There’s been an odd misconception floating around the world of marketing and sales as of late…
For some reason, many entrepreneurs, business owners, and “thought leaders” seem to think that it’s no longer necessary to focus on optimizing the prices of their products.
Giving the benefit of the doubt to these individuals, the spread of this misconception may be due to a misunderstanding of the idea that most modern consumers place an increasing amount of value on factors like customer experience and the level of service and support companies provide them.
While this is certainly true, that doesn’t mean that optimising your pricing strategies has little to no bearing on the success your company experiences.
On the contrary, the more this misconception spreads, the more important it will become to have a proper pricing strategy in place.
In other words, since many other companies within your industry may inadvertently be neglecting their pricing strategies (and instead focusing on other aspects of their service), you may stand to benefit from focusing on this more basic aspect of your business.
(Of course, this isn’t to say that the other aspects are any less important. The point is you shouldn’t ignore your pricing strategy in favor of other areas.)
In this article, we’re going to discuss:
- The most effective high-level pricing frameworks for ecommerce companies
- The most effective ground-level pricing tactics used by successful ecommerce companies
- Why, when, and how to utilize these frameworks and tactics to help your ecommerce company grow
Before we dive in, though, let’s take a moment to discuss why it’s still incredibly important to optimize the prices of your ecommerce products.
The Importance of Price Optimisation
As we said, although price isn’t the only factor consumers consider when making a purchasing decision, most consumers absolutely do pay attention to price whenever they’re about to open their wallets.
Case in point, 80% of consumers say competitive pricing is the most important factor for driving purchasing decisions. And, even if they believe it isn’t the most important factor, nearly half of consumers rank pricing among the top three factors influencing their purchasing decision.
It’s also worth noting that, according to data collected by Strategy&, 61% of consumers visit retail and ecommerce sites specifically to compare prices of similar items.
From a business standpoint, your choice of pricing strategies and tactics have a number of far-reaching effects. Implemented correctly, your pricing strategy of choice can provide for maximum profitability across the board – from your most expensive to your least-valuable products. On the other hand, a poor approach to pricing can be incredibly detrimental to your sales numbers, your profit margin, or both.
With all this in mind, let’s take a look at the most effective pricing frameworks used by many successful ecommerce companies today.
The Three Most Commonly-Used Pricing Frameworks for Ecommerce
We’ll get into the more “down and dirty” pricing tactics used by both on- and offline companies a bit later in this article.
Before we do so, though, we need to discuss the overarching pricing frameworks and philosophies that essentially inform how and why you may choose to implement the tactics we’ll talk about in a bit.
Let’s dive in.
Cost-Based pricing is perhaps the most common and well-known pricing frameworks in existence.
(Speaking in general terms, cost-based pricing is typically how most “outsiders” assume companies price their products.)
Essentially, cost-based pricing is the process of marking up a product (by either a percentage or a dollar amount) over the manufacturer’s or supplier’s initial price – whether for the product itself, or the cost of the sum of the product’s parts.
Cost-Based pricing can be broken down into one of three different types:
- Markup pricing
- Margin pricing
- Planned-Profit pricing
Markup pricing considers the difference between the price a company sets for an item and the original cost of that item to the company.
The formula for markup amount is as follows:
(Selling Price) – (Original Cost)
Taking this a step further, markup percentage is then measured using the following formula:
(Markup Amount) / (Original Cost)
For example, if the price you pay your supplier comes out to $10 per unit, and you want to sell the product for $15, the markup amount would be $5:
($15 Selling Price) – ($10 Original Cost)
The markup percentage for the product would be .5, or 50% of the original cost:
($5 Markup Amount) / ($10 Original Cost)
Working backward, you’d then know that you’d want to markup the prices of your products by 50% in order to sustain this pricing model.
Margin pricing takes markup pricing a step further, and looks at the actual profit margin of a given markup percentage for an item.
To determine your optimal margin percentage, you first need to calculate your gross margin:
(Selling Price) – (Cost of Goods Sold)
You’d then take this number and divide it by the Selling Price of the item, and multiply this number by 100:
(Gross Margin) / (Selling Price) x 100
Using the example from above, your gross margin would be $5:
($15 Selling Price) – ($10 Cost of Goods Sold)
Your margin percentage would then be 33.33%:
($5 Gross Margin) / ($15 Selling Price) x 100
Again, working backward, you can use margin pricing to determine what your actual profit will be per unit sold (rather than total revenues).
