Pricing Structure

What is a Pricing Structure?

A pricing structure is the method and rationale a business uses to price its goods or services. It’s a critical component of a business’s overall strategy, as it not only affects profitability but also how the market perceives its offerings.

The key determinants of a company’s pricing structure are:

• The nature of the product or service they offer
• The target market and its buying power
• Price sensitivity
• Competition within the industry
• Cost structure
• Marketing goals and objectives
• Company growth stage

Most industries have a well-defined pricing structure new entrants use as a North Star. For instance, most SaaS companies use a combination of tiered, flat-rate, and usage-based pricing models.

This structure is ideal for these businesses in particular because it allows them to maximize revenue without compromising on the value they provide their customers. And, of course, customers understand and are willing to pay for this approach (which is the ultimate goal of any pricing method).

Synonyms

• Pricing method
• Pricing plan
• Pricing strategy

Pricing Structure and Pricing Strategy: What’s the Difference?

The difference between a pricing structure and a pricing strategy lies in their scope and application within a business model.

• A pricing structure refers to the specific way prices are set or organized within a business. It deals with how prices are arranged for different products or services and can include various models such as flat rate, tiered pricing, pay-per-use, bundle pricing, and psychological pricing.

For instance, a flat rate pricing structure means customers pay a set amount for a product, while tiered pricing structures offer different price levels based on features or usage.

The choice of a pricing structure often reflects the nature of the product or service, customer needs, and the business’s operational model. It’s more about the “how” of pricing — how prices are displayed and organized for the consumer​.

• A pricing strategy is broader. It encompasses a business’s overall approach to set and adjust prices to achieve its financial objectives. It includes considering factors like market demand, competition, cost of goods sold, and brand positioning.

Normally, it’s the company’s broader goals — maximizing profits, increasing market share, or positioning the brand in a certain way — that drive the pricing strategy. Examples include cost-plus, value-based, competition-based, and dynamic pricing.

There is overlap here in the terms they describe (these are all considered pricing structures). But when we refer to a pricing strategy, it’s more about the “why” behind pricing decisions — why a certain price point is chosen based on various internal and external factors​.

Importance of Pricing Structures in Growing Revenue

The importance of pricing structures in growing revenue for different types of businesses lies in their ability to balance profitability, market competitiveness, and customer value perception. Businesses strategically employ various types of pricing structures to create a sustained competitive advantage.

• Businesses entering a new market often use penetration pricing, setting lower prices to quickly gain market share.
• Companies with innovative products might use price skimming, initially setting high prices before gradually reducing them.
• Companies in highly competitive markets might use competition pricing, setting prices in relation to competitors’ prices.
• Businesses with a range of products often use product line pricing, where they set different price points for different products based on features and quality.
• Psychological pricing, such as setting prices at $9.99 instead of $10, plays on customer perceptions to make products appear more affordable.
• Premium pricing gives the impression of a high-value, luxury product.
• For businesses with a broad range of customers, variable pricing allows for custom pricing negotiations, especially for high-value clients or large-scale deployments.
• A tiered pricing structure, where different features or service levels are offered at different price points, caters to a diverse customer base and enables businesses to target budget-conscious and premium customers.
• SaaS and service industries charge a fixed price per user, while usage-based pricing charges based on the actual usage of the service or product.

Each of these pricing structures has unique advantages that can be particularly effective in certain business contexts. By carefully selecting and implementing the appropriate structure, businesses can effectively grow revenue while creating value for their customers.

How to Determine Your Company’s Pricing Structure

Taking a strategic approach to pricing doesn’t just impact your bottom line. It also shapes brand perception and customer engagement​.

Here’s a step-by-step guide to determining your company’s pricing structure:

1. Do your homework.

Research is always the first step.

• Your target audience
• Their value perception
• Competition
• The marketplace
• Local laws and industry regulations
• Production costs
• Rent, payroll, and taxes
• Sales and marketing expenses

All this information impacts the pricing strategy you use. Map out all your operating costs, competitor prices, market demands, and how your customers will perceive your product.

That’s how you determine your product positioning (and, by extension, how pricing could fit into that).

2. Define your success metrics.

Once you’ve organized all your research, you have to decide how you’ll measure sales performance. Will you look at the number of subscription sign-ups or units sold? Is top-line revenue more important than a numerical sales figure?

Here are a few examples of sales metrics:

• Revenue generated
• Average order value (AOV)
• Customer lifetime value (CLV)
• Gross profit margin

Of course, you need to look at all of these. To properly evaluate your pricing structure, though, you’ll want to look at all of these from the perspective of product pricing.

