Setting prices is an ongoing battle.

Most business owners worry about being undercut by competitors. No one wants to lose a sale because they’re too expensive.

The recent global pandemic has only magnified the problem. As a result, consumers now put more thought into what they buy and how they spend money, a trend that will continue.

So, what was once already difficult has become even more challenging. That’s why it’s so important to choose the right pricing strategy for your business.

In this article, you’ll discover:

• The actual reasons so many businesses struggle with pricing
• Why “value” won’t help you make sales and what to focus on instead
• How the right strategy will help you overcome price pressure once and for all

There are two problems most business owners face when pricing their products and services. Let’s look at each.

Pricing Problem #1: Chasing Competitors to the Bottom

Many businesses believe the price is the critical factor in the buying decision. After all, one of the first things people want to know is how much something costs. So, they try to outsell competitors by keeping their prices in line or just underneath the “going rate”.

Underselling the competition seems like a good idea—at first. But what happens when competitors find out you’re charging less? They reduce prices.

Now, you face pressure to reduce yours again. It becomes a race to the bottom that no one wins.

I want to challenge the belief that people buy on price alone because it simply isn’t true.

Still, there’s another essential reason to stand firm with pricing.

People will pay more if you can show them why they should.

Is It Too Good to Be True?

Did you know a cheap price can erode the value of your product or service in the minds of consumers?

Something strange happens when we buy the cheapest product we can find. A voice in our head tells us we should probably lower our expectations of it. Are we surprised when it quits working, the terms change, or the company we bought it from won’t call us back?

The price of something can be an indicator of quality. This study shows the direct correlation between the perceived quality of a product (or service) and its cost. This idea is even more true when comparisons between brands are difficult to make.

Your customers still expect to get what you promise, even if they pay less. To do that, you must set prices that allow you to deliver.

We can’t give our customers what they expect if we can’t afford the means to provide it.

There’s another good reason to avoid using your competitors’ prices as a baseline for yours. They’re almost always using guesswork instead of data to set them.

It’s rare for businesses to support their prices with anything other than an opinion. The last thing you want to do is tie your company’s financial success to “opinion-based” pricing.

READ MORE: Is it possible to DOUBLE your prices?

Pricing Problem #2: Value Is Subjective

We hear a lot about “providing value”. But value itself is subjective. I may find something valuable while you may not.

This subjectivity creates a disconnect between the business and the target market. As a result, companies aren’t sure what to charge because they don’t know how much people will pay.

Prospects must believe your product or service offers more value than the price paid. 

Rather than focus on value, it’s better to influence the perception customers have of your offer.

Before I go any further, let’s hit the pause button to understand more about the basis of value. Then, we’ll look at how to increase your perceived value—the key to a premium pricing strategy.

The Employee Revenue Equation

As an employee, you provide a service to a company for a wage. To get the job, the employer approves of your ability to perform the position you fill. The employer perceives the value you offer to the company and pays you a salary.

A variety of market factors weigh into the salary amount, but the employer has the final say. Also, note that the employee receives money the day they start work.

This concept can best be expressed by what I call the Employee Revenue Equation:

Money received = Employer + Time Worked

The equation illustrates how an employee’s value is tied to a specific dollar amount. It’s possible to find jobs that pay more or less than industry averages. Comparisons can help an employee determine the fair value they offer.

This equation does not apply to business owners. Instead, they must use another one to determine their value.

The Business Revenue Equation

When you became a business owner, the way you earn money changed. You must now replace the Employee Revenue Equation with the Business Revenue Equation:

Differentiation + Perceived Value = Money received

For businesses, the customer is your employer. To earn money, you must create value with an offer—usually around a product or service—for a specific target market. Businesses that don’t do this well end up competing on price and establish no unique competitive qualities.

I’ll use two imaginary landscape companies to illustrate.

GVB Landscaping thrives with 40 employees, company vehicles, and a robust customer base. They have a website, are active on social media, and publish landscaping tips via blogs and videos. Their target market comprises affluent neighborhoods and resorts.

