Part 2: Comparing the most common pricing strategies in small business
Note: I recommend starting with the first post before jumping in to this one, as it will set a firm foundation for what we discuss here.
In Part 1 - What is Best Pricing Strategy for Small Business?, we covered the key basics of small business pricing:
Cost Analysis - Understanding how to set profitable pricing
Market Research - Knowing your customer and competition
Perceived Value - How customers decide to buy
Choosing a Strategy When Setting Your Prices
Choosing the right pricing strategy initially can be daunting, but it's essential for setting the tone of your business. Whether it’s your first pricing strategy or your 100th, it’s still a big deal.
Here the most common types of price setting methods:
Cost-Plus Pricing
If it’s your first time, consider starting with a cost-plus approach. It’s the simplest to work out and quickly get into the market. Cost-Plus is a method where you work out how much something costs you to sell, and then add a desired profit margin to your cost.
The best things about it are that it’s simple and initially at least, guaranteed to make you profit if you do it intelligently.
As the business grows and other expenses like staffing grow, your margins can quickly be eroded.
It’s also super important to monitor costs when you use this model as any supplier costs need to be passed on immediately, or absorbed as a lessened profit.
Value-Based Pricing
Alternatively, value-based pricing sets prices based on how much customers believe your product or service is worth.
This method is more rewarding, but more difficult. It’s my personal favourite, because when you work it out, it works so well and everyone is happy.
A simple rule of thumb I use is the rule of 10x - Try and create more than 10x the value you sell the service or package for, and you’ll never have trouble selling it.
To do this successfully, you need to understand how big and valuable the problem is that your service or package solves.
Think of it this way - If you’re helping people decide what to have for dinner, that’s a $30 problem at most. BUT, if you’re helping decide what to have for dinner so that they can lead a healthy, energetic, long, fulfilling life, that’s a substantially bigger problem you’re solving.
To nail value based pricing, you need to nail the value piece. The best way to do this is to look for identity based value in your products, services or packages. They need to help the person build wealth, health, status, community or knowledge.
When using value based pricing, it’s important that your pricing aligns with your brand's identity and value proposition.
Competitor or Market Pricing
The final basic pricing strategy is to look to the market and your competitors and set your pricing ‘against’ them. This could be the same, higher or lower, or a combination of all three depending on how you want to position yourself.
Most large FMCG (Fast Moving Consumer Goods) businesses in Australia set their pricing this way and then also employ ‘loss leaders’* which are products that they deliberately make low, or negative profit on that are used to excite customers into buying. Once the customer is in store or online buying that product, the hope is that they also buy other products which they maintain a better margin on.
In service industries, you could think of free trials and audits and the like as loss leaders. Many people in the professional advice business offer free or low cost first consults which are packed with value in the hope that upon experiencing the initial taster, which they lose money on, the client will sign up for a more expensive product.
*Note of interest: In FMCG and retail, the strategy of setting prices on well known products extremely low can also positively impact customer value perception of the business in general. It’s called the “Halo effect” and the reasoning goes that ‘if they’re cheap on this product, they must be cheap for everything else too!’.
The Australian supermarket giants even extend it out to a ‘comparison basket’ of maybe 100 or so well known goods that most people know the price of. Think brand name milk, butter, bread etc. They price these products hyper aggressively to create a perception of lowest prices across the store. And unless you’re a pricing analyst, you probably don’t notice where they make up the margin on all of the other products. You’d be surprised how often this tactic is employed.
Pricing Strategy Comparison
Pricing Strategy | Pros | Cons | Best For |
Cost-Plus | Simple calculation, consistent margins | Ignores market demand and competition | Products with stable, predictable costs |
Value-Based | Aligns price with perceived value | Requires understanding of customer perception | Unique products or services with high customer value |
Competitive | Matches market rates, competitive | May lead to a price war, lower margins | Markets with many similar products/services |
Testing and Adapting Your Pricing Strategy
Once you've set your prices, the next step is to test their effectiveness. Pricing is never a static “one and done”. Collect customer feedback on pricing and analyse your sales data to understand how price changes impact sales volumes. Being adaptable and willing to modify your prices based on real-world data is key to finding the optimal price point.
You always need to tune and refine the balance between more sales and more profit per sale.
