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Overpricing

What is Overpricing?

Overpricing (also called prestige pricing) refers to the practice of setting a price for a product or service significantly higher than its initial perceived value. Essentially, it means charging more than customers are generally willing to pay for a particular offering.

Companies may choose to overprice their offerings for any of the following reasons:

  • Give the appearance of quality or exclusivity
  • Reflect a target customer’s desire to feel “elite” or “luxurious”
  • Create a sense of scarcity or urgency around a product
  • Reflect actual differences in supply and demand
  • Increase profit margins at the expense of sales volume
  • Isolate and prioritize higher-value customers by pricing out lower-value ones
  • Attract top-tier consumers willing to pay more for the latest innovation (market skimming)
  • Garner interest and demand for a product before eventually lowering the price

Although it seems counterintuitive to offer goods and services at a higher price than what’s considered reasonable, overpricing can actually be a successful pricing strategy for certain products and businesses.

If you’re selling a unique patented product, branding your business as “luxury” or “exclusive,” or selling to high-ticket customers with little price sensitivity, it could work in your favor. However, overpricing can have negative consequences for small businesses and most everyday products.

Synonyms

  • Overpricing pricing strategy 
  • Premium pricing
  • Prestige pricing

How (and Why) Overpricing Works

Focuses on Key Differentiators

One of the best ways to justify higher product prices is by establishing an association between the product and a key differentiator (its value proposition). This could be anything — product quality, design, patented technology, customer service level, branding, or even packaging.

By overpricing a product, a company might also be able to target specific customer segments that value product differentiation enough to pay a premium. This creates a more focused marketing approach and can build a loyal customer base that feels it is part of an exclusive group.

Implies Premium Products or Services

For some consumers, a product’s intrinsic value is more important than its cost. These customers are willing to pay a premium for products that offer superior performance, durability, or aesthetic appeal, especially in categories like electronics, automobiles, and fashion.

Consumers might see your product as an investment. If they believe paying more upfront will lead to lower long-term costs due to better durability or performance, they can justify the initial premium.

Instills Consumer Confidence

Many consumers use price as a heuristic, or a mental shortcut, to judge quality. A higher price can lead to the assumption that a product is made with better materials, offers superior features, or delivers a better experience. This is why companies that sell premium-quality products often realize there is no reason to adopt a competitive pricing strategy

Reinforces Brand Identity

There’s a certain degree of overpricing even in everyday, non-luxury goods. When you pay nearly twice as much for brand-name Bounty paper towels vs. generic ones, the brand is counting on your perception of its added value to justify a higher cost.

Nearly every brand-name product does this. They invest millions in advertising (and often do have a better product) to sway you to their side. In the case of Bounty, the paper towels are generally a little more absorbent, so they can get away with it.

Of course, these brands can ‘afford’ to come down on the price (and would maybe capture more market share if they did). But, to a certain extent, the target market somewhat expects to pay more for the product because it’s a trusted name.

Attracts Early Adopters

Especially in the technology sector, businesses sometimes use overpricing as their penetration pricing strategy. By setting an initial price considerably higher, they can attract early adopters (who are willing to pay top dollar) and use that as leverage when they start competing more on price with rivals.

The goal is usually to make enough of a profit on the product before lowering the price to its “regular” range. Early adopter customers are often some of the most valuable. Since others will follow suit at lower prices, it makes sense to generate as much sales revenue as possible from those willing to pay.

Apple is the perfect example of this. It’s well-known that the best time to buy a new iPhone is September — right after the next one has been announced.

Why? Because you can get a fantastic deal on the older model once they lower the price by $200+.

Appeals to a Price Insensitive Customer Base

There are several reasons rich customers don’t mind “overpaying.” This applies to B2C customers (rich people) and B2B buyers (enterprise companies).

  • For many of luxury fashion’s target customers, $500 is pennies compared to their net worth. And to some, a $500 designer-brand t-shirt is a status symbol that’s worth more than money.
  • Some consumers have no interest in comparing prices or looking for deals. They want what they want when they want it, period. That means going straight to high-end products where there’s less competition, and price sensitivity is lower.
  • Enterprise companies are happy to pay a consulting firm $100k+ for its services (even if all they do is interview team members, report back, and propose a seemingly obvious solution). Why? The business impact of this feedback is worth well into the millions, so $100k+ is a bargain.

In many of these cases, these types of customers won’t even consider a low-cost option, even if the quality is on par with the higher-priced option. There’s a general expectation that price = quality, so when money isn’t as much of an issue, guaranteeing quality is more important than cost savings.