(A quick side note: Though not exactly a topic for discussion within this article, it’s important that you understand the difference between Markup and Margin Pricing, as confusion in this area can lead to major unexpected losses down the road.)
Planned-Profit pricing requires companies to determine how much profit they intend to generate overall by selling a specific product, then fix the price of each individual unit accordingly.
The formula for planned-profit pricing is:
(Cost) + (Desired Profit Margin Per Unit)
So, if a clothing company intends to make $10 per sale of a specific t-shirt, and each shirt costs the company $2 to purchase (or have made), the planned-profit price would be $12 ($2 + $10).
As for whether or not to use cost-based pricing in your own business, it’s important to consider the pros and cons.
First, the benefits:
- It allows you to easily determine the price at which you offer your products
- It ensures a certain amount of profit from each sale
- It allows you to justify price increases if the cost per product increases on your end
However, there are definitely some major drawbacks to cost-based pricing, as well:
- Because you won’t be taking into consideration the competition, you may end up overpricing your products – or underpricing them
- Because you won’t be taking into consideration consumer demand for your products, the same issues may arise
- Consumers typically don’t care about costs to your company, so they may not react well to an increase in the price they pay due to issues on your end
Overall, cost-based pricing may be a decent way for fledgling ecommerce companies to get started, but it’s typically not sustainable in the long run. Not only is it company-centric by nature (a big no-no by today’s standards), but it also forces companies to operate in a vacuum of sorts – which, of course, is not how things work in the real world.
Also referred to as market or competitor-based pricing, dynamic pricing is the process of using industry standards to set prices competitively – but such that increased profitability is ensured, as well.
While getting started with dynamic pricing can be done manually, your first order of business should be to invest in software that allows you to:
- Easily collect and analyze industry data
- Calculate the profitability of different price ranges for different items
- Potentially create pricing segments (more on this in a bit)
The manual part, of course, is understanding what data to collect – and what it all means.
Regarding your industry, you’ll want to know the average (mean) price of a specific product, as well as the most common price and mid-range price for said product. The case may very well be that you don’t necessarily need to undercut your competitors; you might simply need to offer a price that’s a bit lower than that which most companies offer the same product for.
You’ll also, of course, want to take into consideration the profit margin you hope to attain, as well as the overall revenues you hope to generate, by selling the product in question. Completely undercutting your competition might lead to an increase in your sales numbers, but if you aren’t making as much per sale as you’d hoped, your sales numbers are a moot point.
Another important factor, here, is your store’s reputation. Reason being: the better your rep, the more flexible you can be with your dynamic pricing. For example, take a look at the following screenshot:
Notice how much higher Foot Locker has priced the same running shoe? Being the popular sneaker depot it is, there’s little doubt the company still generates a ton of sales at this higher-than-average price – a feat which almost certainly couldn’t be accomplished by a smaller brand.
At any rate, once you’ve determined the price at which you want to set your products, you want to keep a close eye on your conversion rates and revenues, as well as on fluctuations within the market that will dictate the need for a change in your pricing.
(It’s called “dynamic pricing” for a reason, after all.)
The benefits of dynamic pricing are as follows:
First of all, it allows you to find the “sweet spot” in terms of sales and profit generated. In other words, you won’t be undercutting the competition to make more sales (and sacrificing profits in the process), and you also won’t be losing sales by unintentionally setting your prices too high.
Additionally, dynamic pricing allows you to increase your prices when doing so is deemed acceptable to – or, at least, expected by – the consumer. Simply put, as the average price of the product in question increases, you can feel free to increase the price at which you offer the product accordingly.
Still, dynamic pricing does come with a few downsides and/or pitfalls to watch out for.
Firstly, implementing dynamic pricing can be time- and labor-intensive – not to mention costly. As mentioned earlier, you’ll almost certainly need to invest in a software solution that allows you to analyze industry trends via automation and other assistive measures. Moreover, dynamic pricing, by nature, isn’t a “set it and forget it” type deal; you’ll need to stay abreast of changes within your industry at all times – or find yourself losing out to your competitors immediately.
Another thing to consider is that price fluctuations – whether up or down – can cause hesitation among your customer base. At best, switching up your pricing too often may cause consumers to wait until the price of a product goes back down before they purchase it from your store – even if this means waiting ad infinitum. At worst, doing so might cause your customers to begin distrusting your brand altogether – causing them to move on to one of your more steady competitors.
Finally, dynamic pricing can potentially cause price wars to break out among you and your competitors. In turn, everyone involved will begin a “race to the bottom,” which will essentially decimate profit margins across the board.
