Business Pricing Guide: How To Price Your Products or Services

February 24, 2021
Quick Summary: In this guide, you will learn everything you need to know about pricing your products and services, including understanding the Laws of Supply and Demand, how to perform Market Research, common pricing mistakes to avoid, and how to implement proven pricing strategies into your business.

Table of Contents


To run a business successfully, you need to know how to price your products and services correctly. Many business owners get lazy with their pricing strategies, which results in lower profits and potentially unhappy customers. 

Pricing your products the right way takes time and can get pretty complicated. This guide helps you understand the science behind your prices and clears up any misunderstandings. I will give you tips and tricks on what to do and what not to do, as well as a list of proven strategies that you can implement into your business. By the end, you will be a pricing professional.  

First thing’s first: You must understand how important the Laws of Supply and Demand are. This is the interaction between the sellers of a resource and the buyers of that resource. 

Supply is how much of a product you have, while demand is how many of that product is wanted by your customers. 

Generally, when the supply of a product is greater than the demand, prices are lower. However, when the demand for that product is greater, prices are usually higher.  

Additionally, if demand increases but supply remains the same, prices increase. If supply increases but demand remains the same, prices decrease. 

As you can see, supply and demand are the driving force behind great pricing techniques. In the next section, I will teach you how to perform Market Research to help you understand the supply and demand of your products in your market.  

Market Research

Cost Analysis

Let’s do a Cost Analysis of your business first. To do this, you need to calculate the Cost of Production of your products. The cost of production affects how much of that product you have to supply and the price it takes to supply it. This includes Overhead Costs as well, not just the literal costs of that item. 

There are two common mistakes that businesses will make: not factoring in all costs and expecting all costs to be covered under the sale of a single item. 

By not factoring in all costs, you will likely misprice your products. This hurts revenue and could potentially lead you to become unprofitable. 

Alternatively, expecting all costs to be covered under a single item is ridiculous. The goal is to set healthy Profit Margins across all of your items so that you build a substantial profit over time. 

Depending on what type of business you own, this can be more or less complicated. (A retail store has way more products than a lemonade stand.) When doing your cost analysis, you need to account for three main types of costs:

  • Materials are the raw components that it takes to produce your product. You should know the Material Cost Per Item. To calculate this, you need to know how much you spend on acquiring the supplies and how many products they can produce.

*Material Cost Per Item = Cost Of Supplies / Number of Products Produced

  • Labor costs are how much it takes to fund all of the physical and mental manpower necessary to create the product. This includes more than just hourly wage (insurance, retirement plans, payroll taxes, etc.). 
  • Overhead expenses are any expenses that aren’t covered under materials or labor. You can categorize these expenses into fixed and variable costs. 
    • Fixed costs are costs that you must pay every month, no matter how profitable or unprofitable you are. The amount is around the same every month.
    • Variable costs vary from month-to-month depending on external factors like seasonal changes or fluctuations in your profits.

*Rental Lease Payments, Interest Expenses, Depreciation, Utilities

*One-Time Expenditures, Marketing and Advertising, Shipping Costs

Once you have all of your costs, add them together for a combined total cost. When you set a price on your product, it should almost always be higher than the variable cost. This results in each sale contributing towards paying for your fixed costs, which results in a profit. 

Sometimes, however, you might purposefully lose money on a product to make more money elsewhere. I’ll touch more on that later in the guide. For now, it is time to select your Target Customer. 

Know Your Customers

Understanding your current customer base and potential consumers you are missing out on is a great way to know how you should run your business. 

First, you need to research these customers by understanding the following points:

  • Demographics: What are their age, gender, and income level?
  • Competition: List all of the options they might go through when comparing your products to the competition.
  • Motivation: When they make a purchase, do they prioritize priceconvenience, or status?
  • Value Perception: How much do consumers think your products are worth? (probably different than your price)

Once you do your research, segment your potential customers into three different categories:

  • Budget Sensitive customers focus on price the most. Discounts and Rebates work well on this group.
  • Convenience Centered customers will pay more for a product if it is more convenient than the alternative. 
  • Status Conscious customers focus on Brand Name and the quality of the product they are purchasing. They don’t mind spending more money if it means they get better quality. 

Now you can determine which one you want to target. 

There are two more factors that you should consider: Customer Acquisition Cost and Customer Lifetime Value.

Your Customer Acquisition Cost (CAC) is how much you spend to get new customers. For example, If you acquire ten more customers after spending $100, your CAC is $10.

*CAC = (Cost of Sales + Cost of Marketing) / New Customers Acquired

The Customer Lifetime Value (CLV) is a measurement of how much money a customer will bring your business throughout their entire time as a paying customer. Calculating this will help you understand how much profit you should risk acquiring new customers. 

It can be a good idea to sell a product at a loss if it gets new customers in the door. If you make good impressions, they will likely come back to spend more. 

