Pricing Decisions

What are Pricing Decisions?

Pricing decisions are critical determinations businesses make when setting prices for their products and services, based on factors like supply and demand, price sensitivity, production and delivery costs, and competitor prices.

Examples of pricing decisions include:

• Determining a product price for a new product
• Figuring out how much more to charge for the next tier of a subscription service
• Deciding to increase or decrease prices in response to market changes
• Choosing between cost-based pricing and value-based pricing strategies
• Determining the optimal per-unit cost to implement usage-based pricing
• Calculating the total cost of a manufacturing contract based on overhead costs and markup percentages
• Defining parameters for discounts and promotions (e.g., how long they last, what thresholds a buyer has to meet)
• Setting a low end figure for contract negotiation
• Seeing whether a weekly or monthly billing cycle works better for your micro-SaaS

As you can tell, there’s a lot more to product pricing than a few numbers on your website. Everything from how much your customers pay to how often you bill them is a pricing decision that impacts how your business operates (and how your product sells). The more pricing variables there are, the more complicated it becomes.

Synonyms

• Price setting
• Product pricing strategies

Pricing Decision Objectives

Of course, the underlying goal of every pricing decision is to achieve price optimization — the “sweet spot” between covering costs, maximizing profits, and accurately reflecting product value. And, of course, successfully achieving that means better sales, happier customers, and a healthier business.

But beyond these top-level objectives, pricing decisions can also be made with other objectives in mind:

• Market penetration. You may decide to offer lower prices to attract more customers and gain a foothold in the market (penetration pricing).
• Influencing perceived value. Through your marketing strategy, you might build trust, create an emotional connection, highlight a need, or develop a trend that makes customers feel like they need your product, irrespective of the price. In those cases, a slightly higher price than your “off-brand” competitors can actually reinforce the idea that your product is “better.”
• Competitive advantage. It’s sometimes advantageous to set prices below competitors’ to undercut them and gain a larger share of the market. Other times, it’s smarter to use a less complicated pricing structure to make yourself seem more trustworthy or user-friendly.
• Brand positioning. Businesses sometimes charge premium prices to position their product as high-quality or exclusive, or they may offer lower prices at lower margins to appeal to a more budget-conscious market.
• Psychology. There are plenty of psychological pricing tactics out there, all of which serve to influence how people perceive prices and decide whether or not to buy. For example, you may price something at $10.99 instead of $11 to make it seem cheaper, even though there’s only a one-cent difference.

All of these decisions have consequences. So, the core objective of the pricing decision-making process is to make decisions that are as low-risk as possible while showing a potential upside for the business.

How Pricing Decisions Impact Company Profitability

Like we said, every pricing decision counts. Consumers ultimately buy your products or invest in your services with their money — something they take very seriously. If your pricing, their needs, and your ability to deliver on their needs don’t add up, you won’t have a sustainable business long-term.

Take Netflix, for example. The company faced significant backlash in 2011 when it attempted to separate its streaming service from DVD delivery, effectively raising prices by 60%. While this sounds like they’d see higher profitability, it ultimately led to a loss of 800,000 subscribers and a 77% drop in stock price.

When the company made this decision, there were a few glaring issues:

• Reed Hastings, then-CEO, ignored others’ concerns.
• Netflix misinterpreted the growing preference for streaming content as a rejection of DVDs altogether.
• The changes were poorly communicated, which caused frustration among the customer base.

In the decade following, Netflix managed to increase prices with far less outrage by framing subsequent price increases as necessary investments in the consumer experience (which they actually delivered on).

It’s worth mentioning higher prices aren’t always the gateway to better profits, though. In many cases, lowering prices can drive sales enough to compensate for the dip in profit margins and ultimately lead to higher overall profits. And, if that same company can become more operationally efficient, they can recoup those margins and gain more customers at the same time.

