By Crystal Sutterlin

January 10, 2020

The researchers at Clicksuasion Labs created a pricing strategy matrix that is actionable, relevant and supports sustainable cash flow when applied in conjunction with behavioral science. The six pricing strategies included are (1) competitive pricing, (2) price skimming, (3) penetration pricing, (4) cost plus, (5) value-based pricing and (6) behavioral pricing.

Also called strategic pricing, competition based pricing is a pricing method that involves looking at the prices set by other businesses in the same sector, and then adopting a price similar to their price. The competition-based pricing method focuses solely on the public information competitors release, not customer value.

Let’s say there are three companies: company A, company B and your company. Company A sells their product for $99. Company B sells their product for $95. You sell your product for $90.

Competitor-based pricing is a lot like a bad case of plagiarism in a college class. You’ve partied a little too hard the night before, forgot about the paper you were supposed to write, and then think it’s a good idea to paraphrase the Wikipedia article you found on Reagan-nomics. The market doesn’t dole out suspensions for copying prices; however, the process of swiping an essay and competitor-based pricing are pretty similar.

Another way to think about it: imagine stacking all of your competitors on a totem pole with the most premium or luxury brand on top and the bargain brand on the bottom. You then decide where on the pole you fit, place yourself in there, and set your price accordingly. Wait though, isn’t that a bit arbitrary? Of course it is, which is why we’ll take a look at the advantages and disadvantages of competitor-based pricing.

There are three significant advantages of competitor-based pricing (1) simplicity, (2) low risk, and (3) accuracy.

If you’re in an industry with as little as one or two direct competitors you can implement a reasonable competitor-based pricing strategy. In most industries, marketing and product managers will have to do relatively little research to find a price. It is possible to make adjustments in prices by following revisions made by competitors. Keep in mind that this gets much more complicated when you’re not comparing congruent goods.

It’s rare to miss finding a reliable price range when applying the competitive pricing strategy. If you have a fairly solid grasp on your product’s quality, target audience and cost of production, this method could reduce the risk of bankruptcy. It’s kept your competitors afloat, so similarly, it should do the same for you. The keyword is “should”.

In saturated industries like retail, competitor-based pricing can be fairly accurate. After all, for most consumer products there are large quantities of customers and enough data to move pricing towards a market-based methodology.

The three significant disadvantages of competitive pricing are (1) missed opportunities, (2) following the herd, and (3) short term fallacies.

The most common ways businesses raise profits are by increasing sales, decreasing cost of production, and lowering overhead. Pricing is often neglected, which is a shame, because it’s their main consideration sometimes an incentive and more often a barrier before the consumer decides to purchase your product. Simply copying your market’s prices leads to a lot of wrong prices and lost profits, even if you believe you’re doing well. The goal of your business should be to maximize revenue and profits, even if it does take a little bit of extra work on the pricing initiative.

Competitor-based pricing operates with the assumption that businesses already in the market have the correct answer and that every decision competitors’ make are intelligent. This can be a fair strategy if only one business determines its price after taking into consideration the variety of prices existing at the time. However, if a large portion of companies all use this tactic, then with time competitor-based pricing can lead to the entire industry losing touch with demand. You’ll end up either keeping the same price forever, because competitor A hasn’t changed her price or you’ll simply raise or lower prices in response to trigger happy competitors. Remember though, it’s your business, your product, and your revenue. Every customer a competitor serves is an opportunity lost for you. Why would you let people in the other end zone determine the baseline for your price?

Maintaining a lower price than your competitors isn’t always the best way to attract consumers. Competitor-based pricing exacerbates that idea by simplifying price as a barrier that constantly must be lowered. Yet, the lowering of prices in most industries leads to doubts about quality and lower revenue from tiny profit margins even though customers would be willing to pay more. As we alluded to earlier, competitor-based pricing gives you too much of a “set it and forget it” mentality. Pricing is a process that requires data and attention. If you’re not changing your prices and differentiating your product over time, you’re like a shark who’s stopped swimming: dead in the water.

To summarize, certain businesses need to use competitor-based pricing extensively, because consumers price compare and their switching costs from buying a product at store X or store Y are exceptionally low. Yet, for most businesses, especially in the software or Software-as-a-Service (SaaS) space, competitor data should not be the central tenet of your pricing strategy, because there are many variables to consider when you’re not comparing congruent products.

To be successful and experience the benefits of this strategy, retailers should have a solid data collection system in order to get fresh data from the competition and act with immediate and effective responses towards the competitors. In a nutshell, a competitive pricing strategy requires a detailed market analysis.