*Customer Lifetime Value = Average Value of Purchase x Number Of Purchases x Length Of Relationship

Now that you have your Target Customer, the Acquisition Cost of that customer, and the Lifetime Value of that customer, you are ready to do the fun part: competitor research!

Competitor Research

Consumers are surprisingly good at selecting the best deal, which means they will look at your competition to make a purchasing decision. Since they make comparisons, you should too!

To do this the right way, you need to prepare a head-to-head comparison. 

  • Identify: The first step is to identify your competition. Who is selling the same products and is in the same market as you?
  • Customer Experience: Next, examine the customer experience that your competitors provide. Answer questions like:
    • How is their customer service?
    • How detailed are their product descriptions?
    • Do customers look happy?
    • Are customers leaving good reviews? 
  • Product & Pricing: Your pricing strategy should partly be based on your competition’s prices and products. If you provide a higher quality product, you can probably have higher prices than the competition.  
    • What are they pricing their products at?
    • Are their products high or low quality?
    • How many of each product are they selling?

You can get the information you need for this comparison through secret shopping, reading reviews online, and studying published data.

Finding this information will help reveal inefficiencies in your competitors that you can act on. Now, make a comparison to your business. Do you offer better products and a better customer experience?

After your comparison to the competition, you need to analyze your current pricing strategy. This can be tedious but is very important to running a successful business with long-term, sustainable profits. 

Price Analysis

You should be running a price analysis on your business every month. This will help you identify any opportunities for improvements you might be missing out on.

Before you run your analysis, it is a good idea to understand the relationship between costs, prices, and your customers’ actual perception of value in your product.

  • Cost is the amount you spend to produce the item you are selling
  • Price is the financial reward you get for selling that item
  • Value is what your customers believe the product is worth

Companies that don’t understand the relationship between these factors often end up underpricing or overpricing their products.

  • Underpricing is when a business sets its price too low in the hopes of increasing sales volume. This usually has the opposite effect because most consumers will perceive their products as “cheap” compared to the competition. Underpricing occurs when:
    • Cost Is Greater Than Price Or Value: If your cost of making the product is greater than the price you are selling it, you are underpricing the product. Alternatively, if your expenses are more significant than the product’s value, your costs are too high, and it will be near impossible to make that product profitable. 
    • Price Is Less Than Value: If the price is less than your product’s value, you can usually raise prices. Customers are willing to pay more, so it is probably a good idea to charge more. Businesses often ignore Consumer Surplus, which is the difference between what the customer pays and what they would have been willing to pay. Keeping Consumer Surplus in mind will help you maximize profits by not leaving any money on the table.
  • Overpricing is when a business is tempted to overprice their product because they misunderstand their customers’ perceived value in that product. Remember, consumers always look at your competitors. If your prices are too high, they will go to your competitors and leave you with decreased sales. Overpricing occurs when:
    • Price Is Greater Than Value: If you price your product higher than the amount the consumer is willing to pay, you are overpricing. When this happens, most consumers will go to your competitors because they think they can get a better deal. 

When your price is equal to the perceived value of that product, you are maximizing your profits. If you have made price changes in the past and are stilling have problems, you might need to look at your costs instead of your price.

If your costs are higher than the perceived value of a product, you will never be able to make that product profitable. In this situation, you should lower your costs and then adjust your price to the perceived value of the consumer. 

Now that you understand the relationship between costs, prices, and value, it is time to analyze your current prices. To do this:

  • Determine the true costs of your product
  • Understand how your Target Market and Customer Base responds to your existing pricing structure 
  • Review any legal or ethical constraints to cost and price

This analysis should give you a good idea of where you are currently and where it might be useful to make changes.

The next step is to set your revenue and profit goals!

Set Revenue Goal

With any business, it is vital to set goals and always be working towards those goals. You should set base revenue and profit goals. These are the minimum amounts that you would like to make from your business.

Of course, you want to make as much money as possible. We will go over how to do that soon, but for now, let’s set your base goals. It is essential to make these goals reasonable and achievable, which is why you should determine these goals after you do your market research.

First, set your revenue target. Take into account the total costs it takes to run your business for an entire year. Once you have our total yearly cost, add your desired profit margin on top to get your revenue target.

*Revenue Target = Total Yearly Costs + Desired Profit Margin

Once you have your total revenue goal, you will want to set revenue goals for each product. Start by calculating your Price Per Product for each item that you sell. To do this:

1. Find Your Base Production Cost Per Item

*Material Costs + Labor Costs + Overhead Expenses = Base Production Cost

2. Determine Your Profit Margin Per Item

*Base Production Cost x Markup = Profit Margin

3. Establish Your Price Per Product

*Profit Margin + Base Production Cost = Price Per Product

Doing this gives you a good idea of where to price your product around. This is used only to get a good idea of the whereabouts to set your price. This will usually not be your final price. Remember, The Map is Not the Territory.

Once you do this with every product, add them all up to ensure that the total is greater than your revenue target. If not, make adjustments to either your product prices or your revenue goal. 

