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Pricing Strategy Overview

11 minutes

What is Pricing Strategy?

Pricing strategy is how a business determines the ideal price of a product or service, informed by a range of factors such as business costs, competition, and customer value. 


Why is it important?

An effective pricing strategy enables an employment social enterprise to: 

  • Protect profits by ensuring that prices sufficiently cover production costs
  • Remain competitive by responding to changing market conditions 
  • Capture untapped value by considering customer need and willingness-to-pay

How is this topic different in an employment social enterprise context? 

Pricing is especially difficult for social enterprises because costs are higher due to programming and transitional workforce training costs. There is additional value to the product or service from being mission-based that can come into play in pricing.

Best practices

Best practices are broken down into three main areas, each of which is covered in detail in the remainder of this document. 

A.Foundational CONCEPTSB.PRICING TACTICSC.PRICING MAINTENANCE
Cost-plus PricingDiscount tacticsRules and guidelines
Competition-based pricingBundling tacticsSales staff training
Value-based pricingVariable pricing tacticsReview and update prices

A. Foundational Concepts

There are three foundational pricing strategies used in most businesses.  Ideally, elements from each are considered during pricing decisions.    

  • Cost-plus pricing is based on achieving a markup on your costs. Accounting software can support the calculations shown in the examples below.
    • a. Brief overview:  Ensure that your costs of production, distribution, and sales are being covered to avoid selling at a loss.  Based on your prices, calculate how much profit (gross margin and net profit) you are achieving with your current pricing.
      • Gross Margin = Revenue – Cost of Goods Sold
        • Example: Let’s say your ESE brings in $20,000 from landscaping services (revenue). It costs you $10,000 in labor and materials to provide the landscaping services (Cost of Goods Sold). Your gross margin is $10,000. 
      • Net Profit = Total Revenue – Total Expenses
        • Example Continued: In addition to the $10,000 in cost of goods sold, your ESE spent $5,000 in operating expenses (e.g., rent, marketing, utilities, taxes). Your total revenue stays the same at $20,000 but your net profit considers all expenses. Your net profit is $5,000 ($20,000 – $10,000 – $5,000).
    • b. Method:  
      • Calculate all your costs: Determine the direct costs (materials, labor, etc.) and indirect costs (overhead expenses like rent, utilities) associated with your product or service. If you have more than one product or service, you will need to allocate indirect costs, also known as overhead costs, to each product or service. Accounting software can help select and use an allocation method of indirect costs across products or services. 
        • Example: Your ESE makes both candles and lip balm. Your direct costs are $5,400 for lip balm and $10,600 for candles. Your only indirect cost is the factory you use to make both candles and lip balm. The indirect cost of the rent of the factory is $24,000 total. To determine how much indirect cost should be applied to candles and lip balm, you look at square foot usage of the factory floor. The 1,000 square foot factory dedicates 400 square feet to lip balm production and 600 square feet to candle production. The $24,000 indirect cost should allocate 40% (400/1,000) to lip balm and 60% (600/1,000) to candles. You would include $9,600 ($24,000×0.4) in cost for lip balm and $14,400 ($24,000×0.6) for candles. Your total cost for lip balm is $15,000 ($5,400+$9,600) and for candles is $25,000 ($10,600 + 14,400).
ProductDIRECT COSTSINDIRECT COSTSTOTAL COST
Lip Balm$5,400$9,600$15,000
Candle$10,600$14,400$25,000
  • Determine your profit margin: Decide on the percentage of profit you want to make on top of your costs.
    • Example: You decide you want a 40% profit on lip balm and a 50% margin on candles. 
  • Determine the revenue you need to make this profit margin a reality.
    • Net Profit Margin = Net Profit / Revenue or Revenue = Cost/(1-net profit margin)
    • Example: This means for 40% margin on lip balm you would need revenue to be $25,000 ($15,000/(1-0.4) and for a 50% margin on candles you would need revenue of $50,000 ($25,000/(1-0.5).
PRODUCTPROFIT MARGINTOTAL COSTREVENUE
Lip Balm40%$15,000$25,000
Candle50%$25,000$50,000
  • Divide by your quantity: Now that you know your costs, profit margin, and revenue, you only need to divide by quantity to arrive at the selling price.
    • Revenue/Quantity = Price
    • Example: You can make 10,000 lip balms and 2,500 candles for the costs used above. This means your lip balm will be priced at $2.50 per item ($25,000/10,000) and candles will be priced at $20 ($50,000/2,500)
PRODUCTREVENUEQUANTITYPRICE
Lip Balm$25,00010,000$2.5
Candle$50,0002,500$20
  • Use when:  There is little available data on customer demand (willingness to pay) and
  • Competition-based pricing sets prices based on competitor prices for similar products/services. competitor prices.
    • Brief overview:  Align your prices with the market to avoid leaving money (underpricing) on the table or being undercut by competitors (overpricing).
  • Method: 
    • Research competitors: Analyze their pricing and value proposition to understand the market landscape.
    • Identify your cost: Analyze total cost to develop, produce, and sell your product or service.
    • Set prices in line with competitors: Price your products or services at a similar level to avoid being too high or too low.
  • Use when:  There is competitor data available. If competitor pricing is below the cost to produce the product or provide a service then competitive pricing should not be used. A different pricing strategy that shows the value of the product or service is needed to justify the higher price point.
  • Value-based pricing sets prices based on the perceived customer value of the product or willingness-to-pay.
    • Brief overview:  Delivering uniquely valuable products/services can allow for prices to be set higher than the competition 
    • Method:
      • Understand customer perception: Gauge how much value your customers attach to your product or service.
      • Highlight unique selling points: Identify the features, benefits, or advantages that set your offering apart from competitors.
      • Determine the price ceiling: Based on the perceived value, set a price that your target market is willing to pay.
      • Justify the price: Clearly communicate the value your customers will receive, explaining how it outweighs the cost.
      • Review and adjust price: Continue to collect data and customer feedback to adapt pricing to the value being provided to the customer.
    • Use when:  Your product/service is differentiated from the competition.
Concepts in Action

