyze their purchasing behavior. These methods will allow you to gather valuable information about what your customers really think of your products and services.

Once this perceived value is identified, it can guide your pricing strategy. If perceived value is high, you can implement a higher pricing strategy, thus increasing your margins. Conversely, if perceived value is low, you'll need to work on improving your product or service, or revise your communication strategy to increase this value perception.

It's also crucial to understand that value perceptions can vary from one market segment to another. Therefore, a differentiated pricing approach may be necessary to meet different customer groups' expectations.

Finally, remember that perceived value is a dynamic concept that can evolve over time. That's why it's essential to regularly conduct evaluations to adjust your pricing strategy accordingly.

What Pricing Strategies Can You Use?

Main Pricing Strategies: Skimming, Penetration, Alignment, Premium

Skimming, penetration, alignment, and premium strategy are the four main pricing strategies.

• Skimming involves setting a higher price than competitors when launching a product. This strategy targets a segment of consumers willing to pay more to get the product before others, thus maximizing company margins.

• Penetration strategy consists of offering a price below competitors to capture significant market share.

• Alignment strategy involves setting a price similar to competitors. It's often used when the proposed product or service is similar to competitors' with limited differentiation possibilities (commodity markets, for example).

• Finally, premium strategy involves setting a high price to position the product as high quality, often associated with a strong brand image. This strategy allows the best margins but requires the most investment in marketing.

These are fairly generic strategies to guide you at the beginning of your thinking. Then you can refine with the following approaches.

The Cost-Plus Approach: Starting from Your Costs

The cost-plus approach, also called cost markup, is a pricing strategy that involves determining a product or service's selling price by adding a fixed profit margin to the total production cost.

Implementing this strategy is relatively simple:

• First, it's necessary to determine the product's production cost. This includes direct costs (raw materials, labor) and indirect costs (overhead, depreciation).

• Then, a profit margin is added to this production cost to obtain the selling price. This margin can be expressed as a percentage of production cost.

This approach is often used for its simplicity and transparency. It ensures minimum profitability on each sale but doesn't account for customer perceived value or competitor pricing (unless margin calculation is based on competitor standards).

It's often used in manufacturing industries.

Dynamic and Personalized Pricing Strategies: Starting from Your Customers or Market Conditions

Dynamic and personalized pricing strategies are two sophisticated mechanisms for adjusting prices in real-time based on various factors. Dynamic pricing relies on constant price adjustment based on market demand, market conditions, or contextual factors. This is common practice in sectors like aviation or hospitality.

For its part, personalized pricing aims to offer a specific price to a customer based on their purchasing behaviors or value to the company. This type of pricing is generally possible through customer data exploitation and requires advanced technologies for implementation. Thus, these two strategies allow revenue optimization and price adjustment based on each situation or clientele's specificities.

Segmentation Pricing: Refining Your "Custom" Pricing Strategy by Segment

Segmentation pricing relies on market segmentation to offer different price structures to each segment. This approach maximizes revenue and margins by adjusting prices based on each segment's specific characteristics and needs.

Here are some examples of segmentation criteria used to define rates:

• Purchasing power: segments with high purchasing power can be offered higher prices.

• Price sensitivity: for highly price-sensitive segments, a company can adopt a lower pricing strategy.

• Purchasing habits: certain segments may be willing to pay more for additional services or favorable purchase conditions.

It's crucial to note that each segment must have a specific offer aligned with the proposed price. Offer differentiation is essential to justify price differences between segments.

Subscription Models and Recurring Pricing: Betting on Revenue Predictability

Subscription models and recurring pricing are strategies that ensure constant revenue for the company. In a subscription model, customers pay a fixed amount periodically (monthly, annually, etc.) to access a product or service.

This pricing strategy is commonly used for SaaS software, streaming, and media, among others. The advantage of this model is that it allows excellent revenue predictability, customer loyalty, and flexible pricing based on subscription characteristics.