To maximize profitability, set prices that reflect the value you provide, not just the costs. To do this, put yourself in your customers’ shoes. Are the prices fair? Take your emotions out of this question and look at it as a customer. 

Finance Your Business Needs Today! ➞

Mistakes To Avoid

Ok, now you should have all of your market research completed. You should understand your current costs, have comparisons to your competition, know which customer group you are targeting, and have revenue goals. 

You are almost ready to go through the various proven pricing strategies you can use in your business, but first, I want to touch on a few common mistakes that you should try to avoid. 

These mistakes could ultimately hurt your bottom line and result in you closing your doors if you are unaware of them. 

Mistake #1: Not Experimenting

The biggest mistake that businesses make is not experimenting with their prices. They often will put in the time to create a pricing plan but then won’t follow through with it. Or they will be lazy and use the same pricing strategy for years and years without making any changes at all. DON’T DO THIS!

Testing new prices, offers, and combinations of benefits and premiums to help sell more of your product at a better price is what creates a successful business. If you never test the fences, you never know how far you can go!

If you are running a business, you should always be testing everything: new products, new designs, new layouts, new marketing, and new prices. 

Markets are continually changing. With them, consumers shift their interests from one product to the next. To stay on top of these changes, you should always be testing new strategies and analyzing your current processes. To do this effectively, perform monthly analysis every month. 

Experimenting will allow you to maximize profits while also capturing more market share, which is the percentage of an industry that your business controls. By maximizing your market share, you can decrease your business’s costs through the “Network Effect.” 

The Network Effect states that the value of your product increases as more people use it. The best example of this? Social Media! The more people use Facebook, Twitter, Instagram, Snapchat, and Pinterest, the more profitable those companies become.  

Mistake #2: Not Monitoring

As previously states, experimenting new things is important. To do this effectively, you will need to monitor everything your business, market, and competition. 

Every month, you should :

Research

  • What consumers are willing to pay for your products
  • The perceived value of your products
  • What your competitors are charging
  • Whether your product has high visibility in the market
  • The average volume of your product that you sell

Re-Evaluate Your Costs

To sell right, you have to know how to buy right. If you are having a hard time selling specific products at an acceptable profit, it is probably because you are paying too much to provide that product. In this case, lower your costs to increase your profit margin.

Monitor Prices

You should continuously monitor your prices and profitability every month. Don’t look at just your business’s overall profitability; look at the profitability of every product you sell. This will allow you to measure how much every product you sell contributes to your revenue goal each month. 

Mistake #3: Not Understanding Price Elasticity

Price Elasticity is used to determine how a change in price affects consumer demand. It measures the relationship between a change in the quantity demanded of a particular product and its price. 

If consumers are still willing to purchase a product despite a price increase, the price is considered elastic. (cigarettes and fuel)

If consumers are unwilling to purchase a product after a price increase, the price is considered inelastic. (cable TV and movie tickets)

You can calculate Price Elasticity by dividing the Change in Demand by the Change in Price. 

* % Change in Demand / % Change in Price = Price Elasticity

For example, let’s say that you sold a product 10 times for $5 apiece in a week. The next week, you changed the price to $10 and only sold 5 of that product. The Change in Demand is five sales or 50%. The Change in Price is $5, also 50%. So the Price Elasticity is 1, which is pretty high. 

Calculating the Price Elasticity for your products will help you understand whether your products are sensitive to price fluctuations.

These mistakes can make or break a great business. Avoid them at all costs, and don’t get lazy with your prices!

Pricing Strategies

Ok, now it is time to pick your pricing strategy. These are some of the best and most used strategies across a wide array of business types. When creating your pricing plan, remember that you can use more than one. Test different combinations to see what works best for your business to maximize profits and market share. 

Cost-Plus Pricing

Cost-Plus Pricing

Cost-based pricing involves calculating the total cost it takes to produce a product, then adding a markup to determine the final price. Essentially, you make the product, add a fixed percentage on top of all costs, then sell it for that final price. 

Although this pricing model is fast and simple, it fails to account for influential factors like customer preference, brand awareness, and competition. Do not rely too heavily on this strategy because it completely ignores the laws of supply and demand.

Pros: This strategy is fast and simple, which gives you more time to work on other essential parts of your business. You should already be tracking your production and labor costs, so all you have to do is add a percentage on top, and you get your selling price. Doing this can provide consistent returns in the right market as long as your costs stay the same. 

Cons: If you run a complex business in a complex market (like most businesses), this is not usually the best strategy to go with. It doesn’t account for market conditions such as competitor pricing and perceived customer value. 