While typically used by companies within service industries (such as airlines and hotels), dynamic pricing can be utilized to success by ecommerce companies, as well – as long as it’s approached cautiously and strategically.
Above all else, the main thing to consider when implementing dynamic pricing strategies is to do so within a set of defined parameters (such as minimum and maximum prices, and a maximum amount of changes in a specific amount of time). In doing so, you’ll be able to make changes to your products’ prices as necessary without the risk of falling into one of the aforementioned traps.
Value-Based pricing is the process of setting prices for your products based on the value of said product from the customer’s perspective.
In other words, with value-based pricing, your goal is to determine the exact amount of money your customers would be willing to part with in exchange for a specific product.
As value-based pricing is, of course, a more customer-centric undertaking, you’ll want to first develop and consult your customer personas. In addition to basic “on-paper” demographic data (such as income level, occupation, etc.), you’ll also want to dig deep into the psychographic and behavioral aspects of your customers, such as:
- Their goals for using a specific product
- The benefits and features of a product that are important to them (and which aren’t essential to them)
- Their ability (and desire) to spend money on the product
Once you’ve determined these factors, your next step will be to determine exactly how your products fit these expectations.
For example, take a look at the following Google Shopping results for a search for “Chromebooks”:
For individuals looking for a simple word-processing laptop, that $749 Pixelbook is way too expensive. Sure, it has extra features and all; but if these features don’t matter to the customer, then there’s no reason to spend an extra $500+ on a more advanced machine.
At the same time, this doesn’t mean that all Chromebooks should be priced in the $700 range. Needless to say, the more affordable, stripped-down versions would not be nearly as successful if that were the case. The point, here, is that the $150-250 price range matches the amount of money those looking for a basic laptop are willing to spend.
Another area to consider when implementing value-based pricing is the value your company provides your customers outside of the actual product being offered. For example, if you offer top-notch customer service, money-back guarantees, and other such services that go well beyond what your competition offers, you certainly want to factor that into the cost of your product.
(Again, though: You need to be sure this additional service is seen as valuable by your target consumers – otherwise they won’t be willing to pay extra to receive it.)
Now, the major issue with value-based pricing is that value is almost entirely subjective to the individual consumer. As we alluded to earlier, those who don’t value touch-screen capabilities would have no interest in purchasing the $750 Chromebook; on the other hand, there are certainly many consumers out there who would consider $750 to be an incredible bargain for a touch-screen laptop.
(Source / Caption: Case in point…)
That being said, the final step in implementing value-based pricing is rather ongoing, in that you’ll need to test and tweak a number of different variables until you get it just right.
Obviously, you’ll need to tweak your pricing depending on how your products sell over a certain period of time. But, unlike with dynamic pricing (in which you change your pricing based on changes in the market, your competition, etc.), here you’ll want to do so based solely on your target customers’ expectations. While industry averages and like will certainly play a role in your customers’ expectations, it’s more important that you pay attention to the perceived value of your products in the eyes of your customers in order to find your “sweet spot” for profitability.
As mentioned earlier, you’ll also want to continue improving the supplementary services you provide along with your product offerings, as well. You might, for example, find that a competing company is selling a similar (or even the same) product for 10% more than your company does – and also offers free two-day shipping for said item. All other things being equal, it could well be that this extra offer is what enables your competitor to successfully sell the product for more than your company does.
Finally, you’ll also need to make the appropriate changes to your marketing content so that the value you provide to your customers (through both your products and your services) is crystal clear. The better able you are to differentiate yourself from your competition, the more valid your higher prices will be in the eyes of your customers.
It’s probably clear by now that value-based pricing is the way to go for ecommerce companies looking to reach next-level success. There are a few reasons for this:
First, it allows you to meet your customers’ expectations in terms of pricing and, of course, the value you provide them in exchange for their hard-earned cash. In other words, value-based pricing allows you to offer your products at a price at which your customers aren’t just willing to pay – but at which they’re happy to pay.
Additionally, value-based pricing allows you to justify your pricing in a way that matters to your customers. In contrast to the way this works for cost-based pricing, since you’ll be explaining the added value that’s being passed to the customer, they’ll likely be much more receptive to increases in your prices over time.
Finally, value-based pricing allows you to be lean in terms of product and service development, in that you’ll be aiming to include only those features which your customers will find valuable. In essence, adopting this framework could not only lower your costs of doing business, but can actually transform the way in which your organization operates overall.