We've seen numerous attempts in recent years to transform "one-shot" sales models into subscription models. In reality, this is often a failure. What's important to understand is that the model must match the "consumption unit." Subscription software is used continuously and users will naturally pay throughout their usage. But in the case of training, for example, which has often been the subject of this type of experimentation, it makes no sense. The consumer wants to train at a given moment and will follow this training. Once completed, why would they need to continue paying?

Recurring pricing is similar but can vary based on the customer's use of the service or product. For example, a service company might charge a daily rate corresponding to the amount of work performed each month for their client's account. This amount varies but is recurring because it continues as long as the client company uses the service provider's work.

Free Pricing Policy and Freemium Models

Free pricing policy and freemium models are based on a price structure where a basic product or service is offered for free, while additional or advanced features require payment. This model is notably used in SaaS software and video games.

• Free: Attracts a large audience by offering free access to a basic product or service. This can help quickly acquire market share and create a loyal user community. Often monetization of the service or product will happen through advertising.

• Freemium: This strategy combines free with premium paid options. Users can access basic features for free but must pay to unlock additional or premium features. In video games and software, this is widely used. We make consumers "addicted" to a base of key features and create frustration by blocking certain advanced features for the most invested users.

These two models are particularly effective for creating a solid user base and converting some of these users into paying customers. However, their implementation requires effective management of the balance between free and premium offers, to ensure both profitability and offer attractiveness.

How to Influence Your Customers' Perception of Your Pricing Strategy

Branding and Marketing Significantly Impact Perceived Value

Branding and marketing play a key role in creating perceived value for a product or service. They significantly strengthen your product's market position and influence customer perception of its price.

For example, a strong brand and effective marketing communication can help create a perception of superior quality, thus justifying a higher price. This is particularly true in sectors where product differentiation is low, such as consumer goods.

It should be noted that branding isn't only linked to brand image but also to the overall customer experience. Quality customer service, smooth user experience, or coherent brand promise can strengthen perceived value and therefore price acceptability by the customer.

Regarding marketing, it has the capacity to highlight differentiating advantages, unique characteristics, or technological innovation of a product, thus increasing its perceived value.

• Storytelling can be used to reinforce emotional aspects and brand connection.

• Content marketing can educate consumers about product benefits, demonstrating its added value.

• Digital marketing, thanks to its interactive aspect, can favor customer engagement and strengthen brand relationship.

Note that branding and marketing must be harmonized with pricing strategy to avoid any dissonance and guarantee overall offer coherence.

Leveraging Cognitive Biases to Influence Price Perception

Cognitive biases are distortions in our thinking that can influence our price perception. They can be used to improve engagement and conversion, so it's important to know them when working on your pricing strategy. Here are some examples:

• Anchoring bias pushes us to give significant weight to the first information received. In the pricing context, setting a high initial price makes a lower selling price appear as a good deal.

• Left-digit effect is related to how we compare prices, for example $5.99 and $6.00. Our brain focuses on the 5 and tends to think that $5.99 is more attractive.

• Framing effect suggests that individuals react differently to the same information depending on how it's presented. For example, a product with a 20% reduction may seem more attractive than a product with a $5 reduction, even if both reductions are equivalent.

• Decoy effect relies on contrast between multiple offers. We'll create a high-priced offer, a low-priced offer, and the real offer we want to sell. By reducing interest in the first two offers, we overvalue the middle one regardless of its price.

Innovation to Remove Comparison Elements

Innovation can play a crucial role in removing comparison elements. By offering a unique product or service in the market, the company creates an environment where price comparison becomes difficult for consumers. For example, a product with cutting-edge technology or offering unmatched features can justify a higher price. Potential customers having no direct reference are more inclined to accept the price set by the company.

Innovation can also manifest in commercial strategy and business model. Using an innovative freemium subscription model or offering a free trial can be approaches that remove comparison points. These strategies create a unique customer experience, thus increasing perceived value and minimizing the importance of price comparison.