Competition-Based Pricing

Competition-Based Pricing

Also known as Market-Oriented Pricing, this model compares your competition in the market. Once you do your competitor research, you can decide whether you want to price your product above or below your competitor’s price. This should be dependent on how your product compares to your competitors:

  • Price Above: If you consciously price your product above the competition to brand yourself as having higher quality, you should actually have higher quality, and you should know how to market well. If your perceived value is less than your price, this will fail.
  • Copy Price: Selling your item at the same price could be an excellent way to maximize profit while staying competitive. Although, your products should be very similar. If your competition’s products have higher quality for the same price, consumers will choose them over you. 
  • Price Below: Carefully pricing your product below competitors is a great way to lure customers into your store. This strategy focuses on an increase in sales volume instead of a price increase. Before you choose this route, ensure that you will drive enough sales to make up for the missed profit per item sold by lowering your prices. Additionally, consumers often perceive a cheaper product as having lower quality. If your target customer segment is budget-conscious, this is perfect. If they are focused on status or convenience, this is not. 

It is important to know the costs of making your product and the quality of that product compared to your competition. Using this pricing data as a benchmark and consciously pricing your product around theirs can be a great pricing strategy. 

Keep in mind that your competition can change their prices too. If you change your prices by too much, you might cause them to do the same. 

This model is usually used in an industry with higher similar products because they are simpler to compare. For industries with difficult comparisons, price wars are generally not the way to go. Instead, focus on your brand appeal and the customer segment you are targeting. 

In markets with indistinguishable products (think airline industry), businesses use a competitive pricing model. A market leader often sets the standard, and all of the smaller competitors follow suit. 

If the smaller competitors wish to charge more, they must convince the consumer that they provide a higher quality product. Investing in the right marketing tactics can increase the perceived value of your products. 

Pros: If you can lower your costs per unit, this is a fantastic pricing strategy. While cutting costs and actively promoting your special pricing, you will most likely see a profit increase. 

Cons: There are a few caveats to this method, however. Lower profits mean lower profit margins, which means it can be challenging to sustain for long periods of time. Also, don’t forget that the competition can choose to change their prices as well. 

Premium Pricing

Premium-Pricing

Premium-Pricing, also known as Value-Added Pricing, is a sub-method of Competition Pricing. When you are consciously pricing your products above the competition to make yourself seem more prestigious or exclusive, you are using the Premium Pricing strategy. 

Remember, changing your prices depends heavily on your target consumers. If those shoppers aren’t price-conscious, they might accept higher prices when they perceive added value in your product. If you choose to go with this method, follow some of the tactics below to ensure it is successful:

  • Focus on Convenience: Some consumers would rather pay more for convenience than go out of their way to purchase the product. 
  • Branding: When focusing on a higher perceived value in your products, it is important to ensure your brand becomes well-known in the market. There are a lot of shoppers who will pay more money for a name they know and trust. 
  • Set A Trend: Certain customers are always the first to purchase the newest technology or the next big fad. If you think your product is an eligible trend-setter, you should market around this and consider partnerships with various influencers and content creators that focus on your target market. 
  • Create Scarcity: Creating artificial scarcity in your product is a great way to increase the perceived value. Consumers have major FOMO (fear of missing out). If they think they can’t get a product after a certain amount of time, they are more likely to purchase it. Be careful though, doing this can lead to frustrated consumers if you focus on the wrong demographics. 
  • Niche Down: Remember, everything comes down to supply and demand. If you are one of the only suppliers of a product in your market, and there is a high demand, you can probably raise your prices. Make sure you do this gradually over time instead of one steep price increase. Steep price increases lead to unhappy customers.
  • Customer Service: As online shopping is becoming more and more popular, customers rely on customer service more than ever. If you have fantastic customer service, this could set your business apart from the competition and result in returning shoppers in the future. 

Pros: If you focus on the right customer group, consumers will perceive your products as having better quality than competitors. The right consumers will be ok with paying more money if they feel that they are getting their money’s worth. 

Cons: Depending on your location and target customers, this can be very difficult to implement. If customers are budget conscious or have multiple other competitors to choose from, this pricing strategy could fail. Make sure you do your market research and understand your target customer. 

Dynamic Pricing

Dynamic Pricing

Dynamic Pricing (Other names include Demand and Time-Based Pricing) is a strategy in which you set flexible prices for your product based on current market demands and then change those prices every time that demands changes. This method is heavily reliant on the laws of supply and demand and requires high price elasticity. 

The most common examples of this type of pricing are Uber and gas stations. They are constantly changing their prices, and customers continue to purchase their products or services.

The price of your product will vary based on when and where you are selling it, as well as the demand for that item in that area. This method requires you to keep constant tabs on the demand for your product and then raise prices based on that. 

If you have the budget, you can use software that helps automatically apply dynamic pricing to your products:

Discount Pricing

Discount Pricing

A simple way to attract customers is to make them feel like they are getting a deal. Discount Pricing is the perfect way to do this. This strategy attracts new customers who might not have bought a particular product at a higher price. 

As with the other strategies, it is especially important to make sure you aren’t losing money through this strategy. To keep this profitable, keep your profit margins close to $0 or above. It is generally not good to sell products at a discount to get customers in the door when you are losing money.

