Pricing strategy for your small business will set the standard for your product or service in the marketplace, and is an important dimension to both your bottom line and your competitive edge. Early in the life of your small business, research your intended market as deeply as possible, and pay close attention to past fluctuations in competition and demand.
When developing a business plan, owners often make the mistake of setting their pricing strategy to match the lowest-price provider in the market. This approach comes from a cursory understanding of direct competitors, and the assumption that the only way to win business is by having the lowest price.
Don't Compete on Price Alone
Having the lowest price is not a strong pricing strategy for small business, as it invites customers to see your product or service as a commodity, and obscures the value of your offering. If you're operating within a niche market, larger competitors with the ability to lower operating costs may eventually enter your segment, and can destroy any small business attempting to compete on price alone. Avoid the low price strategy through research on the market you intend to enter, and by repeatedly analyzing the following variables:
Ceiling Price: The ceiling price is the highest price the market will bear, which can be explored by surveying both experts and consumers, and by asking questions regarding pricing limits. Keep in mind that the highest price available on the market may not necessarily be the ceiling price.
Competitive Analysis: Don't exclusively look at your competitor's pricing; look at the whole value of what they're offering. Are they serving price-conscious consumers or an affluent niche? What are the value-added services, if any? How do you compare?
Price Elasticity: This method shows the responsiveness, or elasticity, of the demand of a product or service when nothing changes but the price. Jill Avery, a senior lecturer at Harvard Business School told the Harvard Business Review:
"Marketers need to understand how elastic, sensitive to fluctuations in price, or inelastic, largely ambivalent about price changes, their products are when contemplating how to set or change a price. Some products have a much more immediate and dramatic response to price changes, usually because they’re considered nice-to-have or non-essential, or because there are many substitutes available."
Choosing Price Strategy for Your Business
Once you understand consumer demand within your market, review your own costs, supply chain, and profit goals as a way to inform your choice on pricing strategy. Below are a few pricing models to consider:
- Cost-plus pricing: The selling price is determined by adding a markup to the unit cost.
- Competitive pricing: Setting a price based on the price of the competition.
- Value-based pricing: The price is based on the perceived or estimated value of a product or service.
- Price skimming: Setting the price high initially and then lowering as competitors enter the market.
- Penetration pricing: The price is set low to rapidly enter a competitive market and provoke word-of-mouth recommendations, only to be raised later.
Avoiding a Price War
A price war is when competitors continually lower their prices to undercut one another and gain market share. This almost never works out in a small business' favor, especially when competing against globalized pricing. According to Wharton School marketing professor, Z. John Zhang, the outbreak of a price war is considered a legitimate and effective business strategy in China:
“Chinese companies do have a lot more experience with price wars, which are widely reported business events. They are good at it. In the past 10 years, what triggered the price wars is the fact that the markets in China are growing. This business environment provides many profitable opportunities for [companies] to engage in price wars and to hone their skills. In a growing market, there are all different companies competing—some good, some bad—and the industry finds a way to consolidate. The only way to do that is a price war, where you bring down the prices and squeeze out the inefficient [companies].”
But in the U.S., Zhang explains, the markets are more mature and they offer, “oligopolistic competition among mostly equals and [therefore] encourages more finesse in devising marketing strategies.”
Below are tips to avoid a price war with your competitors:
- Develop your brand name to build recognition of your small business and to build resilience if a price war ensues.
- Find unique values which your business can add to stand out in the marketplace.
- Provide products or services that are exclusive to your business to ensure further protection from falling prices.
- Eliminate high maintenance goods and determine what customers do and don't want through market research.
If you create market research habits early in your journey as a small business owner, you will have greater foresight when setting prices for your products or services, and an ability to adjust when necessary. Research will help you avoid taking a problematically low price-position in the market, and will provide valuable insights into how your future customers will spend money.