Competitive Pricing Guide: Pricing for growth—not a race to the bottom!

Pricing has come up on a few recent client calls. Not our pricing, but theirs. What should their price point be? When do you raise prices? Hold steady? Lower them?

Today, let’s talk about pricing. We’ll cover different models for pricing goods and services, look at some examples of brands who price themselves differently, and evaluate how to price yourself for success.

Price-based selling, commodities, and undercutting: a deadly race to nowhere

First, let’s look at price-based selling. Price-based selling is the simplest way of looking at pricing. By undercutting competitors with a lower price, you all but guarantee customer growth. If you’re the cheapest to offer a given product or service, a certain percentage of your target market will default to you.

There are clear downsides to this approach. The most obvious appears directly on your balance sheet. Price-based selling cuts into margins. Even if you’re profitable selling at a low price, your competitors that charge more can invest their even greater profits into growth and improvement. If your margins are too thin, you will lack the resources needed to grow in the long-term.

Another problem is that someone else can always go lower. If you position yourself as the budget option, you face competition from new startups and massive conglomerates alike.

A startup or independent operator may choose to run at a loss to acquire clients or cut their profit margins to the bone to provide even more competitive pricing. Think of a landscaping company losing business to a teenage lawn mower willing to work for a fraction the price.

This is usually a temporary strategy, where the operator raises prices once they acquire a customer base. In some cases, it can be temporary due to specific market conditions allowing for lower-than-market pricing. Take our teenage lawn mowing example: due to the teen’s subsidized expenses (no overhead as parents cover their costs) they can enter the market at a lower price than any normal company. When that same teen is an independent adult, they will not be able to continue offering such a competitive price for their services. In a sense, this is how Uber and other apps disrupted existing markets. Because they were propped up with immense amounts of cheap capital, they could operate at a loss for years, gobbling market share until it made sense to start monetizing.

Sometimes it’s the big companies that compete on price. A large player in your sector may have the infrastructure and expertise to deliver their product more efficiently than you. Think of Wal Mart’s lowest price guarantee. The scale of their operations allow them to absorb occasional losses while consistently offering the lowest price for a huge range of goods. SMBs typically cannot afford to compete with this kind of scale.

Don’t make your product a commodity

A commodity is a product differentiated purely by price. Think of gasoline, wheat, or copper. Regardless of the producer, each product is essentially identical. In the case of an elemental metal like copper, it is literally identical—regardless of the mine it’s extracted from or the broker one purchases it from.

As price-based selling infects your market, it leads to cost-cutting measures and “efficiency-finding” that can leave each competitor’s offer feeling roughly the same. The overall quality of the product tends to suffer as businesses race to the bottom to compete on price.

A good example is the airline industry. Decades of no-frills providers undercutting each other have resulted in a price-based climate for economy class tickets. Brand loyalty is nonexistent as the average traveller simply chooses the cheapest flight compatible with their travel plans.

Brand Case Study: Apple. A Premium Product in a Commodified Market

 

Ubiquitous products tend to face commoditization. What’s more ubiquitous today than the smartphone?

Today’s budget and mid-range smartphones are capable of running almost any app and accomplishing almost every common task. A mid-range Motorola phone might not turn heads like a brand-new iPhone, but their functional capacity is about the same.

Yet Apple remains one of the world’s most profitable tech companies. Their phones haven’t become cheaper. Despite the introduction of their budget-friendly SE lineup several years ago, the average iPhone sold today is worth well over $800. Top-of-the-line phones have never been more expensive.

Apple rejects commoditization by focusing on user experience—and walled gardens. Once you buy in to the Apple ecosystem, it’s hard to leave. Their products work very well, but they play best with other Apple products. By creating an “Apple” experience and consistently framing themselves as the cool, trendy technology company, Apple maintains a level of exclusivity. Sure, you can do everything you need to do on a cheap Android phone. But once you’ve had the Apple experience, are you likely to go back?

For some, the answer is yes. But Apple’s continued market dominance suggests that many enter Apple’s walled garden and never leave.

Reactive pricing: letting the market set the price

A common way to set prices is by establishing a baseline from competitors and adjusting it to suit your business model. Let’s call it reactive pricing.

Reactive pricing can be a good starting point. It gets you in the ballpark immediately. Provided your research is accurate, you will have a range of competitor prices from high to low. Choose a position within that market based on your offer and you’re set.