Let’s say you sell a B2B SaaS subscription, so you use a tiered structure. To understand the success of each particular tier compared to the others and as a whole, you’d look at revenue generated from subscription sales separately for each tier.

3. Set your base price.

All pricing plans have a baseline cost, whether it’s a flat rate for a product or the starting price of a tiered plan. This makes your whole pricing structure understandable for customers. And, for you, it serves as the reference point for all the other elements of your strategy — you can assess how other price points perform, when and how much to discount, and other high-level decisions.

Usually, your base price should cover your production costs and overhead while still allowing some room for profit. It also sets the foundation for your pricing structure. Since your product is more valuable to some customers than others, your tiers should be based on the value of features and level of service.

4. Build a pricing model.

Together, your success metrics and base price should guide the next level of pricing decisions. It’s essentially the final step in the series of actions aimed at defining the optimal pricing strategy for your business. This is where you decide how your business will grow its customer base and expand.

This includes planned pricing changes throughout the year and accounts for how different external factors can impact your business. Let’s say you’re a retailer that sells beachwear and swim products. Every year, summertime is your time to shine.

There’s obviously no point in reducing your prices between April and June. Everyone’s lining up to get new spring/summer clothing. But, as fall approaches, much fewer places will be warm enough to enjoy beach life. That’s when you put your spring/summer collection on sale — some customers think they’re getting a good deal, and your inventory would have just sat there otherwise.

In every business, situations like this are planned well in advance. To optimize your cost structure, you’d plan production for at least six months ahead. In the next stage, you’ll monitor how sales go and adjust your prices based on previous performance.

A subscription company would have different challenges in this step. There’s normally less of a seasonal influence (people tend to subscribe to software platforms year-round), but you have to consider usage-based elements.

Allowing customers to add others to your account, for example, would mean additional revenue without even needing to close a whole other customer. On a $30/month subscription, you might charge an additional $10/month for anyone added.

There are millions of ways to approach your full pricing model. The point is, the final mix of different pricing strategies (and the actual number you set them at) should be optimized for sales/marketing efficiency and profitability.

5. Experiment with different prices and strategies.

There’s a 100% chance you won’t get it completely right on your first go. In reality, you’ll probably never find the ‘perfect’ price for anything — it’s always changing. And you won’t have any idea how customers will react until you actually list your prices.

Today’s customers are fairly used to dynamic pricing, a pricing strategy where prices fluctuate based on demand, seasonality, or other factors. Think about Amazon, which changes its pricing once every ten minutes.

Once you introduce your pricing structure, measure your product’s performance against the metrics you defined at the beginning. Get a month’s or quarter’s worth of sales to establish a baseline. Find what works and what doesn’t, and use that to refine your pricing structure over time.

Of course, be careful here. Subscription customers value consistency. And B2C customers probably won’t value your product at a higher price if they see it available for 50% less the next time they shop for it. Testing prices is a delicate balance between finding what your customers will pay and delivering consistent value.

Types of Pricing Structures

Cost-Plus Pricing

Cost-plus pricing is one of the most straightforward pricing structures out there. The formula is simple:

Production Costs + Desired Profit = Final Price

It’s easy to calculate, but it doesn’t always reflect the true value of a product and can lead to over or underpricing. If you only factor in your costs, you’ll fail to account for your product’s actual worth to customers.

Value-Based Pricing

Value-based pricing focuses on determining what customers are willing to pay for a product based on its perceived value. This pricing structure holistically accounts for product value:

• How much a product solves a problem for customers
• The quality of the product
• Its uniqueness and differentiation from competitors
• Real willingness-to-pay data from customers

There are two main types of value-based pricing: good value pricing and value-added pricing.

Good value pricing is about setting a “fair” price, which could be high or low. Amazon is a great example of a company that could realistically charge more, but instead passes on the benefits of its operational efficiency to the customer. Luxury airlines are the opposite — customers happily pay the premium because they’re happy with the proportional improvement in the experience.

Value-added pricing is the concept of offering additional bundled services (i.e., more value) as a way of justifying a higher cost. For example, a software company could convince more customers to choose a higher tier if they offer white-glove support. Even if they might not benefit from all the additional features, they might choose that tier specifically for the dedicated support.

Usage-Based Pricing

Usage-based pricing models align costs with customer usage patterns, making them attractive to customers who prefer paying for what they actually use.

Popularly used by subscription-based companies, this pricing structure often involves tiers with different features and usage limits. For example, a company could offer a basic plan priced at $10/month for 100 GB of storage, and then charge an additional $5 for every 50 GB after that.