Meanwhile, Billy’s Lawn Care is a five-person operation that struggles to survive. While they have less overhead than GVB, their prices are 15-20% lower. They work for a variety of customers and rely on word-of-mouth marketing. They had a five-year business plan, but it fell to the wayside after the first year.

Both companies manage their money well and are skilled landscapers. GVB started small, just as Billy’s did, and grew into a large company.

So, how can one landscaper be so much more successful than the other They have done a better job of building value. How?

GVB created a brand.

Businesses that differentiate and create more perceived value will outperform those that don’t.

Now, let’s pick up where we left off and discover how to build a brand, create more perceived value, and select the right pricing strategy for your business.

Building a Brand Supports Your Pricing Strategy

Consumers have endless choices. To them, your business looks like all the others that do what you do. Because the marketplace is saturated, it’s tough for them to see your unique value.

That’s why you must show them what makes you different.

A brand is an impression people have of your business. It’s how they feel and what they think of you. It also helps them compare you to competitors.

Whether or not you know it, your business is already making an impression on prospective customers. And that impression is moving them closer to you or pushing them away.

The branding process creates more value for your products and services and makes you more competitive.

A powerful brand supports your pricing strategy. How?

It reinforces that the value you offer—functionally, technically, and emotionally—is higher than the price you charge. There’s a real connection between a company’s brand and the perceived value of its products and services. Starbucks, BMW, and Disney are just a few examples of brands that have built a superior value and quality reputation.

And none of them offer the cheapest option.

Consumers must believe your product or service is the best solution for them and that its value exceeds the price.

Pricing Strategies for Small Businesses

Now, let’s explore some specific pricing strategies. Though there are several, I’ll cover the ones used most by small businesses. To decide which is best for you, be sure it aligns with your business goals and target market.

Competitor-based Pricing

This pricing strategy is the most common. Competitors’ prices serve as a baseline. Other factors, such as demand and brand value, are secondary.

This method is the easiest. It’s also an effective method to use if you don’t have a specific target customer profile or sell at high volumes.

We covered the risks of this strategy in the sections above.

Cost-plus Pricing

This simple pricing method involves adding a percentage to the cost of goods and services. For example, if a product costs $50 to produce, and the goal is to make a 20% profit, the product’s price would be $60.

This pricing method is better for businesses that sell low-cost goods and services.

Hourly Pricing

Hourly pricing is a popular method for individual service providers such as attorneys, plumbers, and consultants. A “fair” hourly charge is based on average market rates.

The provider’s opinion of their services (quality, expertise) comes into play. Often, this will affect whether prices are above, below, or on par with market averages.

This pricing strategy can be challenging to implement because defining a “fair hourly rate” is subjective.

Penetration Pricing

This pricing strategy is popular among startups. The concept is to charge below-market prices in the beginning to get customers. Then, prices will increase as the business grows.

If you use this pricing strategy, it may be difficult to raise prices later. If you have positioned your business as a low-cost brand, people may resist the change. You may have to change target markets to support price increases.

Project-based Pricing

Project-based pricing allows the business to create a fixed price for work over a defined timeframe.

Be careful when estimating the time and work required for a project. You can end up investing much more time and money in a contract than planned, which can lead to considerable losses and unhappy customers.

Value-based Pricing

With this pricing strategy, research and data help determine the value of the product or service. Prices are then set just below their actual worth. This pricing strategy is effective because it creates the perception that the value received is higher than the price paid.

Keep in mind that it takes more effort to stay up to date on the value and cost of the product or service you provide.

Premium Pricing

This pricing strategy leverages psychology and brand building. You must be able to justify premium prices. Brand building and defined targeting can also support price levels.

I covered this approach in the sections above.

READ MORE: Premium Pricing Strategy for Small Businesses

Conclusion

Some key takeaways from this article are:

• Not everyone buys on price. Look for customers who appreciate the quality of work you do and the value you offer.
• Avoid chasing competitors and focus on creating perceived value.
• Leverage brand building to create differentiation.
• Research the pricing strategy best suited for your business goals.

Until next time,

Chris