A major drawback of reactive pricing is its potential for inefficiency. A reactive pricing strategy often results in median pricing. But what if your offer is truly better than your competitors? What if your sales team is exceptional? Setting a middle-of-the-road price might result in underwhelming margins. A bolder pricing scheme with higher prices might be trickier to sell, but the challenge could be well worth it.

Brand Case Study: Oldsmobile. Classic car brand courts youthful buyers, loses its edge

 

Oldsmobile was one of the longest-lasting vehicle brands in the world. Founded in 1897 and dissolved in 2004, the company produced reliable family cars with big engines and plenty of power. Positioned to sell to upper-middle-class buyers, Oldsmobile became perceived as a “grown-up car”—your father’s automobile.

In the 80s and 90s, Oldsmobile attempted to change this perception. Amid flagging sales, they launched new ad campaigns claiming that their newest vehicles were “not your father’s Oldsmobile.”

The campaign backfired, resulting in even more rapidly declining sales. In less than twenty years, the century-old brand would be put out to pasture.

Oldsmobile attempted to reach a new audience by changing what worked for them. They offered cheaper vehicles designed for an audience that had never been interested in their brand. Instead of attracting this new audience, they drove away their existing base, who had fond associations of the conservative, powerful, higher-end Oldsmobiles of yesteryear.

The lesson is clear. Higher prices don’t necessarily make a product less attractive. Price yourself for your specific market position, rather than chasing the same position as your competitors.

Value-based pricing: a fairer way to charge for services?

Value-based pricing emphasizes value delivered. Prices are set not by the cost of labour and goods, or indexed to any market average. Instead, value-based pricing sets prices based on the perceived value provided to the customer.

This is common for luxury brands. Take Rolex as an example. Their watches may be well-made and stylish, but their materials and craftsmanship aren’t worth $10,000 or more. Not until you factor in the perceived value to its customers.

Rolex watches are so valued by their audience that they become investments, often holding their value for decades. There is intrinsic value to the product beyond its function, and Rolex charges accordingly.

Luxury brands are one example of value-based pricing. It can be applied to industrial goods and services as well. For example, custom chemicals to enhance manufacturing processes may be relatively simple in their composition, but subtle differences in formulation can provide tremendous value to manufacturers. Instead of charging for the value of the materials and time spent blending the custom solution, a value-based company would charge based on the impact to the customer’s bottom line.

This can be a great win/win situation. Value-based pricing results in healthy margins for service providers. It encourages providers to deliver results; if the provider does not deliver consistent value, their value-based pricing model will fail. It sets realistic expectations for customers and providers alike. If a customer knows they’re paying for outcomes, they can hold their provider to their promises. Likewise, if a provider charges for value delivered, they have a clear and measurable target to hit.

Value-based pricing can be challenging to implement. It takes deep knowledge of one’s own products and services and their impact on your clients. It can also feel like a challenge to pitch your product with a price that isn’t tied to parts and labour. Many businesses in the manufacturing sector are more comfortable with a “parts and labour” pricing model. But we aren’t all automotive shops. Value-based pricing allows us to charge for intangible but important attributes—reliability, customer service, product experience, and more.

Freemium services, stubborn pricing, and more: alternative pricing models to consider

There are exceptions to every rule. While most companies benefit from straightforward competitive pricing, there are some interesting examples of other models.

Tiered services and free plans

Many software companies use what’s called a freemium model. Customers get access to a fraction of the software’s features for free and indefinitely. The best features are locked behind a paywall, whether it’s a subscription or a one time payment.

This is tricky to implement in the world of industrial products, but the concept of tiered offers is worth considering for some businesses.

Free or low-cost tiered services provide some benefits for companies looking to grow aggressively. By offering a base level service at a lower cost than competitors, you can capture market share quickly. Customers become used to your products and services. Provided the offer is structured correctly, with significant value gated behind a higher payment tier, many customers who purchase a starter plan will eventually purchase a higher tier.

Service providers like Amazon and Google excel at this model with their cloud platforms. It is more valuable for them to offer a wide range of “free” services with rate limits that prevent commercial use than to charge for every single use of their systems. By allowing hobbyists and students to learn their systems for free, they’re creating an audience of commercial customers once those hobbyists and students go pro.