Now, as with the other strategies we’ve mentioned so far, value-based pricing does have a few downsides.
For one thing, much more research is involved in order to be successful – and this research needs to be ongoing. You’ll not only need to stay ahead of your competitors in terms of the value you provide your customers, but you’ll also need to keep ahead of trends in terms of what your customers actually value in the first place. As this data can fluctuate rather quickly (quite literally with the weather, in some cases), you need to stay on top of this at all times.
Also, as mentioned above, value is subjective to each of your individual customers. The more your customer base varies in terms of persona, the more work you’ll need to do to ensure that you offer products that each of them will find valuable in the first place – and the more work you’ll need to do to ensure you meet each of their needs in terms of pricing.
Overall, though, adopting a value-based pricing framework is your best for experiencing massive amounts of success in the modern customer-centric world of ecommerce (and retail in general). By pricing your products in a manner that consumers deem 100% fair, you stand a great chance of keeping your current customer base on board – and generating a ton of new business, as well.
Pricing Tactics to Help Your Ecommerce Company Sell More
As promised, now it’s time to get into the more “down and dirty” pricing tactics you can implement in order to persuade potential customers to make a purchase – and to get your current customers to buy even more.
A quick note: The point of explaining these tactics is not to help you “fleece” your customers or anything like that. One way or another, the goal of these tactics is to showcase the value your products provide your customers – in turn making them more likely to make a purchase.
That said, let’s dig in.
Premium pricing is essentially the opposite of the process of undercutting the competition:
Rather than offering a given product at a lower price than your competitors, premium pricing dictates that you offer your product at a price that’s higher than expected.
You’re almost certainly familiar with a number of companies that implement this strategy, such as:
- Apple’s Macbooks
- Grey Goose’s brand of vodka
- Rolex watches of pretty much any variety
Now, to be sure, the value of these products do match their quality – for the audience being targeted by the company in question, at least:
- Apple’s laptops are generally higher in quality, and are also incredibly powerful in terms of multimedia capabilities
- Grey Goose’s upscale nature appeals to those who can afford better-than-bottom-shelf vodka
- Rolex watches are certainly more well-made than lower-priced watches (though, some would argue, not well enough to warrant such high prices)
(Source / Caption: I can tell time for free by looking at the sun, thank you very much…)
When implementing premium pricing, of course your main concern is going to be marketing to consumers who aren’t afraid to spend a little more cash. Additionally, though, you want to be sure that your product truly is, in fact, more valuable than your competitors in one way or another; simply jacking up the price isn’t going to fool anyone.
Using premium pricing tactics can have a number of benefits to your company:
- It maximizes your profits for high-value and in-demand products
- It allows you to make up for manufacturing costs (for the product in question and others, potentially)
- It enhances your brand’s image, overall
The downsides of implementing premium pricing include:
- The fact that your marketing, as well as your customer service and support initiatives, absolutely need to be optimized in order to justify the increased price
- Competition makes it difficult to sell at higher prices – especially when your product doesn’t truly offer enhanced value
- You’ll inherently be targeting a smaller audience with your premium-priced products
All that said, done well, premium pricing can lead to major growth for your company. It just makes sense: if customers are willing to pay more for a specific product, let them.
Logic- or Emotion-Based Pricing
While logic- and emotion-based pricing are polar opposite tactics, we’re going to discuss them within the same section, here.
Logic-based pricing works on the premise that consumers will assign specific value to individual features of a given product – meaning they’ll expect to see a more specific price for the product, overall.
(Source / Caption: Think “The Price is Right” prices”)
Take the following laptop, for example:
That $681.96 price tag, believe it or not, is almost certainly much more attractive than, for example, $675.99, for the simple reason that it doesn’t seem arbitrary. In other words, because it’s such a specific number, most consumers are likely to see it as representative of the cost of sum of all the parts of the product.
(This, perhaps, is as close to consumers will get to caring about the cost of producing a product.)
Emotion-based pricing, on the other hand, works on the premise that, sometimes, minor product specifications simply don’t matter to the customer as much as the feeling the product provides them.
Chances are, most customers who plan on purchasing this aren’t going to care much about how much it cost to commission the painting, have it mass produced, etc. Additionally, the fact that watercolor paints cost less than, say, acrylics, likely won’t factor into whether or not an individual buys this product. All they know is, it makes them happy, and it costs $28. Done and done.
Whether you’re able to implement logic- or emotion-based pricing depends solely on the type of product you offer. If the product provides some sort of functional value, logic-based is the way to go; if the product provides more aesthetic value, go with emotion-based pricing.