Price skimming is the strategy of charging a relatively high price during the launch of a new, innovative product, then lowering the price over time to access different points on the demand curve.

Customers known as early adopters are likely to pay steeper prices for a cutting edge product if it’s marketed as a “must have”, whether the price accurately reflects the value or not. Eventually, prices are lowered to follow the product demand curve and attract more price-sensitive customers. Theoretically, as each customer segment is “skimmed” off the top a company can capture some of the consumer surplus by charging the maximum price each segment is willing to pay.

“Theoretically” is the key word here, because although price skimming can effectively segment the market, it’s almost impossible for the strategy to capture all of the consumer surplus. Price skimming is most effective when the product follows an inelastic demand curve, meaning the quantity demanded doesn’t rise or fall drastically in response to a change in prices. While necessities like fuel and electricity are almost always inelastic, state-of-the-art products like smartphones can potentially walk the same path. Let’s uncover the advantages and disadvantages of price skimming before exploring the market characteristics that make the strategy a viable tactic for your business.

There are three significant advantages to a price skimming strategy (1) increased return on investment, (2) manageable brand equity, and (3) market segmentation.

Charging more during the launch of an innovative product, particularly in high tech industries, can help your company recoup research and development costs as well as promotional expenses. Apple Computer likely benefits from high short term profits during a product’s introduction, and the initial higher prices are justified by the technological breakthroughs they achieve.

Price skimming can also create the perception that a product is a high quality “must have” for those early adopters who can’t live without the latest tech products. Higher prices in the beginning of a product’s life cycle enables you to build a prestigious brand image that attracts status conscious consumers, and in addition, you’ll have the breathing room you need to lower prices as competitors enter the market. In some cases a lower starting price in the beginning can also increase customer price sensitivity, making it impossible to raise rates in the future without losing sales.

As previously discussed, price skimming is an effective way to segment your customer base, potentially allowing you to earn the greatest possible profits from different types of customers as you reduce the price. Starting with a higher price isn’t likely to deter your early adopters, and as you lower the price over time you’ll likely attract more price sensitive consumers. If you alter prices based on the product demand curve and the maximum price the customers are willing to pay, you can capture some of that consumer surplus and earn more revenue.

There are additional benefits to early adaptors, which include research, development and beta testing of new products.

Those status conscious consumers that purchase your innovative product as early adopters can provide valuable feedback and help you work out the kinks before the next update and foreseeably a wider user base. In addition to being valuable testers, early adopters who love your product can act as brand evangelists that create a perception of quality via word of mouth. This low cost promotion could persuade new customers to purchase the product when the price decreases.

When there are advantages, there are disadvantages. The three significant disadvantages for price skimming include market inelasticity, crowded markets and the attraction of competitors.

Price skimming might be a viable tactic for Apple, but that’s because the quantity demanded doesn’t rise and fall dramatically when the prices change. If the demand curve for your product is generally elastic, meaning price changes have a greater effect on product demand, then initial high prices could really hurt your sales. The goal of any company is to make a product as inelastic as possible, but not everyone is selling tech products or services that are ingenious enough to appear indispensable to consumers.

In most industries, assessing customer valuations and analyzing the competition prior to setting your prices is crucial. If you already have a lot of competitors then chances are your demand curve is fairly elastic, and high prices during your product launch will send customers running in the other direction. Price skimming is not a viable strategy in an already busy market, so unless your product includes amazing new features no one can match, it might be a good idea to avoid skimming if fierce competition already exists.

Maybe your product is groundbreaking enough that it will create a new market, but as shown by the introduction of the iPhone and the iPad, competitors like Samsung and Microsoft are lurking around the corner. The success of high prices in the beginning of a new product’s life cycle will intrigue competitors to enter the market, and the inelasticity of a demand curve is almost always reduced over time due to the introduction of viable substitutes (For more information on entering markets: listen to Clicksuasion Podcast: Crossing the Chasm | Episode 3 | Season 3 with Michael Barbera and Geoffrey Moore). Price skimming can also slow the rate of adoption by your potential customers, giving the competition more time to imitate and improve upon your product before you’ve capitalized on the demand for the innovation.

Furthermore, remember the brand evangelists that bought your product first? They can easily trigger your worst public relations nightmare. If prices drop too much or too soon after the initial product launch, your early adopters are likely to feel used and cheated. Apple experienced a similar backlash in 2007 when the company reduced the price of the iPhone by $200 dollars just two months after its introduction. The quick 33% price drop from $599 to $399 may have helped increase demand, but some of the phone’s early adopters were understandably upset.