15 Factors to Consider When Pricing Products and Services

1. Market demand

How many customers are willing to pay for your product or service? How elastic is the demand? How many sales can you realistically expect?

The overall demand for what you’re offering will have a major impact on your pricing strategy. If you know there’s significant demand for your product or service, you may be able to charge higher prices.

On the flip side, you probably won’t have much luck charging high prices for a low-demand product — that is, unless your target market has very specific needs that your product fulfills and they’re willing to pay that price to fulfill them.

2. The competitive landscape

When you look at market conditions, you should always compare to the number of competitors around you. If you’re one of the only companies offering something that’s of high value, the sale price becomes much less of a factor, and you may be able to charge premium prices.

For example, gas stations in the middle of nowhere often decide to price their gas higher than in other areas because there are few, if any, competitors. If you’re driving through a rural area in the mountains and you’re out of gas, you’re taking the $7/gallon deal because it’s the only station for miles.

The same concept applies to businesses selling in local markets and setting localized prices. In that case, you have to make pricing decisions according to locals’ purchasing power and availability of other local options.

3. Competitor pricing

Competitive pricing, where you set your prices in relation to your competitors’ prices, is part of nearly every major pricing decision, especially in markets with well-established competitors.

In the CRM software market, for example, there’s no reason to charge an exorbitant amount or try to be a loss leader. And there’s no reason to diverge from the standard tiered pricing structure buyers are used to. That would only confuse them.

While your product is obviously different from others’ in some way, part of your decision-making process should analyze what customers are paying for similar products (or expect to). Since they’re going to see the selling price before they hear you out, you need them to think it’s reasonable to get them into the funnel.

4. Value and quality perception

A lot of factors influence perceived value. Depending on the nature of your product and how you sell it, this will have a different impact on your pricing decisions.

If you’re selling a commodity product, price will probably be a larger factor in the customer’s decision-making process because they can get it at the market price elsewhere. If your product is highly specialized and you market it correctly, you might get them to buy even if it costs 4-5x a similar product.

There are, however, things that are more important than money to many of your customers. This could be:

• Feelings
• Appearance
• Social status
• Convenience
• Exclusivity
• Performance

Ultimately, this comes down to knowing your target market. If you know they pride themselves on having the best of the best, you’ll want to put more emphasis on quality and performance, then reinforce that by setting higher prices.

5. Customers’ willingness to pay

Price sensitivity is the other side of value perception. If you have customers who are only willing to pay a certain amount for your product, that’s your upper limit for prices.

Aside from perceived value, a few factors determine price elasticities and what customers would be happy with paying for your product:

• Their need (or perceived need) for it
• Purchasing power
• Availability of alternatives
• Prices of alternatives
• Opportunity cost of buying vs. not taking action
• Your product’s expected ROI

Expectations are also important here. Generally, a customer looking for the highest-quality item knows “you get what you pay for.” They’ll be turned off by a product that seems too cheap.

You can evaluate willingness to pay by surveying your current customers about whether they’d pay more or what they think the product is actually worth. You could also conduct external market research to see how closely your prices align with their expectations.

6. Variable and fixed costs

Some businesses, like grocery store products, find success by being loss leaders. Others might be comfortable burning cash to create something innovative (Uber didn’t become profitable until its fifth year after IPO).

For most, looking at cost structures before determining a sale price is a much smarter approach. You’ll want to consider:

• Production costs
• Raw materials expenditures
• Packaging and shipping costs
• Labor costs
• Overhead expenses (rent, utilities, etc.)
• Commission rates (if you have salespeople)
• Development (for SaaS companies)

For the costs that vary, like raw materials, you’ll want to look at the unit costs for each item/service. Also pay attention to how they fluctuate throughout the year, so you can give yourself enough wiggle room for when costs increase.

7. Economic conditions

The economy doesn’t always have the impact on purchasing behavior that you’d think it would. For instance, some businesses actually do better during recessions, as people look for ways to save money. Peloton’s sales more than doubled from 2019 to 2020, then doubled again in 2021, despite it being the middle of a pandemic and their machines being priced at a premium of ~$1,500.