Per-user pricing is another common usage-based model, often seen with software platforms. This involves charging per user, regardless of how much they use the product. A company could offer a $15/month plan for five users and charge an additional $5/month for each additional user.

Price Skimming

This approach effectively recuperates development costs and maximizes profits over a product’s lifecycle. Price skimming involves launching a new product at a high price and gradually decreasing the price over time. This is particularly useful in industries where there’s heavy competition or fast-changing technology.

The advantage of this pricing structure is that it can help you quickly recoup your costs, especially if you’ve invested heavily in research and development. It can also take advantage of early adopters who are willing to pay a premium for the latest and greatest product.

The downside is it can alienate price-sensitive customers or those who feel like they’re being taken advantage of with the high prices. It also requires careful planning on how quickly to decrease prices over time, as you don’t want to lose too much profit in the process.

Penetration Pricing

Penetration pricing is the opposite of price skimming. In this approach, companies set a low initial price for their product to attract customers and gain market share quickly. The goal is to establish a foothold in the market and then gradually increase prices over time.

This strategy can be useful if you have a new product or are entering a highly competitive market. It allows you to quickly penetrate the market and gain customers who are sensitive to price. If you’re selling on a marketplace like Amazon, it’s a strategy that can help you reach enough orders to tip the algorithm in your favor.

Dynamic Pricing

Dynamic pricing is a newer pricing structure that uses algorithms to constantly adjust prices based on market demand and other external factors. This can be seen in action on e-commerce sites, where prices for certain products may fluctuate throughout the day.

The idea behind dynamic pricing is to find the optimal price point for each customer at any given time. While this approach can lead to maximizing profits, it also requires advanced technology and data analytics to be successful.

Variable Pricing

Variable pricing comes in lots of shapes and sizes. Here’s a look at the most common:

• Surge pricing (Uber charges more during peak demand times)
• Location-based pricing (gas stations charging more in rural areas)
• Time-based pricing (matinee movie prices vs. evening prices)
• Seasonal pricing (higher travel costs during peak vacation season)
• Custom pricing (enterprise and bespoke products and solutions normally require quote-based prices)
• “Pay what you want” (some media outlets and charities use this approach)

While it may not be ideal for all products, it’s a good fit for industries where external factors can significantly impact demand and sales.

Freemium Pricing

Freemium is an element of lots of SaaS companies’ pricing structures because it can help capture leads and demonstrate value. Essentially, the company offers a basic version of its product for free (or a free trial period) to attract potential customers.

The idea is that once they’ve seen the value in the product, they’ll be more likely to upgrade to a paid plan for additional features or functionality. This also helps with customer retention as users become more invested in the product after using it for free.

Bundle Pricing

Bundle pricing, where multiple products are sold together at a discount, encourages customers to purchase more. This increases the overall sales volume and average order value. This can also be used as a value-add pricing strategy, where additional services or products are bundled in with the main product for a higher overall cost.

This approach works well for companies selling complementary products or services and helps increase the perceived value of each individual item in the bundle. It’s also an effective way to upsell customers who may have only been interested in one product. If a competitor also sells the complementary product, you’re also capturing more market share by doing this.

Psychological Pricing

Psychological pricing takes advantage of the fact that people often make purchasing decisions based on emotion rather than logic. This includes strategies like:

• Using a “charm price” (just under a round number) to make it seem more affordable
• Offering discounts for products with prices ending in certain numbers (like $0.99 or $0.95)
• Implementing “anchoring” by showing a higher price first, making the actual price seem lower in comparison
• Using words like “sale” or “limited time offer” to create a sense of urgency

While these tactics may seem manipulative, they can be effective in driving sales and increasing perceived value for customers. They also add value to the customer by helping them make a purchase decision more quickly and feel confident in their purchases.

Subscription Pricing

Subscription-based pricing could refer to any combination of pricing strategies on this list, so long as the company’s main source of income is recurring revenue.

Subscription-based pricing can come in many forms, but it’s normally structured as monthly or annual payments. It’s a popular choice for B2B SaaS companies and other subscription-based services like Netflix and Spotify.

Time-Based Pricing

Time-based pricing is a form of dynamic pricing where prices change based on the time of purchase. This is commonly seen in industries like travel, where airfare and hotel prices generally increase as the departure date gets closer.

This can also be used to incentivize customers to purchase during off-peak times by offering discounted prices for certain periods. For example, a restaurant may offer lunch specials at a lower price than dinner to attract more customers who probably wouldn’t go there otherwise.

