Pricing Strategies: A Comprehensive Guide for Businesses
Pricing is much more than just putting a price tag on a product. It’s a powerful tool that influences your brand positioning, profitability, and long-term business success. Choosing the right pricing strategy can be the difference between thriving in a competitive market or falling short.
In this article, we’ll explore a wide variety of pricing strategies, their advantages and disadvantages, examples of companies that use them, and how businesses can build and choose the best pricing strategy for their needs.
Types of pricing strategies
Businesses have access to many pricing strategies, each suited to different goals, markets, and customer bases. Here are some of the most widely used pricing models:
- Cost-based or cost-plus pricing
- Value-based pricing
- Usage-based pricing
- Competitor-based pricing
- Dynamic pricing
- Penetration pricing
- Skimming pricing
- Geographic pricing
Cost-based or cost-plus pricing
Cost-based or cost-plus pricing is one of the most straightforward pricing strategies. Here, businesses calculate the cost of producing a product and then add a markup to ensure profitability.
In cost-plus pricing, cost of goods sold (COGS) is the foundational cost component used to calculate the price of a product or service by adding a markup. This ensures that the company covers its production costs while securing a desired profit margin.
Today, cost-plus pricing is less common than value-based pricing models, but it can still be used in certain scenarios.
The cost-plus pricing model can help ensure that the provider covers its expenses while making a predictable margin on top, allowing for scalability in services based on the customer’s requirements.
However, things usually aren’t this simple and there are important reasons that some companies avoid cost-based or cost-plus pricing. SaaS companies, for example, often have relatively fixed development costs (R&D, software maintenance), but scaling to new users is relatively inexpensive. As a result, the marginal cost per user is low, making cost-plus pricing less effective than value-based models. In addition, value-based pricing models do a better job of capturing the customer’s willingness to pay for the perceived value of the software.
Example: In the aerospace and defense industry, it is common for companies like Lockheed Martin to use cost-plus pricing when fulfilling government contracts, especially for large-scale projects. In this model, the government agrees to reimburse the company for the cost of producing the equipment, including labor, materials, and overhead. Lockheed Martin is then allowed to add a fixed percentage or fee as profit.
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Value-based pricing
Value-based pricing is a pricing model where the price of a product or service is based on a customer’s perceived value of that product or service. Put simply, if your customer feels your product or service offers them high value, they will be willing to pay a higher price for it.
This pricing model is not suitable for every type of business. Companies commonly use value-based pricing in highly competitive and price-sensitive markets or when selling add-ons to other products or services.
Value-based pricing revolves around the customer’s perceived value of a product or service, rather than the actual cost of production.
Willingness to pay (WTP) is the maximum price a customer is willing to pay for a product or service. Typically WTP represents a figure, but in some cases it could be a range. Assessing WTP is key to driving value-based pricing instead of cost-plus, because it incorporates the customer’s perception of the product or service.
The most direct way to understand the value of your product for subscribers is to somehow quantify how much the product helps their business. In other words, you need to link the perceived subscriber value with a unit of measurement.
This metric should be a useful tool for both the company and the customer in terms of evaluating the effectiveness of the product. These value metrics should be easy for the customer to understand when they are perusing your pricing tiers. They should clearly communicate the value creation associated with the product or service, and demonstrate how the value will grow with customers’ usage over time.
Example: As companies launch new or integrated AI or GenAI offerings, some choose to implement value-based pricing in an effort to accurately convey and capture the true potential of this very new technology. For example, the Google Gemini version for consumers is accessible via a Google One “Premium AI” plan priced at $19.99/month in comparison, the non-AI Google One “Premium” plan is $9.99/month. In this case, the value added by GenAI is considered great enough to warrant the price difference.
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Usage-based pricing
Usage-based pricing, often seen in SaaS and utility companies, charges customers based on how much they use a product or service. This could be anything from the number of API calls, gigabytes of data used, kilowatt hours of energy, or outputs from a chatbot.
Usage is fast emerging as a top pricing model for companies across industries, especially those developing and launching new GenAI offers. This is because the model provides good alignment with and demonstration of value to the customer. Customers like flexibility when they are first trying a product, which makes simple pay-as-you-go usage pricing a good option for onboarding new customers.
Usage-based pricing can also be a competitive differentiator and may enable a lower cost of sale and lower barriers to entry. And when used as part of a hybrid model, usage has been shown to contribute to higher year-over-year (YoY) annual recurring revenue (ARR) growth across all company sizes.
Example: Cloud storage services like AWS S3 employ usage-based pricing, charging customers based on the amount of storage they use.
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Competitor-based pricing
Competitor-based pricing involves setting prices based on what competitors are charging. There are three main approaches:
Co-operative pricing
In cooperative pricing, businesses align their pricing closely with competitors to avoid price wars.
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Dismissive pricing
Dismissive pricing means ignoring competitors’ pricing and setting prices based purely on your business’s strategy and customer value.