There are, however, a few different economic scenarios that affect customer behavior and your pricing decisions:

• Inflation
• Unemployment rates
• Consumer confidence
• Interest rates and borrowing power
• Disposable income levels

These factors will influence how much people are willing to spend, as well as what they perceive as a reasonable price for your product.

8. Regulatory constraints

Depending on the industry you’re in, there may be legal limits to how much you can charge for certain products. For example, pharmaceutical companies are often heavily regulated and required to justify their pricing decisions.

Beyond those requirements, there are other regulations that might affect your prices. These could include taxes, tariffs and duties (if importing/exporting), minimum wage laws (affecting labor costs), and environmental regulations (affecting production costs).

9. Brand positioning

When you make pricing decisions, you want them to reflect your brand and its values. As an extreme example of this principle, high-fashion brands burn much of their excess inventory instead of selling it at a discount.

While that isn’t an eco-friendly approach, it does preserve their brand identity as exclusive and high-end. If these companies were to admit how much of their product went unsold and release it at, say, half the cost, many of their customers would wait for a sale, thus reducing the perceived value of their brand.

Also consider your product positioning and how much authority you have in your niche. If you’re constantly featured in the media, have a cult-like following, or are generally seen as the “expert” because of your content, you can almost certainly get away with charging more.

10. Distribution channels

Your distribution strategy will also play a role in your pricing. If you’re selling through retailers, they’ll take a cut of the price you’ll have to factor into what you charge.

If you’re using ecommerce platforms like Amazon or a 3PL, they will also take fees for each sale. These fees can range from a small percentage to a fixed amount per transaction, so be sure to factor them into your pricing decisions.

Additionally, if you’re selling through multiple channels (e.g. website, brick-and-mortar store, third-party ecommerce platforms, value-added resellers), you’ll need to implement every pricing decision across all channels.

11. Skimming or penetration strategy

As part of your go-to-market strategy, you might use price skimming or penetration pricing in the short term.

• Price skimming involves high-price/low-volume sales to cover costs and capitalize on the novelty of your product.
• Penetration pricing is the opposite: offering a lower price initially to gain market share, with plans to increase prices later.

Which one you choose depends on your objectives. If you’re a SaaS company that needs funding, has high development costs, or wants to quickly grow its user base, go with penetration pricing. If your product is established and/or there is a lot of hype from a specific audience, you can use price skimming to your advantage.

12. Promotional strategies

If you want to draw in price-sensitive customers, you might offer competitive prices for a limited time as a promotional offer. Once your customers have familiarized themselves with your product, some of them will be more willing to stick with it after the promotional period.

Promoting your brand and product through limited discounts, free trials, flash sales, or bundling products together can also increase brand awareness and loyalty, making customers more likely to purchase at a higher price point in the future.

Running a promotion doesn’t always have to be related to pricing, though. You might try to generate top-of-funnel demand for your product by highlighting a specific risk of not using it — for example, why failing to invest in New Software X is “killing your business.” If that’s the case, you probably wouldn’t decide to price the product lower.

13. Product bundles

Bundle pricing is a special type of pricing where you offer two or more complementary products at a discounted price, usually lower than the cost of buying each item separately. For example, Microsoft Office bundles Word, Excel and Powerpoint for a single license fee.

Bundling is an effective pricing strategy to drive sales by offering discounted bundles to attract customers and as well increase order value per customer. It also gets your customers to use more of your products, instead of potentially using a competitor’s for one or two tasks.

Pricing product bundles can be tricky becayse you don’t want to lose potential revenue by pricing too low, but you also don’t want to price too high and discourage customers from purchasing. You also don’t want to give too much of a discount, because your profit margin could take a big hit.

14. Production scale

Economies of scale is the reason major companies like Amazon and Walmart can come in and undercut practically any market they want.