The goal is to increase foot traffic in your store. Customers will rarely leave your store with only one item (especially if you are a retailer). So you use the discount to get them in the door and then upsell other items to increase profits and sales volume across the board. 

Pros: Attracting new customers will increase the foot traffic in your store, boosting profits and getting rid of old inventory. 

Cons: Be sure not to use this too often. Frequent discounts can lead to customers perceiving you as a bargain retailer and could hurt your products’ sales at everyday prices. It can also hinder the perception of quality around your brand.

Penetration Pricing

Penetration Pricing

Penetration Pricing or Price Skimming is one of the most common methods companies use to sell new products. The idea is to charge the highest initial price that customers are willing to pay, then lowering it over time. Again, this goes back to supply and demand.

As the demand for the first customers is satisfied, you lower the price to attract new, price-conscious customers. The goal is to drive more profit while demand is high and competition is low. 

Skimming the price is useful when:

  • Enough consumers are willing to purchase your product at a high price
  • The high price isn’t too high to where it attracts competitors
  • Lowering the price minimally impacts profitability 
  • The high price is perceived as exclusive and high quality

The best example of this is Apple. Every time they release new products, they go through this same pricing model. 

Alternatively, this can work the opposite way for new brands. Set lower prices to introduce your new product to the market to gain more market share, then raise your prices over time as the Network Effect sets in. 

Just remember to lower or raise your prices over time. Do not make sudden, significant price increases, or you will have unhappy customers.  

Pros: This method can lead to high, short-term profits when launching a new product. If you have a prestigious brand, skimming maintains this level of brand awareness and attracts loyal customers. This works exceptionally well with scarcity as well. High-demand with low-supply products can be priced higher, and as supply increases, prices drop. 

Cons: If you are positioned in a crowded market, it will be a lot more difficult to pull this off. If you slash prices too soon and too much after launch, you will bother early adopters. 

Loss-Leader Pricing

Loss-Leader Pricing

This is similar to Discount Pricing but is much riskier. Loss-Leader Pricing is when a store sells certain products below cost to attract new customers who will make up for losses through additional purchases. The idea is to attract customers with a desirable discounted product and encourage them to buy additional items with the discounted item. 

The difference between this and Discount Pricing is that businesses often know that they will not profit on items sold as loss-leaders. 

Like I said earlier, customers rarely purchase only one item. Using loss-leaders can attract large numbers of people who would otherwise shop elsewhere. As a result, these customers will likely buy other products that have a higher profit margin. 

Pros: By encouraging shoppers to buy multiple items in a single transaction, you will boost sales per customer and cover any profit loss from cutting the original product’s price. This is a great way to increase foot traffic to your store and creates an excellent opportunity for new loyal, returning customers.

Cons: If you overuse this strategy, customers might expect bargains and will be hesitant to pay the full price for products when you don’t have discounts. Also, if you don’t choose to discount an item that leads to other items being purchased, you can end up hurting your revenue instead of helping it.

Keystone Pricing

Keystone Pricing

Keystone Pricing is when a retailer simply doubles the wholesale cost that they paid for the product. This is a fast and straightforward way to price an item and can be very useful for highly commoditized products that are easily found elsewhere. 

However, this does not work with products with a slow turnover, high shipping and handling costs, or are scarce in some sense. If your product meets any of these points and uses Keystone Pricing, you are probably selling yourself short. 

Pros: This is a quick and easy profit strategy that generally returns substantial profit margins. Using this method will allow you to worry less about prices and more about your business’s day-to-day operations.

Cons: If you are doing this with the wrong product, you are likely selling yourself short. Depending on the item’s demand and scarcity, it might be a bad idea to mark up a product so high above the costs. 

Manufacturer Suggested Retail Price

MSRP Pricing

The Manufacturer Suggested Retail Price (MSRP) is a price that a manufacturer recommends to use when selling the product(s) you bought from them. Using this price can be a good rule of thumb on highly standardized products like electronics and appliances.

It is usually a good idea to deviate from the MSRP a little bit, but be careful. The manufacturer might cut ties with you if they find out you are selling their product for too much more than what they sold it to you for. 

Pros: This is a simple way to price your products. The price is backed by the manufacturer, who has likely performed its own market research to develop that price. 

Cons: This pricing strategy doesn’t take your profit margins and costs into account. Since you aren’t able to change the price too much, you cannot compete on price with your competitors. Thus, you are stuck with a product that isn’t profitable. 

Bundle Pricing

Bundle Pricing

Bundling Pricing, also known as Multiple Pricing, is when a store owner will sell more than one product for a single price. Products can be bundled together as an upsell, or a cross-sell, depending on the products they contain:

  • Upsells are used to convince the customer to purchase a higher-end product rather than the one they are thinking about buying.
  • Cross-Sells are used to promote complementary items that are related.