Problem:  I’ve recently launched a landscaping business and am thinking about revamping pricing using the three foundational pricing strategies, but I’m not sure where to start.

Solution:
1.) Since you’re just starting out, take a look at your costs using your accounting software or bookkeeper.  Considering labor and materials costs, figure out whether or not your current project pricing is allowing you to break even on each project.  Don’t forget to consider overhead!  (Cost-based pricing)

2.) Investigate the competition by getting estimates from other landscaping businesses in the area to understand what the market rate is.  Compare your prices to the market and assess whether you could raise prices or if your total costs allow you to reduce prices to match competitors.  (Competition-based pricing)

3.) Later, once you’ve made sure that you’re covering your costs and considering your competition, you could survey your customers or conduct focus groups to see if you’re offering significantly more value than you’re aware of and could potentially raise prices.  (Value-based pricing)

B. Pricing Tactics

In addition to the foundational concepts discussed above, some businesses employ targeted tactics to encourage customer behavior in specific situations.    

  • Pricing Tactic #1: Discount products/services to drive sales and move inventory
    • There are four primary types of discounts:
      1. Seasonal, where businesses offer promotional discounts on seasonal goods or during particular seasons. Sometimes seasonal discounts are applied to out-of-season merchandise to sell old inventory or are used to drive demand for services and products during periods when customers will likely be shopping (e.g., 10% off all inventory or services on 4th of July weekend)
      2. Clearance, where businesses sell their products at unusual discounts, like a buy one get one free offer for a limited time only. This is typically used to clear out discontinued items to liquidate what’s left in stock (e.g., 50% off certain items)
      3. Volume, where businesses incentivize customers to purchase in multiple or larger quantities (e.g., annual subscription to services for $100 or monthly for $12.99 per month)
      4. Customer Type, where certain groups of customers pay less for products or services (e.g., 10% off for veterans)
    • Some of the benefits of discounting include:
      1. Introducing your product / service to new customers who may be otherwise unlikely to purchase and closing deals/increasing sales
      2. Moving stale inventory that hasn’t sold at posted prices 
      3. Increasing business volume to provide more work hours for participants
      4. Locking in revenue for a longer term of service, which decreases the likelihood of customers switching to another service provider and increases customer loyalty
    • Keep an eye out for risks and learn to mitigate them:
      1. Risks:  Decreased customer willingness to pay when customers become accustomed to discounted prices, which may result in lower customer retention rates, and a negative impact on your profits / margins
      2. Mitigation:  Review sales data after pricing changes to ensure that volume and profitability aren’t declining 
  • Pricing Tactic #2: Bundle multiple products/services to provide greater value to the customer and encourage larger order sizes 
    • Price bundling is a marketing strategy where businesses combine complementary products or services into one package deal, where the bundled price is usually lower than the sum of the individual prices of the products sold separately
    • Examples of price bundling include:
      1. Lawn mowing + gutter cleaning/power washing/tree trimming
      2. Soup + side salad
      3. Cell phone + data plan
      4. Holiday gift boxes
    • The benefits of discounting can include:
      1. Providing benefits that can only be achieved through combination 
      2. Increasing average spend per customer 
