Figuring out the right price for your products and services is dependent on your customers and what they are willing to pay. If you segment your customers, you may determine that different groups have varying price sensitivities. In order to figure out the most profitable pricing strategy for your business plan, it’s important to take note of the market size. This way, you’ll be able to get the maximum revenue with the least-possible alienation of potential customers.
Determining Your Market Size
When determining your total market size, it’s best to start by understanding what problems your products solve. While many businesses believe everyone is a potential customer, that isn’t always the case. Your market size is only the people whose problems you can solve with your offerings. Using market segmentation can help your small business to understand the actual size of your market.
Market segmentation involves identifying portions of the market that are different from one another and grouping those differences together. This strategy helps businesses to understand the specific needs or problems that groups of customers are facing so they can address them with personalized marketing and promotions. For example, a car dealership may have a market segment of families with children and a market segment of young, single males; those two segments will have vastly different needs for transportation.
Narrow down your total addressable market by segmenting them using specific characteristics such as:
- Demographics: This includes age group, gender, marital status, education level, occupation, annual income and family size.
- Geographic: This includes climate, region and population density.
- Psychographic: This includes values, opinions, attitudes and interests.
- Behavioral: This includes brand loyalty, number of purchases, frequency of purchases and readiness to buy.
To make sure your pricing strategy garners you the maximum amount of revenue, it’s important to determine the price sensitivities of each segment to know how much they are willing to spend. You may have to use different pricing strategies for different market segments in order to gain the most revenue.
What Is a Pricing Strategy?
A pricing strategy is the way a business decides to price its products and services in order to achieve its business goals. In many cases, the goal of the pricing strategy is to provide the company with the highest profit. However, that’s not the only reason to develop a pricing strategy for your business. Pricing strategies can also help your business to:
- Improve cash flow by generating more revenue
- Penetrate the market and take over competitive market share
- Fill business capacity and maximize use of resources
- Reach a new target market segment
- Identify new market trends, market potential and potential revenue
- Increase prospect conversion rates and reduce cost per customer acquisition
- Grow your number of customers and share of the market
- Get insight into your market sizing evaluation and the actual available market
When developing a pricing strategy, it’s vital to consider to whom you’re selling and what your customer segment is willing to pay for your products. However, that’s not the only element to review when developing a pricing strategy. The size of your total addressable market is key.
If your customer segment is willing to pay a large price premium but your market size is small, you may not make enough revenue to survive. If you lowered the price, you may be able to increase your market size and your revenue in the process. Other elements of a pricing strategy you should consider are:
- Market conditions: What is the current economy like, and how fast is the industry growing?
- Competitive landscape: How many competitors do you have, and what kind of pricing strategies are they using?
- Production and distribution costs: How much does it cost to develop, create, market, sell and deliver your product to your customers?
- Trade margins: What do your resellers, distributors and retailers need to make?
- Variable costs: What expenses do you have that increase with the amount of production?
Different Types of Pricing Strategies
There are several different pricing strategies that small businesses can use to improve profits, increase revenue and gain market share. Not all pricing strategies work for all market segments or market sizes. Some pricing strategies are more effective for small markets, whereas others work better for large markets. Common pricing strategies that small businesses can employ include:
- Market penetration: If you’re looking to gain market share from a competitor, this is a good strategy to use. This tactic attracts customers by offering lower prices than the competition — for example, if a competitor prices a product at $10, you can offer yours for $7 to gain market share. Keep in mind that this strategy can be risky if your market size is large because it can result in a loss of income for the company. Once you have successfully penetrated the market, it’s best to increase your prices slowly to improve your profit.
- Price skimming: When you’re launching a new product or service, this strategy can help maximize your revenue out of the gate. When you first launch, you set the prices high. If competitors start matching your high prices, you can gradually decrease your price to attract price-sensitive customers. This strategy works with a medium-to-large market, as you can recoup your product development costs quickly.
- Bundle pricing: This is a strategy that can help businesses to sell multiple products together. A bundle price is lower than if the customer purchased each product individually, like buying a burger, soda and fries in a combo, for example. It helps businesses reduce inventory and provides more value for the customers. This tactic can work with all sizes of markets.
- Promotional pricing: This is a tactic that is more time sensitive than size sensitive. Businesses offer discounts on specific products for a limited amount of time. This strategy is useful for generating publicity and encourages customers to make a purchase before time runs out. Promotions can be offered to different market sizes.
- Economy pricing: In this strategy, businesses offer a low sales price by reducing their marketing and production expenses. As a result of the low price point, businesses only earn a small profit on each sale. This is why this strategy only works with a very large market size. Otherwise, the business will not make enough revenue.
- Premium pricing: Businesses price their goods at high prices to create the sense of value and exclusivity. This strategy often works with small market sizes, as only a few sales of the luxury goods are required to meet revenue goals.
- Value pricing: In this strategy, the business prices goods based on the value they bring to customers, not on the market conditions or the cost of goods. For example, a designer piece of furniture can be priced at several thousand dollars because the customer is willing to pay that amount for the custom piece.
- Cost-plus pricing: In this simple strategy, a business calculates the costs of the product and then adds a markup.
How to Expand Your Market Size With Your Pricing Strategy
A pricing strategy can help a small business to increase its market size or captivate an emerging market. If a business is looking to enter new markets with new products, for example, it can employ price skimming to recoup its development costs and then gain new consumers when it lowers the price. If a business is looking to expand the size of its market segment, it may choose to use economy pricing to attract price-sensitive customers and those who are on the fence about purchasing.
Before changing your pricing strategy to expand your market size or enter a new market, it’s best to conduct detailed market research to understand those prospects. If the new market prefers premium-priced products, then a lower price may not attract them enough to make a purchase. As a result, the pricing strategy could negatively affect the success of the business.
Anam Ahmed is a Toronto-based writer and editor with over a decade of experience helping small businesses and entrepreneurs reach new heights. She has experience ghostwriting and editing business books, especially those in the "For Dummies" series, in addition to writing and editing web content for the brand. Anam works as a marketing strategist and copywriter, collaborating with everyone from Fortune 500 companies to start-ups, lifestyle bloggers to professional athletes. As a small business owner herself, she is well-versed in what it takes to run and market a small business. Anam earned an M.A. from the University of Toronto and a B.A.H. from Queen's University. Learn more at www.anamahmed.ca.