There are two types of bundles that you can choose to go with:

  • Pure Bundles contain items that can only be purchased with that bundle.
  • Mixed Bundles contain items that can also be purchased separately but are bundled for convenience. 

The idea behind this method is to reduce the “Pain of paying” for the customer, which is the emotional pain customers go through when spending their money. Bundling items together can seem like a good deal to the customer even if it isn’t saving them any money. This reduces the emotional pain, making it easier for them to make the purchase.

You can add perceived value to the bundle by offering a small discount on the total price or by throwing in a “free” item. The most common example of this is Buy-One-Get-One (BOGO) Discounts. 

Pros: Bundling items can lead to increased sales, reduced “pain of paying,” a surplus in inventory reduction, increased product awareness, and a boost in customer loyalty. If you do this method correctly, there is a high potential to increase your profits dramatically.

Cons: Bundling only increases profits if the bundle itself increases sales volume. If it doesn’t achieve this, you will be reducing your profits and might even be losing money.

Presenting Your Price: Psychological Pricing

After you create a pricing plan for your business, it is time to present your prices to your customers. To do this correctly, you need to understand the “Pain of Paying.” 

Every time we purchase something, we feel the “pain of paying.” This pain emerges from two different factors:

  • Saliency: We feel more pain when we see money leaving our hands.
  • Timing: We feel more pain if we pay after we consume rather than if we were to consume before we paid. 

To reduce this pain and increase profits, you can use Psychological Pricing. Also known as Charm Pricing, Psychological Pricing is the process of using psychological tricks to present your prices in a way that increases conversion rates by reducing the “pain of paying.” 

According to the Weber-Fechner Law Theory, consumers usually have a reference price attached to different products. This reference price is the price they believe the product is worth and is generally based on prices that they have seen before or have paid for in the past. There are different types of reference prices:

  • Internal Reference Prices (Value) are based on the consumer’s inner thoughts on how valuable each item they are looking to purchase is. This internal reference price is typically lower than the actual price that they pay. When the actual price is higher or lower than their internal reference price, the consumer experiences dissonance. Consumer Dissonance is the emotional feeling they get when the price differs from their expectations. The goal as a business is to minimize dissonance in customers as much as possible. If the price is lower than they expected, your product is underpriced. If the price is higher than they expected, your product is overpriced. 
  • External Reference Prices: Consumers also subconsciously “anchor” prices based on their surroundings. For example, suppose there is an expensive item next to an inexpensive item. In that case, the consumer will think the inexpensive item is cheaper than it actually is because they anchored to the expensive item’s price. Retailers use this technique to increase volume in smaller items. So External Reference Prices can increase Internal Reference Prices if done correctly.

Processing Fluency is another factor to consider when picking and presenting your prices. Processing Fluency is the speed at which we process information (prices). When we can quickly and subconsciously process a price, it feels good. So, an increased fluency in your price can increase your sales. 

If your price deviates too far from their Internal Reference Price or your prices are hard to process, you will be causing more pain. Below are External Reference Price Tactics that you can use to reduce your consumers’ Internal Reference Prices and the “pain of paying”:

Reduce The Left Digit

If you walk through any retail store, you will notice one common thing: most prices end with a 9, 99, or 95. Why is this? According to a 2005 study by Thomas and Morwitz, when the cents part of the price ends in 9, 99, or 95, it is perceived as less than if the number were to be rounded instead. 

Thomas and Morwitz found that it isn’t the ending numbers that made the difference but were the beginning number. This strategy only works if the first number is lowered by not rounding the price ( Instead of using $2, use $1.99). 

The reason for this goes back to anchoring. The left digit is the most important because it “anchors” the perceived magnitude of the number. Our brains process numbers so quickly that we often perceive the size of the number before we process the entire number. 

Due to the first number being smaller, we subconsciously think that the price is much lower than it actually is. This can result in increased sales, which increases profits.

Reduce the left digit by one

Choose Prices With Fewer Syllables

I briefly mentioned processing fluency in the intro to this section. Remember: it is the speed at which we process information. Processing fluency is affected by the syllabic length of the price that you choose. 

For example, the price $77.45 (Seventy-seven dollars & forty-five cents) has 8 syllables while $76.50 (seventy-six dollars & forty cents) only has 6. The first number takes more mental resources than the second, which makes it harder to process.

When we expend a larger amount of mental resources, we infer that the price must be higher. To prevent this, choose prices that don’t have very many syllables.

Choose numbers with fewer syllables

Remove The Comma

Another way to decrease the number of syllables in your price is to remove the comma. For example:

  • $1,199 (One Thousand, One Hundred Ninety-Nine) is 9 syllables
  • $1199 (Eleven Ninety-Nine) is only 6 Syllables
Remove the comma

Display Prices In A Small Font Size

Our brains have a universal concept of size that includes an unconscious overlap between visual and numerical sizes. This means that if your price is visually large, it will be perceived as numerically large by your customers.