Price anchoring is the practice of showcasing your more valuable items first, then pointing your customers toward similar products that are lower in price.
The purpose of doing so is to play on the consumer’s “sticker shock” upon seeing the price of the more valuable item, so that they are more easily able to come to terms with the price of the lower-priced item.
To use Grey Goose as an example yet again, it’s common practice for liquor stores to place the more expensive vodka (“top-shelf liquor”) at eye level, and place the less-expensive brands on sequentially lower shelves. In doing so, customers will typically see the ~$75 bottles first, leading them to base the perceived value of the lower-shelf liquors according to that upper-echelon price. In turn, they’ll typically be happy to spend $30 on a lower-quality bottle of vodka of the same size.
Another method that may be more effective in the ecommerce realm (since consumers can typically sort items by price as they wish when browsing a store) is to showcase your products’ original prices (or their MSRP) along with the current price at which you offer them.
By presenting the current price along with a higher original (or, at least, previous) price, you can essentially make the customer feel as if they’re saving money by making a purchase.
Now, again, the point here isn’t to “trick” your customers into making a purchase. That said, you don’t want to:
- Ramp up your prices for a period of time just so you can bring them back down – and thus pretend that the new price is lower than usual
- Straight out lie about the original price of your products
- Lower prices without considering how doing so will affect your bottom line
Additionally, it’s also important to remember that, as we spoke about earlier, many people will actually want to buy your higher-priced items. In other words, you don’t want to just use your premium-priced products as bait for price anchoring, as doing so may end up costing you a massive amount of profits in the long run.
The takeaway, here, is that price anchoring is less about changing the actual prices of your products, and more so about shifting the way you present these prices. Optimize the way you do this, and you’ll make your customers feel like they’re getting a deal every time they make a purchase from your store.
The final pricing tactic we’ll discuss in this article is the use of loss leaders.
A loss leader is a product sold at an incredibly cheap price (usually at a loss, as the name implies) in an effort to get customers to purchase complementary items that are much more profitable for the company.
A few common examples of loss leaders include:
- Gillette manual razors
- Computer printers
- Video game systems
In the case of Gillette, the company sells the actual razors for an incredibly low price, knowing that its customers will need to buy replacement blades at regular intervals – which is where the company makes the majority of its profits.
In similar fashion, computer printers – though still rather pricey – aren’t all that profitable for companies like Canon and Epson. But, as you surely know, customers will certainly need to purchase dozens of ink cartridges over the years in order to actually use said printers; again, this is where profit is made.
Video game systems, such as the Xbox and PlayStation, are also expensive to produce – and Microsoft and Sony don’t make much from each sale. However, these companies are able to recoup their losses and make profits through software licenses and live services.
As these examples illustrate, loss leaders should typically relate – and even be dependent on – another product you offer, so as to ensure that your customers make this additional purchase. Even better, as is the case with razor blades and ink cartridges, it helps if the supplemental products are consumable, requiring the customer to make repeat purchases over time. Finally, while the loss leader may be expensive to produce, the supplemental product should be the exact opposite: cheap to make, and highly-profitable.
However, it is possible to use loss leaders to get customers to purchase unrelated products that are more profitable. A common example is milk in a grocery store: while stores don’t make all that much off of said product, most consumers will typically end up buying more once they set foot inside the store.
That said, using standalone products as loss leaders can lead to acts of “cherry picking,” in which customers consciously go from store to store bagging up these products on the cheap – and not purchasing anything else.
If you’re going to implement this tactic, your best bet is to do so with a product that all but guarantees those who purchase it will come back for more in the future.
By now, we hope you have a pretty good idea of which pricing framework will work best for your ecommerce company – and which on-the-ground pricing tactics you’d be able to utilize successfully.
It may even be the case that one framework might work best for the time being, and that you’ll be looking to evolve to a more involved process as your business starts to grow. While, as we’ve said, certain frameworks are objectively more sustainable than others, you may want to try each one before you settle on what works best for your company.
As for pricing tactics, you should now have a pretty good understanding of the best practices for each – as well as an understanding of when these tactics simply won’t be effective. The main thing to keep in mind is not to “force” the use of any of these tactics if doing so doesn’t make sense for your business; not only will they not work in the first place, but your customers will see right through your attempts – and will begin not to trust you.
Have you used any of these frameworks or tactics in your own ecommerce business? We’d love to hear how it’s been working out for you. Let us know in the comments section below!