      3. Moving inventory of less popular goods and services
      4. Improving customer retention
  • Pricing Tactic #3: Deploy variable pricing, which adjusts prices based on known changes in demand for products or services
    • This pricing tactic increases prices when there is an above average demand for services or products. It is especially good for businesses with varying cycles in demand. 
    • Industries that use this pricing include:
      1. Hospitality
      2. Travel
      3. Food
    • Examples of variable pricing include:
      1. Hotels and Airbnbs charging more on weekends with large events
      2. Uber rides cost more based at peak times
      3. Some utility companies charge more for electricity usage during times when more people are using the services
      4. Amusement parks that charge relatively more or less based on the day (e.g., weekends tend to be more expensive)
      5. Happy hours at restaurants apply a lower pricing structure to similar items at times when there is less demand
    • The benefits of variable pricing include:
      1. Capturing additional revenue while demand is high
      2. Lowering pricing when demand is low to remain competitive and attract more customers
  • Learn more about Pricing Tactics: 
    • Pricing tactics:  Get a sense of the range of pricing tactics that can help drive sales and profits

C. Pricing Maintenance

  • Pricing Maintenance #1: Establish rules and guidelines 
    1. Determine reasonable guidelines for discounting and negotiation, that allow flexibility while protecting margin 
    2. Ensure that staff have access to pricing and discounting policies and create incentives to abide by them throughout the sales process 
    3. If there is a commission structure, make sure it rewards salespeople for adhering to prices set by management and disincentivizes widespread discounting 
  • Pricing Maintenance #2: Enhance training for sales staff 
    1. Equip sales personnel with price sheets and other relevant guidelines to promote consistent price getting
    2. Train sales personnel in effective negotiation techniques
    3. Empower employees to turn down unprofitable sales 
  • Pricing Maintenance #3: Keeping prices fresh 
    1. Get feedback from your customers
      1. Using surveys or focus groups, get in touch with customers and learn how much value they’re getting from your product/service 
    2. Update pricing regularly
      1. Establish a regular cadence to review pricing inputs, such as materials and labor costs, competitor pricing, and customer demand 
      2. Consider increased costs of inputs and operating costs due to economic factors (e.g., inflation, rent increases, wage increases) when determining price increases
      3. When estimating the amount of product or services sold consider multiple scenarios and determine what prices would need to be to cover operating costs at different sales volumes
      4. Ensure that prices are updated to reflect changes and maintain profitability 
  • Learn more about Pricing Maintenance
    1. Keeping pricing fresh:  Learn about approaching price-setting and maintenance in a structured way  

Success metrics 

How to go about measuring or tracking the success of the implementation and practice of pricing strategy tactics & recommendations. 

  • Increased revenue: Revenue is calculated by multiplying Price and Quantity. Pricing strategies work to increase revenue by changing price and quantity sold.
  • Improved understanding of costs: All pricing strategies rely on understanding costs for products or services sold as a foundation before being able to change prices up or down.
  • Increased average selling price (ASP): If pursuing certain strategies and tactics, the price per good or service sold should go up. Discounting is an exception to increasing ASP.
  • Increased conversion rate: Adaptive pricing has a goal of converting more browsers to customers.

Additional Resources 

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