To prevent this false perception, use a smaller font size when displaying your price. 

You can also choose to place this item with a price that has a smaller font next to items with prices with a large font. This creates an anchor and reinforces the perception of a small number.

On the flip side, the reverse works for discounts. Display discount numbers in large font sizes to emphasize the size of the discount.

Display prices in a smaller font

Use Words That Are Related To A Small Magnitude

Be careful about what words you are placing around your prices. If you want customers to think you have low prices, choose words that emphasize “small.” Alternatively, if you want customers to think you have the largest discounts, use words that emphasize “big.” 

This can be explained by the Regulatory Focus Theory, which demonstrates that human motivation is rooted in advancement (achieve a gain) and security (avoid a loss). Our purchasing decisions can be affected by whether we lean towards advancement thinking or security thinking.

  • “Get 25% Off” appeals to our advancement thinking.
  • “Save 25%” appeals to our security thinking.
Use words that are related to a small amount

Expose People To Higher Prices

Just like consumers anchor the magnitude of words to the price of a product, they also anchor prices of other items close to the item they are thinking of purchasing. 

When you are organizing your shelves or online store, put moderately-priced products next to more expensive products. This will make the moderately-priced products seem cheaper. This strategy works even if the two items aren’t similar at all. 

Expose shoppers to higher prices

Separate The Shipping And Handling

By separating the shipping and handling, you anchor people on the base price instead of the total cost. When people compare your price to their Internal Reference Price, they are more likely to compare your base price rather than the total cost.

This makes the item seem much more budget-friendly, which could increase sales. 

Separate the shipping and handling

Offer Payments In Installments

This uses the same idea as the previous tactic: anchoring people at a lower price. Instead of showing your product’s total price, provide the option and market around smaller increment payments.

Just like before, when you offer installments, you affect people’s comparison process. This makes them more likely to purchase your product because they perceive the price as cheaper than it actually is.

Another idea that has become more popular recently is to reframe the price into a daily equivalence. This framing influences people to perceive the price as even lower than before. You can also compare your price to a small cash expense, like a cup of coffee.

Offer payments in installments

Position Low Prices Toward The Left

When designing your pricing layouts, keep in mind that directional dues play a part in Charm Pricing. Just like most people have an internal association between “up” and “good,” we subconsciously have an association with “left” and “small.” 

We perceive small numbers as belonging to the left, so positioning prices to the left can trigger the association that the price is smaller than it actually is. Alternatively, if you want to emphasize your discount size, you can position those to the right. 

Position lower prices to the left

Show Prices At The Optimal Time

It is essential to know the order in which to reveal products and prices. This is especially true in marketing when you create video advertisements. 

In 2015, Karmarkar, Shiv, and Knutson found that participants based their purchase on the product qualities when products were displayed first. When prices were displayed first, participants based their purchase decision on the economic value.

So, if you sell luxury products, you want people to base their decision on the products’ quality. To do this, show the product then the price. 

Show product, then price on luxury items

If you sell utilitarian products, customers are more likely to make a purchase based on the purchase’s economic value. In this case, show the price then the product. 

Show price, then product on utilitarian products

Display Red Prices To Men

According to research by Nancy M. Puccinelli of Oxford’s Saïd Business School, male consumers perceive greater savings when prices were presented in red font compared to black. However, this same effect does not apply to females. 

When you are selling products that are marketed towards men, use a red pricing font. The red becomes the focal point of attention and becomes the only information that influences their purchase. 

Additionally, men associate red prices with savings, so showing your prices in red font could lead to increased sales from male shoppers. 

Display red prices to men

Sort Prices From High To Low

By sorting products by descending price, you can influence customers to choose more expensive options. There are two reasons for this:

  • Reason 1: Anchoring – When consumers read a list of products, they will most likely start from the top and go down to the bottom. The initial prices will generate their Internal Reference Price. When consumers evaluate these first options, all other options will seem like a better deal.
  • Reason 2: Loss Aversion – Humans generally focus on losses. When we choose an option, we worry about the option that we didn’t choose and the benefits we might miss out on. If you were to list your prices from low to high, as customers view each new product, they see a new loss in price. To avoid this, price your products from high to low. 

However, keep in mind that this is focusing on customers who are budget conscious. If your target demographic cares more about status, you can flip this and have the higher prices at the bottom of the list. Then, as they skim down the list, they will see value-added instead of the increased price.

Sort prices from high to low

Add Visual Contrast To Sale Prices

People are more likely to purchase your product when they feel like they don’t have to do research to make a good buying decision. By adding visual contrasts to your sales prices, you increase the emphasis on the sale. 