The idea behind economies of scale is that the more products you make and sell, the lower your fixed costs are per unit. Essentially, by producing in large quantities, the cost of making each individual product decreases.

This can have a major impact on pricing decisions, as it may allow for lower prices while still maintaining a healthy profit margin. Even as a small business, if you anticipate significant growth or want to encourage higher efficiency, lowering prices could be a viable option.

15. Supply chain dynamics

There are two sides to this coin:

• How costly is your supply chain?
• Do your customers care?

In some industries, customers are less sensitive to the price of products when they know of a supply chain shortage. For instance, if the price of smartphones went up because semiconductors are in short supply, customers would still buy them. And they’d blame the semiconductor market.

Those same customers don’t care how much it costs to develop and maintain an app like Uber, though. They only care whether it’s cheaper to call one or use a taxi service.

To determine whether to price according to your supply chain costs or find other ways to optimize, consider whether your product is a necessity. Then, look at how the market reacts.

Importance of Making Data-Driven Pricing Decisions

Despite the fact that most companies rigorously test their marketing and sales strategies, relatively few use data to optimize their pricing models. This is a missed opportunity that can have significant impacts on revenue and profit.

Collecting and analyzing data allows you to understand your target market, competitors’ prices, and consumer behavior. It also enables you to track changes in supply chain costs, distribution fees, and all the other variables impacting your final decision.

Examples of Pricing Decisions in Various Industries

Apple Vision Pro and Meta Quest 3

Apple released its hyped-up Vision Pro in early 2024 with a price tag of $3,499. Apple is well-known for price skimming — every year, the new iPhone, MacBook, and iPad models come out with a higher starting price than the previous model. And they always come down.

While Apple’s pricing decisions are based on the expectation that they’ll capture as much sales revenue as possible from early adopters and earn the rest later, they’re also generating a lot of demand for which Meta could be the beneficiary.

While the Meta Quest 3 isn’t exactly on par with Apple’s product, it starts at $499. By setting their prices considerably lower and strategically planning their release shortly after Apple’s, they’ll capitalize on the existing demand Apple has created but can’t fulfill because their product is unaffordable to most.

Basecamp and Twilio

Basecamp, a project management and team collaboration platform, employs a flat-rate pricing model. They charge a flat fee of $99 per month, offering 500 GB of storage, unlimited projects, and unlimited users without any per-user fees.

Twilio, on the other hand, adopts a usage-based pricing model, which is quite common among infrastructure software companies. This model’s cost directly relates to how much a customer uses the service, with prices adjusting based on usage levels such as the number of gigabytes of data used or API requests made.

In SaaS pricing, decisions are all about knowing how your customers will use your product. Basecamp’s customers value straightforward and predictable costs because they’re using the platform in the same way every day​​. Twilio’s customers have fluctuating needs, so they’re looking for scalability and a lower barrier to entry.

Technology Used to Implement Pricing Decisions

Pricing Software

Pricing software collects and analyzes data from customer behavior, market trends, and competitor prices, to provide valuable insights. Some pricing software also offers features for dynamic pricing, where software tests and adjusts prices in real-time based on fluctuations in demand, supply, and other factors.

Artificial Intelligence (AI)

AI-powered tools, such as machine learning algorithms, can analyze large amounts of data and provide valuable predictions and recommendations for pricing decisions. They can also assist with dynamic pricing, continuously adjusting prices based on real-time market conditions.

CPQ

Configure, price, quote (CPQ) software helps companies streamline their sales processes by automatically generating quotes and proposals based on predefined pricing rules and configurations. Modern CPQ platforms also help businesses make pricing decisions with the help of AI.

Billing

Billing software helps companies take a retrospective look at their pricing decisions by tracking and analyzing sales data, customer lifetime value, and other metrics. This data can provide insights into pricing strategies and opportunities for pricing optimization.

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