Because They Can

A Vegas nightclub will never have a problem selling $50 drinks and $100,000 tables. A music festival food vendor will have lines of 20 people even if 3 tacos cost $25. A gas station in the middle of nowhere won’t have an issue bringing in customers while charging $7.00 per gallon.

What do these businesses have in common? Buyers have no choice. They’ll either pay the price or experience severe inconvenience in that moment.

It’s worth mentioning a business can only get away with this if its location plays a significant role in its perceived value. If customers can get a better experience or comparable product nearby, it almost certainly won’t work.

Advantages of an Overpricing Strategy

Higher Profit Margin

Of course, all things being held equal, producing the same output while selling it at a higher price leads to more profits. If the cost of goods sold is 50% and you charge $200 for your product, there’s a $100 profit margin per unit. By raising prices to $250, an extra $50 drops straight to your bottom line.

Reflects True Product Value

Thanks to the subscription economy (among plenty of other factors), consumers have become increasingly disconnected from the amount of value a product truly provides. The fact you can access the world’s music library for $10.99/month through Spotify or Apple Music is the perfect example of this.

It’s not always easy to put an exact dollar amount on something — especially if it pertains to quality and convenience. By setting prices higher than your competitors do, you’re hypothetically telling customers, “our product is worth more than our price” (assuming the quality is better than competitors).

Additionally, if people believe they’ll be better off after consuming your product, price sensitivity tends to go down. This is why certain products, such as info products, have high pricing power due to the perceived value of information.

More Resources to Improve the Product

In theory, overpricing can create artificially high demand and give a business more resources to improve the product.

A high enough profit margin gives you room for creativity in your marketing efforts, brand messaging, partnerships/sponsorships, and other areas of your business. With more cash on hand, businesses can afford to invest in research and development to enhance the product or service they’re selling.

The added resources could lead to a better quality product, which may justify a higher price point in the future. It’s a balancing act of sorts — higher prices lead to resource accumulation that leads to product improvement, which could then justify even higher prices.

Disadvantages of Overpricing

Fewer Sales

All the benefits of a premium pricing strategy work under one condition: people have to actually pay for what you’re selling.

For every “premium customer” you attract, there may be ten customers who refuse to buy your product. If your goal is to isolate a specific type of potential customer and charge more, then this is fine. But where increasing your market share is the goal, you’re better off finding the ideal prices to maximize sales volume and profitability.

It’s also important to remember that a competitive market might not even be able to support higher prices. If the overwhelming majority prefer competitor prices and there isn’t much room for a premium product, your only option for operating a profitable business in that space is to come down on pricing.

Price Hesitance

Your sales and marketing team will have to spend a lot more time addressing pricing-related objections if your solution is considerably more expensive than seemingly comparable ones. Even if your product truly is worth its cost, potential customers who don’t understand why they specifically need it will hesitate to spend more money.

This makes the education process all that much more critical. You don’t want to hard-sell or employ high-pressure tactics, but you do want to be diligent in communicating why your solution is worth its price.

Longer Sales Cycle

In addition to more time spent educating customers, buyers will go back and forth internally or spend more time thinking to themselves about whether to pull the trigger. Hesitant customers might take a few days to email you back or refrain from making a purchase on impulse.

Competition

In some industries, competition regulates the price. This is particularly true in industries with high levels of supply, market demand, and barriers to entry, like telecom, utilities, and aviation.

It’s also the case for industries with a well-established pricing structure, like SaaS. It’s rarely a good idea to reinvent the wheel when it comes to pricing if customers already have an idea of what they’re willing to pay.

Pricing Strategies to Use Instead of Overpricing

Cost-Plus Pricing

Cost-plus pricing is a straightforward pricing strategy where a fixed percentage or set amount of profit (the “plus”) is added to the total cost of producing a product to determine its selling price.

It breaks down into three components:

  1. Total cost — Calculate the total cost of the product, including direct materials, direct labor, and overhead costs.
  2. Markup — Decide on a markup percentage that represents the desired profit.
  3. Selling price — Add the markup to the total cost to set the selling price.

For example, if it costs $50 to produce a product and the company wants a markup of 20%, the selling price would be $60 ($50 cost plus $10 profit).

It’s best for industries like consulting and B2B manufacturing, where each contract is unique, and there’s a general expectation that the business will make a profit on top of operational costs. Small businesses also sometimes find it beneficial because it is simple to calculate and apply without extensive market research.