Big tech companies also use a freemium model for consumer services like email and entertainment platforms. In this case, the free tier is paid for through advertising and data collection. If you’re getting it for free, it’s likely that you (or your data) are the product.

Stubborn pricing

Some companies stubbornly refuse to compromise their pricing. Think of two popular consumer products: Arizona Iced Tea, and Costco hot dogs.

The Costco hot dog is a logistical marvel. When introduced in 1983, it cost $1.50—about $4 today.

In 2023, it cost $1.50—or about $0.50 in 1983 dollars.

Costco leadership cited the deal’s ubiquity as a point of conversation as a key reason why they’re holding steady. When people talk about Costco, the $1.50 hot dog deal is one of the first things mentioned. For the company, providing the dog for—at best—a break-even price is well worth it to get people in the door and signed up for their membership.

It also speaks to Costco’s brand promise. Known for its exceptional deals on bulk items and no-frills shopping experience, Costco’s hot dogs perfectly encapsulate their ethos. Simple, cheap, and consistent. Costco doesn’t need to make money on hot dogs. It’s more valuable for them to continue to make good on their brand promise with consumers.

Arizona Beverage Company is another business with a stubborn pricing model. Their flagship product—oversized cans of iced tea—have maintained a suggested price point of just $0.99 in the US market since 1992.

In fact, the colourful cans have this suggested price printed directly on them—implicitly shaming stores that choose to sell them for more.

Arizona’s ownership claims they’ve kept costs down through automation and supply chain optimization, and that their beverage sales remain profitable. Their strategy keeps the Arizona brand a household name, while expansion into new markets like snack foods and alcoholic beverages provide alternate revenue streams.

Psychological pricing: anchoring and the power of “.99”

Many of the pricing models we’ve covered focus on big picture pricing: ensuring an appropriate margin, or keeping your price in line with competition.

The small picture matters, too. Dropping your price by a penny doesn’t hurt your margins, but it might boost your sales.

We all know that retailers price consumer goods using the “99 model”. Instead of selling for $25, sell it for $24.99. Research conducted in 2003 indicates that prices ending in a “9” perform better than prices ending in other digits—even if the other price is lower. The article highlights a dress that retails for $34. Raising the price to $39 increased sales by a third. The way humans perceive pricing isn’t always logical. A $39 price tag suggests that you’re saving money on a $40 purchase, while a $34 price tag implies that you’re spending $4 extra on a $30 purchase.

This tactic continues to work even once a consumer is made aware of the psychological manipulation at play. Despite our best efforts, we can’t turn off our subconscious minds.

Another example of psychological pricing is the anchoring technique. Anchoring involves playing different prices off of each other to convince the purchaser they’re getting a deal. You might propose a high price for a premium product or service—one the customer may balk at. When they do, you return with a bargain—your regular product at a more reasonable price. The customer’s expectation is now anchored at the premium price. They perceive your regular price as a deep discount, persuading them to buy.

Anchored pricing can be highly effective. It can introduce a “champagne problem”, however. What if the customer wants to buy the premium package? Before employing anchoring, ensure your anchor offer is something on which you can confidently deliver. It doesn’t need to be excellent value—again, it’s more of a tool for persuading customers to go with “plan B”—but it does need to be a legitimate offer.

AI pricing: can AI provide a better way forward?

AI is all the rage in…well, every industry. Everybody wants to know what AI can do for them.

Could AI be the next trend in pricing, too?

We don’t yet know how artificial intelligence will be integrated into business operations. AI services excel at analyzing large volumes of data. In the near future, an AI business assistant may be able to pull in competitor and historic pricing data to forecast the ideal price for your services over the next year. It may be able to adjust to emerging trends in real-time to maximize profitability, or even identify top leads in your CRM that are most likely to be motivated by specific discounts and value adds.

Of course, that’s a lot of trust to place in a robot! Given the current state of generative AI—powerful, but prone to hallucination and lying—it’s going to take some time for AI pricing to be trustworthy enough for your business. Traders and investment firms are already testing AI in the stock market. The day when AI business optimizers are commonplace and effective may be sooner than you think.

Conclusion

Pricing goods and services is far from a one-size-fits-all exercise. As we’ve seen, there are effective real-world examples of many pricing models across a range of industry sectors. The important thing is to price your products and services intelligently. Regardless of which model suits you best, ensure you have the data you need to make a confident decision.