To ensure the customers at the top of your demand curve don’t feel cheated, it’s important to use price skimming in a consistent manner and avoid hurried or blatantly obvious reductions in price. Price skimming can also be considered price discrimination, which is the strategy of selling the same product at different prices to different groups of consumers. In some jurisdictions and scenarios, this strategy incurs legal challenges (For more on the ethical issues of behavioral science, see Clicksuasion’s Behavioral Creed at clicksuasion.com/creed).

After analyzing the advantages and disadvantages, we can see that price skimming is a notable method for pricing an innovative new product, provided that you’re wary of the pitfalls. Be cautious when setting high initial prices and reducing them over time, as the wrong move or quick price drops can elicit a public relations challenge. Analyzing and understanding what customers value with regard to your offering will help you uncover the true nature of the demand curve, as well as the viability of implementing a price skimming strategy. As long as there are few competitors in the market and you communicate the price reductions effectively, skimming can bring in the revenue you need to quickly recoup development costs, continue updating the product, and ensure the survival of your business.

Cost plus pricing is the simplest method of determining price, and embodies the basic idea behind doing business. You make something, sell it for more than you spent making it (because you’ve added value by providing the product). Many businesses use cost plus pricing as their main pricing strategy when releasing products.

A lot of companies calculate their cost of production, determine their desired profit margin by pulling a number out of thin air, slap the two numbers together and then stick it on a couple thousand widgets. It’s really that simple. This method involves very little market research, and also doesn’t take into consideration consumer demands and competitor strategies.

There are three significant advantages with the cost plus strategy (1) limited resources, (2) rate of return, and (3) hedging your bets.

Cost plus pricing doesn’t require a lot of additional market research. Cost of production is something brands are mostly aware of by adding up different invoices, labor costs, etc. Product managers can take the summed costs and place a margin on top of them that they believe the market is willing to pay. Cost plus is simplistic and popular among small businesses or businesses where other aspects of production must take precedent.

Cost plus pricing ensures that the full cost of creating the product, or Cost of Goods Sold (COGS), is covered, allowing the mark-up to ensure a positive rate of return. Often times there are additional costs that can’t be accounted for, which results in reduced margins. Fortunately, by increasing the arbitrary margin, product managers can create a buffer between uncalculated costs and fluctuations in demand. Furthermore, because your prices remain inert, you can easily estimate revenue for a given month based on conversion history, marketing spend, etc.

Cost plus pricing is especially helpful when you have no information about a customer’s willingness to pay and there aren’t direct competitors in the marketplace. Essentially, the limited data you have to guide your pricing decision is the calculation or estimation of your costs, which allows you to push forward an introductory price to work from as the market and customer develop.

There are three significant disadvantages with the cost plus strategy (1) inefficiency, (2) isolation, and (3) consumer willingness to pay.

The guarantee of a target rate of return creates little incentive for cutting costs or for increasing profitability through price differentiation. Stakeholders are likely to become passive towards pricing, facilitating laziness and an atrophy of profits as the market and customer continues to change. For some perspective, the government uses this strategy of guaranteed profit margins on costs to make contracts with private businesses “easier.” The result is an incentive to maximize costs, which has resulted in wasted spending and low quality outcomes.

This inward facing approach discourages market research. Although watching competitor prices isn’t the end all, be all of pricing, it is important. You should be aware of how much a competing good costs because it can affect your own marketing and pricing strategies. Plus with no research, you have little to no data on your customer’s perceived value of the product.

The downfall of cost plus pricing is that it completely disregards the customer’s willingness to pay. To make money, a customer must be involved. They’re the most important part of selling anything, so any pricing strategy that doesn’t take customer value into account is creating a vacuum that’s sucking all of the profit out of the business.

Furthermore, customers aren’t likely to care about how much something costs to create. They understand there are costs associated with doing business, but consumers care more about how much value you’re providing. For example, making a bottle of Rogaine may cost $3, $10, or $50, but consumers only weigh price against the value of a person with hair on their head, which depending on the customer could be 2x, 10x, or 100x the cost depending on follicle effectiveness. Simply barreling ahead with a desired rate of return can result in declining demand that is disregarded until substantial losses occur. Even if consumers are buying your product, there could still be a better price for revenue optimization and price differentiation.

To summarize, cost plus pricing isn’t ideal for most businesses, unless you truly cannot spend some extra time on the most important aspect of your business, which sometimes happens when you’re bogged down by fulfilling orders or the sheer number of items you’re offering customers. Additionally, some businesses have very uniform costs surrounding their offerings that are the same for all competitors. In this case, margins will probably be uniform, as well, which means the pricing methodology should be more competitive or market-based.