Competitive Pricing

Competitive pricing is a strategy where a company’s product or service prices are based on what the competition is charging. Rather than setting prices based solely on costs or consumer demand, a business using this strategy will gather data on competitors’ prices and then set their prices accordingly, which can be lower, higher, or the same as their rivals.

Purely competitor-based models are fairly rare because product differentiation, customer segmentation, and a busineses’s operating costs almost always come into play. It’s primarily used by startups that lack the historical context and market research to understand what their ideal price point is.

It’s also common in competitive markets with very little differentiation from product to product (e.g., telecom, airlines, and other natural oligopolies). In these cases, businesses aren’t trying to maximize profits; they’re looking to stay competitive in the market and maintain enough cash flow to keep going.

Dynamic Pricing

Dynamic pricing, also known as demand pricing or time-based pricing, is a flexible pricing strategy where prices are adjusted in real time based on market demand, competitor prices, time of day, season, or other external factors. This strategy uses algorithms and software to automatically change prices based on these variables.

Dynamic pricing is most commonly seen in the airline and hospitality industries, where prices can change daily or even hourly based on demand. It’s also becoming more prevalent in ecommerce and retail, where businesses can use real-time data to adjust prices based on market trends and consumer behavior. Amazon products, for example, update ~2.5 million times per day.

Bundle Pricing

When a company sells multiple separate components or complementary products, they’ll typically use bundle pricing to get customers to buy all of them. It enables a customer to purchase several items for one fixed price (lower than the per-unit cost

Bundle pricing is common in multiple industries, including:

  • Software
  • Gaming
  • Consumer electronics
  • Telecommunications
  • Contract manufacturing

Physical retailers also use it to encourage impulse purchases., where customers may be more likely to buy a bundle of products at a lower price than individual items. Fast food restaurants, for example, often have combo meals that offer several food items and a drink together for a discounted price.

Value-Based Pricing

Every business uses value-based pricing to a certain degree. It considers a product or service’s value (or perceived value) and sets a price accordingly. The challenge comes in defining that value, which isn’t always straightforward.

Value-based pricing is often used by businesses offering unique or innovative products where market research can only provide limited insight into consumer demand and willingness to pay. It’s also a useful approach when there aren’t many competitors for your product yet, as it allows you to capture a larger portion of the market share.

Promotional Pricing

Companies use promotional pricing when they want to increase short-term sales or brand awareness. This strategy primarily refers to discounting, but it could also include free trials, samples, two-for-one deals, and promotional bundles.

The goal of promotional pricing is usually not to maximize profit but rather to generate buzz and increase sales in the short term. Overusing it causes customers to wait for a discount, which is detrimental to your long-term revenue and brand perception. However, when used strategically and sparingly, it can effectively attract new customers and move inventory.

Economy Pricing

When companies become more efficient and pass those savings on to the consumer, they sometimes use economy pricing. They can afford to offer pricing tied to their production costs because they aren’t spending on marketing and advertising like most other companies.

Trader Joes, Aldi, and other supermarket chains use economy pricing. They keep prices low by having a smaller selection and buying in bulk. This approach is also common for commodity goods like gasoline, where there are many companies selling similar products at similar prices that fluctuate with the price of oil.

Using Pricing Software for Complex Pricing Strategies

Pricing software helps companies better understand their customers and the market, which eventually leads to price optimization.

Briefly, pricing software uses the following steps to achieve this:

  1. Collect data from various sources, including internal sales data, competitor pricing, market trends, customer behavior, and inventory levels.
  2. Analyze the data using sophisticated algorithms and artificial intelligence to gain insights into pricing trends, elasticity, and demand forecasting.
  3. Suggest optimal pricing for different products or services based on willingness to pay, the timing of price changes, and the impact of different pricing strategies on sales and profits.
  4. Real-time pricing allows for instantaneous, automated price adjustments in response to changing market conditions.
  5. Perform A/B tests on different pricing strategies to learn the most effective ones.
  6. Automate routine pricing decisions like setting discounts, promotions, or contract renewals based on product rules in CPQ.
  7. Integrate with CRM, ERP, and ecommerce platforms to ensure consistent pricing across all channels.

People Also Ask

What are the 4 pricing strategies?

The four most common pricing strategies are dynamic pricing, value-based pricing, competitive pricing, and cost-plus pricing.

Who uses premium pricing?

Premium pricing is used by companies that offer high-quality, unique, or innovative products or services. These companies often have a strong brand reputation and target affluent customers who are willing to pay a premium for the product’s perceived value.