By creating visual contrast, you enhance processing fluency. Thus, consumers will be attracted to the sale much quicker. Here are some tips on optimizing your visual contrasts:

  • Font Color: Changing the font color will make it easier for consumers to compare the sales price to the original price
  • Font Size: Changing the font size has the same effect as changing font color, making it easier for consumers to make comparisons. This is especially effective when the sales price font is smaller than the original price font. 
  • Physical Distance: When the sales price is horizontally further away from the original price, people perceive it as a greater sale. 
Add visual contrast to sale prices

Remove The Currency Symbol

As we already know, the “pain of paying” emotion can be triggered pretty easily. Even the dollar sign in your price can remind people of the pain of losing their money. This results in consumers spending less.

To prevent this trigger, remove the dollar signs. However, don’t risk clarity by removing the dollar sign. If it is difficult to tell that a number is a price without the dollar sign, you should leave the dollar sign.

Remove the currency symbol

Charge Customers Before They Consume

By charging your customers before they consume, both you and your customers will benefit. For one, you won’t have to worry about being compensated for your product or service. By receiving payment first, you don’t risk consumers not paying for what you gave them.

Alternatively, the consumers benefit also because they will be happier with their purchase. When people prepay, they focus on the benefits they’ll be receiving. If they have already paid, their payments become more painful because they are focused on the money they lost instead of the benefits that might come with your product.

If your company offers products or services that come with monthly payments, always charge your customers at the beginning of the month. When you send their receipt, frame the wording as forward-looking. 

Charge customers before they consume

Create A Payment Medium

It is always a good idea to create some kind of payment medium. This will distort the customer’s perception of paying, so they won’t feel the pain of losing their money. The best example of this is gift cards. 

The customer pays for the gift card, knowing that they or their friends or family will be able to go back to the store and purchase something. When they go back to the store, they are no longer attached to the money. It is easier for them to make purchases using the gift card. 

create a payment medium

Add Slight Price Differences To Similar Products

If you have multiple similar products that are all priced the same, add some pricing variations. The Paradox of Choice states that people are less likely to make a choice when more options are available. The reasoning behind this can be traced back to loss aversion.

When people choose an option, they lose the benefits of the other options. Humans have a hard time grasping on to those lost benefits. Due to this, they postpone their decision temporarily or end up never making the decision. 

When two similar products are priced the same, consumers seek out other differentiating characteristics. This can hinder your sales. Instead, add slight price differences to reduce the need to search for differences. 

Consumers will rely on the price difference and assume the higher-priced item has better quality. 

Add small price differences to similar items

Use More Frequent Price Increases

The easiest way to make your customers unhappy is to suddenly and dramatically raise prices. Instead, control price perception by using the Just Noticeable Difference (JND). This is the amount of change that is just barely noticeable by customers. 

If you know you will need to raise your prices in the future, don’t wait till the last minute to raise them. Gradually increase them through frequent, small price changes that are just barely noticeable. This will avoid the possibility of customers creating a reference price for that product. 

If your price stays the same for years, people will become used to that price and will create a reference price. If you suddenly and dramatically change that price, they will compare the new price to the old price. The result? Very unhappy customers. 

Use more frequent price increases

Follow The “Rule Of 100”

When giving a discount, you want the discounts to be perceived as having a large magnitude. You can do this by following the Rule of 100. 

The Rule of 100 says to give Percentage Discounts on prices under $100 and give Absolute Discounts on prices over $100. You will be using a discount with a higher numeral which is perceived as greater by doing this. 

Offer percentage discounts on prices under $100
Offer absolute discounts on prices over $100

When To Offer Discounts And Free Trials

The Bottom Dollar Effect explains our tendency to feel less satisfied with our purchases if they exhaust our remaining budget. Most people set budgets on a monthly schedule, which means that their budgets are more likely to be nearing depletion towards the end of the month. 

These customers will feel more pain when purchasing products and services at this time. It is best to offer discounts around the end of the month. Since they have less money to spend, they are more likely to spend money on discounts rather than regular prices. 

Give discounts at the end of the month

Alternatively, you can offer Free Trials towards the beginning of the month when people are more likely to have more expendable cash.

Offer free trials at the beginning of the month

Remember, always consider your target customer base. This pricing trick assumes that your customers have a monthly budget. If your target customers don’t budget their money, this probably won’t work as well.

In Conclusion

Prices are one of the most important aspects of your business. You shouldn’t take them lightly. Spend the time and resources necessary to create and complete and well-thought-out pricing strategy. Doing this will maximize your profits and market share, which will ensure long-term success. 

In this guide, I talked about the Laws of Supply and Demand and how they play a role in pricing products. I explained how to perform crucial market research for your business and how to use that research to pick the right price for your products. This included evaluating your costs, customers, competitors, and current prices. 

Next, I brought up some common mistakes that you can avoid to get ahead of your competition. These mistakes will take some effort to avoid but are well worth the hassle.

Finally, I went through different pricing strategies that you can use in your business, as well as how to present those prices to your customers. 

You should now be much more confident in your business’s pricing strategy and, if implemented well, should start to see higher profits very soon!

Back To The Top

$
$ annually
All rights reserved @ Personal Loans 2021