What Is Strategic Pricing?

Strategic pricing sets a product's price based on the product's value to the customer, or on competitive strategy, rather than on the cost of production. This approach recognizes that people often make purchasing decisions based more on psychology than on logic, and that what's most valuable to the customer may not be what's most expensive to produce.

What customers are willing to pay for a product may be vastly more, or less, than a company would charge if it simply priced based on cost. Discovering what consumers value about the product and how much they value it can let a company increase its price or might suggest that a new product has no chance of turning a profit. For every 1 percent of price increase customers are willing to pay, companies receive 7 to 8 percent higher profits. In this model the product's price is usually set by a marketer or salesperson rather than by the operations and development team.

Traditional pricing is set either based on the cost of production or on the price that competitors are charging. Sometimes this is a reasonable approach; for example, government contractors are often required to bid for projects based on cost plus markup. But when multiple competitors produce the same product at the same price, the only way to compete is to offer a discount. Pricing a company's product strategically is therefore key to avoiding price wars.

Software companies often use strategic pricing because they cannot price on cost. They usually don't know how many copies they will sell, and there is virtually no incremental cost for producing more units. They might poll their potential customers and determine that some people want to use the software a little bit every day, and some want to use it intensely a few times a year. That can lead the company to offer two different pricing plans for the same software: a $19.99 monthly subscription and a $4.95 per use fee. Wi-Fi hotspot connection services often use this model.

Strategic pricing is a marketing decision, which means it should be informed by dialogue with your customers. While examining your competitors is important, they're not the ones purchasing your product, and they may be making mistakes in their own pricing. Competing through pricing means recognizing what your customers value and charging them accordingly. It doesn't mean going head to head on price.