We discuss value-based pricing in many studies and from a lot of stages. The goal is to identify how much each of your customers are willing to pay for your product, so that you can maximize your revenue by charging each of your customers the exact amount they are willing to pay. At this point, you’re at an equilibrium with your customer base, providing exactly the right amount of value for the price you’re charging. Sounds pretty easy right?

Well, sort of…there’s a catch (there’s always a catch). Figuring out customer valuations is harder than it sounds. This is why so many companies choose to focus on cost plus and competitor based pricing (the paths of least resistance, but also the path of least resistance).

Identifying the consumer avatar, buyer persona or target audience is a significant construct in a value-based pricing strategy. Your buyer personas are fictional characters that represent your ideal customer. They embody the people who you believe to be the perfect fit for your product. Of course, your product will most likely fit the needs of many different types of customers, which means that you will need multiple buyer personas. One of your personas might be Founder Fred, the CEO of a small company who wants a smaller service package with fewer bells and whistles. Another might be Marketing Mary, the head of marketing for a large publicly-traded corporation that needs an enterprise-sized package.

What you want to do here is to define exactly who these personas are by thinking about things like their personal background, their role in the company, any challenges they may face, their bosses’ expectations, their needs and pain points, and even their preference in peanut butter (not kidding on the last one – Founder Fred is a crunchy kind of guy).

The point is to know them inside and out because they are the most critical part of your value-based pricing strategy. Without them, you wouldn’t be able to develop your target customer base, which lays the foundation for the rest of the steps in the process. Be sure you don’t skim over this step, and make sure the entire company knows the buyer personas. You should be talking about these customers in meetings as if they’re actually people, because they are people.

The pricing process shouldn’t be this dark secret that is hidden away from customers until you charge them on a pricing page or in a contract. You talk to your customers about their pain points, favorite colors, and what they love about you, there’s no reason you shouldn’t talk to them about the value they’re finding in the product. It’s a two way conversation.

In this manner, value-based pricing is all about data, both qualitative and quantitative. It’s the most objective method to learn how your customers want to pay for your product (per user per month, per video, per GB of bandwidth, etc.) and how much your customers are actually willing to pay. This means the second step of the process is to collect customer data by surveying them about topics such as their price sensitivity and what features/benefits they value most in your product. There are numerous methods out there (including our own willingness to pay research – shameless plug).

Here’s where the buyer personas are applied. You have to target your surveys to people who match your buyer personas so you’re collecting data from people who you believe are actually interested in purchasing your product, whether they’re prospects, actual customers, or market panels. You also want to keep in mind that your customers are doing you a favor by filling out your survey, so be sure to value their time accordingly by keeping your surveys short and objective (or even offering a reward – remember it’s a two way street).

Great. You’ve collected some data and spoken with a few customers. Now go all Rainman, Neo, or Beautiful Mind on the data in analyzing the patterns in features, benefits, and price points your different buyer personas value in your product. You will likely observe patterns that help you to create tiers and proper packages for your product or services. Each tier should align with your different buyer personas so that you’re offering the right amount of product/service to each different customer segment. Going back to our earlier example, if you find the people who match your Founder Fred persona really value a smaller, but inexpensive, package with great customer support, you should create an entry level tier with those features. Comparably, if the people who match your Marketing Mary persona are willing to pay more for a package with lots of cloud storage and unlimited user licenses, you should create an enterprise tier that matches her needs.

Tiers are critical to a great pricing strategy because they allow you to take advantage of the multi-price mindset, pricing along a value metric, and cater to different valuations of your product. After all, you wouldn’t want to charge a large public enterprise the same price for your service as a small startup, especially if the large company is willing to pay more.

One of the bedrock concepts you should remember is that pricing is a process. Customer valuations are constantly evolving due to things like changing consumer trends and the developments in technology. Just think about what’s changed since the Sony Walkman was the must-have accessory. Changing customer preferences and market conditions means your pricing strategy and tiers should be constantly updated as well. You need to continually collect data and analyze price sensitivity and value in order to make sure that what you’re offering is still relevant to what your customers are looking for in your product.

Keep in mind, as well, you need to continually validate and pair your customer personas to their respective tiers and entry points. They should match up to your expectations, meaning that your enterprise tier should be mainly subscribed to by large enterprise customers. If, for example, small businesses are flocking to your enterprise tier, then it might be a good idea to reevaluate and expand your service offerings so that you will have a package to target the larger customers, and the extra revenue they have in their coffers.

