With prices rising and budgets shrinking, pricing for a small business can seem like a make-or-break decision.
Setting prices isn’t easy, and most new business owners rightfully spend more time thinking about how they can improve the customer experience than about the nitty gritty of pricing.
However, retail pricing strategy goes hand in hand with merchandise planning, defining how customers perceive your brand.
In this article, we’ll cover the eight most common retail pricing strategies and how and when to use them.
Why Retail Pricing Strategy Matters
A winning pricing strategy is essential, especially for small businesses facing stiff competition and less visibility.
The right retail pricing strategy will:
- Help you reach the right types of customers and understand customer demand
- Maximize profits and improve financial stability
- Differentiate your store from competitors
- Ensure you cover your overhead costs
- Help you set realistic goals and monitor store performance
It’s worth noting that you don’t have to choose just one pricing strategy and stick with it. Pricing strategy can and should evolve as your business grows.
Also, some retail pricing strategies are only useful for the short term, meaning you should mix and match pricing strategies to find success.
8 Common Retail Pricing Strategies & How To Use Them
A basic understanding of the most common retail pricing strategies is a valuable starting point for determining your niche and setting financial goals.
Here are the eight most common retail pricing strategies you should keep in mind.
1. Cost-Plus Pricing
This is maybe the most straightforward retail pricing strategy. A cost-plus retail pricing strategy involves understanding your cost of goods sold (COGS) (i.e., what you spend on your stock before a customer purchases it) and adding a markup such as a fixed percentage.
For example, if you own a grocery store that makes ready-to-eat meals, you might look at how much the ingredients cost and how much labor goes into making and packaging each serving.
If you find one container of potato salad takes $4 to make and you want a 25% profit margin, you’d price it at $5 ($4 + ($4 x 0.025))
Best for
Cost-plus pricing is best for simple products with predictable supplier and input costs. It’s also a good fit for lower-cost items with high stock rotation since you can afford to earn a lower margin on each item.
If you sell unique products that don’t have a lot of competition, a cost-plus model is also a good way to set an initial price and test the waters.
Drawbacks
While cost-plus pricing is arguably the simplest method for setting prices, it also has numerous drawbacks. First, you’re potentially missing out on profits if you undervalue your products or set a low margin.
Most significantly, it doesn’t account for customer trends or supplier costs. If your COGS increases, you’ll be forced to adjust pricing, which customers may not respond well to.
Related Read: The Crucial Retail Industry Performance Metrics To Track
2. Value-Based Pricing
Value-based pricing doesn’t set the sale price of a product based on the actual value or COGS, but on the item's perceived value.
For example, a purse made by a luxury brand probably doesn’t use materials that are significantly more expensive than a lower-end brand, but it’s the value of the brand, not the purse itself, that determines the higher price.
Similarly, if you sell products or services that no one else does, people may be willing to pay a premium for them.
Best for
Value-based pricing is primarily used for luxury or high-end products with a value that differentiates itself from the competition. While high-end clothes and accessories are easy examples, this can also apply to high-end grocers, meat markets, and restaurants.
In grocery stores, many local or organic brands are priced higher because people perceive them to be higher quality and worth the extra cost. If you import a limited number of international products and there’s enough interest, you could sell them at a higher markup since you’re a sole supplier.
Drawbacks
Value-based pricing can be risky because it’s based entirely on perception and marketing. If you can’t convey why customers should pay more for a product, they won’t. This is especially true for everyday products that are widely available.
It’s also a retail pricing strategy that is (for most small retailers, anyway) decidedly non-scientific. It’s based more on what you feel a customer will pay, and if you don’t judge the market correctly, you’re potentially in for a rough dose of reality and low sales.
3. Competition-Based Pricing
Competition-based or competitive pricing is a pricing strategy that sets prices based on your competitors. New businesses could use this to entice customers from competing brands with lower prices (economy pricing).
However, the goal of competitive pricing isn’t always to undercut rivals. When looking at competitors, you should consider:
- The quality of their products
- The standard of their service and perception of their brand
- How much demand there is for similar products and services
Based on these factors you may determine to set your prices slightly higher and market yourself as a higher quality alternative (premium pricing).
Best for
Competitor-based pricing is most useful in industries where prices are fairly similar and customers are more sensitive to price changes.
Competitive pricing can be a great starting point for many types of retailers. It ensures you don’t undervalue your products and can be a great way to bring customers into your store, especially if you’re new to the neighborhood.
It also helps you understand your place in the market. As you monitor sales data and build your business, you can set benchmarks based on your competitors. Are you a low-cost alternative to luxury brands, or are you the luxury brand people go to for something special?
Drawbacks
When following a competitive pricing model, it can be easy to start constantly looking for the lowest price without thinking about customer preferences and your strengths as a business.
There are other ways to differentiate yourself from competitors than just price, like the quality of your customer service, value-added options like a customer loyalty program, or the variety of products you offer.
While it might be a good starting point, it may not be the best pricing strategy for more established businesses.
Related Read: 4 Point of Sale Reports You Can Use To Grow Your Small Business ASAP
4. Discount Pricing
Who doesn’t love a deal? Customers love a retailer that regularly offers discounts and promotions — and retailers can benefit from more foot traffic and better sales with a solid promotional strategy.
Discounts are a valuable tool for:
- Selling slow-moving inventory
- Reducing spoilage or waste of perishable items
- Creating excitement and driving sales
- Bringing in new customers
Combined with a solid marketing strategy, discounts can be a great short-term tool.
Best for
The occasional discount can be useful for almost every type of retailer. They’re more frequently used in businesses with a high inventory turnover to avoid dead stock, but strategic discounting is a solid tactic for boosting brand visibility or getting customers to try new things.