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Aggressive pricing
This strategy involves setting lower prices to undercut competitors and gain market share
Example: Both Dropbox and Google Drive offer cloud storage solutions with similar features, such as file sharing, synchronization, and collaboration tools. However, Google Drive has historically priced its services lower than Dropbox, leveraging its existing infrastructure and broader ecosystem (such as Google Workspace integration). To remain competitive, Dropbox has adjusted its pricing strategy based on what Google Drive offers, often adding more storage capacity or additional features for similar price points.
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Dynamic pricing
Dynamic pricing adjusts prices in real time based on market demand, customer behavior, and other factors. Dynamic pricing allows prices to shift in response to market conditions like demand, inventory, and competitor actions. Research shows companies that use dynamic pricing experience a 5% average increase in profit margin per product or service sold.
Enabled by AI and advanced algorithms, dynamic pricing factors in inventory counts, monitors consumer demand signals, and assesses external issues like weather, events, and locations that may impact sales. Prices update instantly based on this flow of data. A dynamic pricing system can spot new patterns and improve accuracy without human intervention.
Example: Airlines and ride-hailing services like Uber frequently use dynamic pricing to adjust fares based on demand and availability. Retailers like Amazon also use this strategy, with prices fluctuating by the hour, day, or minute.
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Penetration pricing
Penetration pricing is used by businesses that want to enter a competitive market by offering lower introductory prices to quickly attract customers. They then increase the price of their products and services afterward. Many tech and SaaS startups leverage this strategy.
Example: Streaming services like Netflix or Disney+ utilize penetration pricing to attract users by offering affordable subscription plans.
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Skimming pricing
Skimming pricing involves setting high initial prices for a new or innovative product and gradually lowering the price over time. This strategy works well when there are few competitors in the market and the company knows they can capture high profits from early adopters before reducing the price to appeal to a larger customer base.
Example: Technology companies like Sony use skimming pricing for products like gaming consoles, charging high prices initially and lowering them as the product ages.
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Geographic pricing
Geographic pricing involves setting different prices depending on a customer’s location, often due to varying shipping costs or local market conditions. Prices may also be adjusted based on the competition and demand in different areas. If there’s high demand or little competition in a region, prices may be higher.
Purchasing power may also impact geographic pricing, meaning prices can be set based on the income levels or economic conditions of specific regions. For example, products may be cheaper in countries with lower purchasing power.
Taxes, tariffs, or legal requirements in different regions may also influence price variations.
Example: Spotify uses geographic pricing to adjust subscription fees based on the country where the user resides. For instance, Spotify Premium is priced higher in countries like the U.S. and Europe compared to emerging markets like India or Southeast Asia. This allows Spotify to balance local purchasing power and competition while maximizing its global reach.
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Combining different pricing strategies
Many successful businesses combine different pricing strategies to meet multiple objectives. For example, a company might use penetration pricing to enter a new market and then switch to value-based pricing once they’ve established themselves.
In addition, research shows that some of the fastest growing SaaS companies today are using multiple pricing strategies at once, in the form of hybrid pricing models, to achieve faster growth.
By blending pricing strategies, businesses can optimize profitability, market share, and customer satisfaction. However, it’s essential to monitor the performance of each strategy and make adjustments as needed.
How to choose the best pricing strategy
Choosing the best pricing strategy for your business isn’t a one-size-fits-all approach. It requires understanding your market, customers, and competitors. Here are some factors to consider:
- Business goals: Are you looking to maximize profit, grow your market share, or establish yourself as a premium brand?
- Cost structure: Understand your production costs and ensure your pricing covers these while allowing for profitability.
- Customer perception: How do customers perceive your product’s value? Are they willing to pay more for premium features or services?
- Market conditions: In a competitive market, you might need to adjust your strategy to stay relevant.
How to build a pricing strategy
Building a pricing strategy involves several steps to ensure you’re making the best decision for your business:
- Define your goals: Consider whether your pricing is aimed at acquiring, retaining, or monetizing customers.
- Conduct market research: Understand your market, competitors, and target customers. This will give you insights into what pricing strategies may work best.
- Test pricing: Analyze how your target customers react to different price points. Surveys and A/B testing can help with this.
- Iterate and optimize: Iterating on pricing is a continuous, data-driven process, so be prepared to regularly review and refine your pricing strategy to adapt to changes in the market, fluctuations in customer preferences, and future testing results.
Related resource: Flexible pricing — what it is, why it matters, and how to do it right
The tools to put your pricing models to work
Pricing strategies are essential components in your business’s long term success. By understanding the various options — whether it’s cost-based, competitor-based, dynamic, or penetration pricing — you can make informed decisions that boost profitability and customer satisfaction. Remember, the best pricing strategy is the one that aligns with your goals and resonates with your customers, but you’ll also need the right tools to support quick pricing experimentation and iteration.
Discover how Zuora Billing is designed to scale with your evolving business, with support for your flexible pricing strategy and billing for every pricing model.