You must ensure that your value and pricing matches up to the needs of your customers. Business is a healthy balance, and pricing is one of the best representations of that notion. Everyone can win, from the customer getting exactly what they want at the value they perceive to your company creating a phenomenal pricing strategy that maximizes revenue by aligning everything properly.

We’ve reached the final pricing strategy on the Clicksuasion Pricing Matrix: Behavioral Pricing.

Behavioral pricing is the business practice of establishing prices that cater to the consumer’s decision process. It’s the concept of influencing the consumer that there are other reasons to purchase beyond the price and value.

If we were to discuss every behavioral construct for pricing in this article, it would be too long. We’re giving you a crash course from 35,000 feet above.

The first behavioral construct is time pressure. If you’ve been to any retail establishment in the past few months, it is likely that you’ve seen some form of a sales sign depicting “1 day only sales!” where everything is “50% off!!” There always seems to be this urgency around these sales, which ironically happen every weekend in some fashion. We’re going to let you in on a little secret: The sales are always going to be there. Don’t believe us? Look at how well JCPenney performed when they removed their continuous discounts (hint: not so well).

These “1-Day only” signs are known as artificial time constraints. Stores place these restrictions on their sales because they act as catalysts for consumers to spend. If potential customers believe that the sales are temporary, they’re more likely to make their purchases today, rather than next week. Consumers are afraid of missing out on such an obvious deal, so they make a purchase in order to avoid these potential feelings of regret or the fear of missing out. Plus, they’ll feel peer pressured to buy after observing their fellow shoppers take advantage of this bargain. The most persuasive thing you can do is show that other people are doing it, too.

There’s great power in creating artificial demand. You can take advantage of this psychological fear when you’re selling your own products, from shoes to enterprise software. Reverse the sales paradigm by branding your product as an exclusive, must-have item, and convince potential customers to sell you on why they’re a good fit for your product or service. Essentially, go back to your high school dating days and play hard to get. By doing so, you’ll create this urgency and fear in your prospects that they’re missing out on not only the next big product or trend, but that product at a great price. Be careful though, don’t go too deep onto the discount pricing wagon. You want to make sure this lever reinforces, not deteriorates, your brand. There is a reason we don’t discuss discounts (To get your questions answered about discount strategies, submit your questions at clicksuasion.com/rfi).

The design of your prices can also have a tremendous impact on how customers perceive the value of your product. Next time you go to a fancy restaurant, look at the prices. Most likely they will be in a smaller font and won’t have the added zeroes at the end. They’ll look like “19”, instead of “$19.00”.

There’s a reason for this type of design. Longer prices appear to be more expensive for consumers than shorter prices, even if they represent the same number. This is because cognitively, the longer prices take more time to read. This effect is compounded by the use of a “$” sign for prices. Not only does it make the price longer, but it also firmly relates the number to consumers’ wallets, which exacerbates the pain of paying with their hard earned cash. Similarly, prices with more syllables appear more expensive because consumers pronounce prices in their heads and it takes longer to recite extended numbers. This is an easy tactic to employ for your pricing as well. Omit the “$” signs from your pricing and if you’re pricing at a whole number, forget the “.00” as well.

Anchoring is another phenomenal tactic for behavioral pricing. Let’s say you’ve had a rough day at work and you really need a bottle of wine. You visit the grocery store. There are two bottles of wine on the self. One costs $9 and the other costs $19 (here’s where we want to target individual buyer personas). If asked, “which bottle of wine do you think tastes better, the $9 or the $19?”, you are likely to pause, give some thought and make a selection. Most people believe the $19 bottle of wine tastes better because humans associate price with value and quality. If we asked, “which bottle would you buy to drink at home, alone?”. More than likely, your answer would be the $9 bottle of wine. And lastly, if we asked, “which bottle would you purchase to take to a friend’s house for dinner?”, your answer would likely be the $19 bottle of wine (you don’t want to appear to be a cheap friend, right?). We offered three scenarios, three different types of consumer decisions and we received different responses about the purchase based on the consumer’s behavior with the product.

With a behavioral pricing strategy you can provide a psychological impact that delivers a sense of urgency. You can change the perception of your pricing by adding an odd number, anchor prices, and a handful of other tactics. The most important part about this is that you must convey the value of your product.

Whichever strategy you choose to apply, we ask three things of you, (1) conduct your research, (2) make objective, evidence-based decisions, and (3) be prepared to revise and refine when needed.

Have pricing questions? Drop your questions at clicksuasion.com/rfi.