Geographic Pricing

Geographic pricing is an ecommerce pricing strategy businesses use to set prices for different regions, countries or cities. Depending on where a customer is located, shipping costs, taxes, and cultural differences may affect what they are willing to pay for a product.

This form of price localization is particularly useful when considering international markets where prices might be different due to varying currencies and cost of living. For it to be economically feasible, though, businesses need to achieve economies of scale and have robust logistics networks in place.

Loss Leader Pricing

A loss leader is a company that sells its products at a loss to get more customers or sell other products. Large retailers who use loss leader pricing to drive traffic and sales to their stores, with the hopes of gaining loyal customers that evenually buy other items at regular prices.

This approach really only works for large companies. Unless they’ve prepared for it ahead of time, most smaller companies can’t afford to take a loss by selling an unprofitable product.

Odd-Even Pricing

Odd-even pricing is a form of psychological pricing where prices end in either odd or even numbers. It’s believed that customers perceive items ending in odd numbers as being cheaper than those ending in even ones (e.g., $9.99 vs. $10).

While this may seem insignificant, research has shown that it can make a difference in customer purchasing behavior. This is why you often see retailers using this strategy, especially for products that are priced slightly higher than competitors.

Cost Leadership Pricing

Cost leadership is similar to loss leadership in the sense that it involves selling products at a lower price than competitors. However, in cost leadership, the goal is to still make a profit by keeping costs low and operating efficiently. 

Premium Pricing

Premium is a special type of pricing strategy where businesses charge a higher price for their products or services than competitors. This is usually done when a company offers unique features or high-quality products that justify the higher price.

Premium pricing can also create an aura of exclusivity and luxury, making customers feel like they are getting something special by purchasing from the brand. Whether they actually are or not, part of the customer’s perceived value lies in the fact that they’re paying an excessive amount for it.

Anchor Pricing

Anchor pricing — or anchoring — is a pricing strategy where companies place a multiple items near one another to create a point of reference for the buyer. Since we see one number before the other, we tend to remember that first number and use it as a baseline when evaluating the product’s value.

Anchoring can either turn attention toward a lower- or higher-cost item. For example, if you’re trying to sell a $200 item, you could place it beside a similar $400 item. By doing that, the shopper would compare your product to the more expensive one, and think your product is a bargain.

Auction Pricing

Auction pricing is a type of dynamic pricing where prices are determined by an open market bidding process. This can be seen in traditional auctions, but it’s also used in online marketplaces like eBay and Amazon.

In this model, the price is not set by the seller, but rather the buyer who is willing to pay the most for an item. This allows sellers to potentially make more money by pitting buyers against each other.

EDLP (Everyday Low Pricing)

EDLP is a pricing strategy where companies set prices consistently low and rarely have sales or promotions. This can create a sense of trust with customers, as they know they’re getting the best price without having to wait for a sale. It also simplifies pricing for both the business and the customer.

Managing Complex Pricing Structures

Challenges

Here are five major challenges businesses often struggle with when managing complex pricing structures:

• The scattered and uncoordinated nature of pricing data leads to inconsistencies and errors in pricing.
• Offering multiple pricing options based on features, user categories, or product quality adds complexity, as it requires a nuanced understanding of a diverse customer base.
• A lack of integrated software solutions leads to manual workarounds, resulting in human errors and time-consuming processes.
• The inability to quickly update prices with changing market conditions can result in price inefficiencies that negatively impact revenue.
• To prevent revenue leakage and ensure pricing accuracy, regular audits of pricing structures are necessary.
• Developing and maintaining dynamic pricing systems is resource-intensive.

Technology and Automation

To help businesses manage complex pricing structures more efficiently and accurately, technology and automation play a crucial role.

There are three platforms that primarily contribute to this:

• Configure, price, quote (CPQ) software helps streamline the process of creating and delivering accurate quotes to customers. It also integrates with pricing data to ensure consistency across all quotes and sales channels.
• Pricing optimization software enables businesses to analyze market trends, competitor pricing, and customer behavior to determine the optimal price for their products.
• RevOps software uses advanced algorithms and machine learning to optimize prices in real-time based on demand, supply, and competitor activity.
• Subscription management software allows businesses to set up and manage recurring pricing models with support for flat-rate subscription plans, usage-based pricing, and tiered pricing.
• Billing software is ideal for service-baed businesses, which have to handle complex pricing structures such as hourly rate pricing and project-based billing

It’s worth mentioning some of these tools work together. CPQ, for instance, can be integrated with billing software to seamlessly create invoices based on the pricing data.

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