It’s a bit like walking a tight-rope, and constantly adjusting balance as you go. You can’t just throw your weight all in one direction, because you’ll go too far and lose balance, and then you’re off the rope. We need to keep moving forward without losing balance.
Personally, I want to know that my pricing is sustainable and profitable, both for myself and my client. To be able to know this with confidence, I need to be in the details.
How do you manage price changes?
- I change the prices for everyone all at once
- I test small in groups first, then expand to everyone
- I don't make price changes
Adjusting Prices for Growth
The world changes, and so should your pricing. Whether it's due to cost changes, increased demand, or shifts in the competitive landscape, revising your prices regularly is a must if you want a business that is built to last. Without googling it, I’m pretty confident that a bottle of Coca Cola cost less in 1920 than it does now, but they’re still here and probably still profitable.
When you modify pricing, it’s crucial to consider and acknowledge how these changes are perceived by your customers. Sudden and frequent changes can lead to uncertainty or distrust, so communicate clearly about why prices are changing.
Remember, you’re in this for the long run.
Incorporating Feedback in Pricing Decisions
Feedback from customers and employees can provide invaluable insights into your pricing strategy.
Employees who deal with customers will be able to give you a sense of how your pricing is received. So will your customers directly. Some will even give you that feedback directly without you asking for it!
Single points of feedback though, are like brushstrokes in a painting - just because one brush stroke is blue, doesn’t mean the whole painting is blue. You need to look at the way the brushstrokes come together to form an entire picture.
More feedback is better to a point. There’s no hard and fast rule here, but most of the time you need more than one opinion and you need less than 10 000.
Two easy ways to tell if pricing is uncalibrated:
If no one ever questions your pricing / everyone accepts every quote, you’re probably too cheap.
If you don’t have enough sales / people aren’t getting back to you, you’re too expensive / not articulating your value adequately.
In the end, it all comes down to how you create value for your customers, and whether or not they perceive that value the same as you do.
Customer Feedback Methods
Here are some simple methods of collecting feedback.
Feedback Method | Description | Benefits | Tips for Effective Use |
Surveys | Collects direct customer feedback | Quantitative and qualitative data | Keep surveys short and focused; offer incentives for completion. Acknowledge feedback provided. |
Focus Groups | In-depth discussion with select customers | Detailed customer insights | Select diverse groups for varied perspectives; prepare open-ended questions, limit assumptions. Stay curious. |
Sales Data Analysis | Analyse actual sales data for insights | Real-world impact of pricing | Use data analytics tools for trend analysis; correlate changes in pricing with sales volume. |
The simplest method isn’t here though - have an honest conversation with a customer you trust. Pick up the phone, buy a coffee, get in touch and ask them the questions you need answers to. You’d be surprised how helpful people will be when you start from a place of trying to understand their situation so that you can help them.
How do you get the trust of these customers though?
Creating a Culture of Price Transparency
Building trust with your customers involves being transparent about your pricing.
Understand their world and what matters to them and then clearly communicate the value they are getting and any changes in pricing that are necessary. This transparency builds trust and loyalty, encouraging customers to see the value in your offerings beyond just the price tag.
In small business, people buy from people, not companies.
You can’t hide behind a brand and ‘blame corporate’ every time.
Honesty, transparency and vulnerability build trust.
Communicating Price Changes
Let’s be honest, this is probably the main reason you’re reading this blog.
Nearly every business owner gets stuck on this point. You’re either hesitant to put your prices up or you want to but aren’t sure how to communicate it.
The main point though is this - communicate with your customers like humans, give them a say in the matter where possible, and communicate with plenty of time if you can. Not everyone needs exactly the same pricing and set of rules and there are plenty of ways to increase value for the customer without increasing the cost to provide it.
What Now?
Part 3 of the guide covers some advanced pricing considerations, as well as common FAQ's that you may face when implementing this process.
Also, if you missed it, here is my post on the fundamentals of pricing in small business.
Hi, Jake here! I wrote this, thanks for reading, I hope you got what you needed out of it.
As always, I'm keen to help, so if you have questions I'm only ever an email away (jake@upperlimit.com.au)
Or book a time to find out if and how I could help your small business thrive.
Onward and Upward, Jake