Drawbacks
Discounting too frequently can lead to customers thinking your brand is low value or that your regular prices aren’t worth it. This can be particularly bad for luxury or high-quality brands since their higher price point is part of the allure and brand identity.
In other words, if you discount too frequently, people will be less willing to buy at regular prices. Instead, discounting should be used with a specific goal in mind (e.g., moving particular inventory, supporting a seasonal sale, etc.).
5. Bundle Pricing
Bundle pricing involves offering discounts on bulk purchases or unique product bundles to sell a higher volume of items. For example:
- Selling a tablet together with Bluetooth headphones and a case for 20% off the regular price
- A meal set at a grocery store or restaurant that offers a discount for buying a lunch item, drink, and chips together
- Food and meat subscription boxes that provide a discount for setting up a recurring order
- A liquor store offering a cocktail set with all the bottles needed to make the perfect Negroni
Other examples of bundle pricing include mix and match promotions and buy one get one (BOGO) offers.
Best for
Bundle pricing is useful for several reasons. It allows you to:
- Increase the average cart size
- Attract new buyers
- Show off your expertise while adding value
- Sell obscure SKUs or underperforming items
- Sell multiple items at a single appealing price point
The key to bundle pricing is to be strategic about your price point. If the price is too high, people will do the math and realize the bundle deal isn’t much of a deal. Set it too low, and you might be practically giving away items.
Drawbacks
Bundle pricing can lead to product cannibalization, which is when a new product (your bundle) effectively replaces sales of the individual product. If you overuse bundle pricing customers may hold off on buying items at full price to wait for a bundle deal instead.
6. Loss Leader Pricing
A loss leader is a product priced below its production cost to sell other, more profitable products.
Common examples of loss leader pricing in retail are:
- Offering free flu shots along with a $15 grocery discount
- Selling hardware and tools at lower prices to sell accessories
- Selling razors at a low cost to sell replacement blades and shaving cream
Upsells, promotions, and bundle pricing can also be part of a loss-leader retail pricing strategy as long as one of the items is discounted below its minimum profit margin.
Best for
Loss leader pricing brings in new customers with the promise of a great deal and then keeps them spending. Upselling and cross-promotion are a must to recoup the value of a loss leader pricing strategy (e.g., giving away a free cocktail shaker for liquor sales over $150).
Drawbacks
The drawbacks of loss leader pricing are obvious: you’re selling items at a loss. If you can’t upsell customers on regularly priced items, you’re practically giving items away.
Like other bundling and discounting pricing strategies, it also comes with the risk of customers waiting for a deal instead of buying items at a regular price. So, use this strategy sparingly.
7. Penetration Pricing
Penetration pricing is when a business deliberately undercuts competitors’ prices to quickly gain customers in a competitive market. The goal is to capture customers from competitors and then slowly raise prices after they switch loyalty.
For example, a cell phone repair service might offer cheaper repairs and prices on accessories in their first few months of operation. After enough time, the business gathers a ton of positive reviews and loyal customers and starts to raise its prices.
Best for
Penetration pricing is used by businesses or individual products to enter a crowded market quickly. People are drawn to low prices, and it can be a way to win business when you don’t have any brand recognition.
Drawbacks
Penetration pricing is also extremely risky and requires a good amount of upfront cost since you’ll potentially operate at a loss for a while. Worse, if your service doesn’t stand out or offer better quality than competitors, your customers might run back into the arms of your competitors when you eventually raise your prices.
Penetration pricing is generally best used for individual products or particular services.
8. Psychological Pricing
Why is it that paying $19.99 just feels different than paying $20? If you’ve felt this, you’re not alone. This is the result of a pricing tactic called psychological pricing.
Psychological pricing uses certain formatting tricks to influence a customer’s behavior. There are a few psychological pricing techniques commonly used in retail:
- Left digit bias: Also called charm pricing, this is exactly what we called out in our example above. Research consistently shows that stores make more sales when prices end in “99” instead of rounding up because people perceive value based on the leftmost digit in a number.
- Center stage: If presented with three similar products and services at increasing price points, many people pick the middle option.
- Innumeracy: This simply refers to how labeling deals affects how people perceive them. For example, one study found that sales increased when stores labeled a deal as “buy two items at 50% off” vs. “buy one get one free” (despite giving customers the same value).
- Formatting: People tend to perceive longer prices as more expensive. For example, if you list something at “$20” versus “$20.00” people are more likely to buy it if you drop the extra two digits.
Best for
This tactic isn’t so helpful for certain products or industries — instead, it adds to other retail pricing strategies.
For example, if something isn’t selling at $5, try changing the price to $4.99. Then, use the reports on your POS system to see if the labeling change makes a difference in sales. If a promotional sale underperforms, look at your signage to see if you could word the deal another way next time.
Sometimes, the effectiveness of your pricing strategy isn’t the value itself, but how it’s presented.
Drawbacks
Psychological pricing is widely used, but consumers aren’t dummies. If you’re constantly changing numbers and typefaces, it not only makes the shopping experience less consistent, but it can make customers lose trust in your brand.
Just like discounting, use psychological pricing tactics sparingly and with a goal in mind, not just for its own sake. Use your POS system to identify products or deals that could use a boost and measure the results of what you do.
Which Retail Pricing Strategy Should You Use?
With so many pricing strategies to consider, which is the right one for your business?
First things first: define your goals. Are you trying to boost sales at an existing business, open a new business, define your brand identity, or do something else entirely? Knowing what you want to achieve will determine what pricing strategy you should use.
Second: know your customer. If you live in an area where customers don’t have a lot of disposable income, you’re not likely to find success trying to sell products at luxury prices.
Last: know your niche. Many local businesses undervalue themselves because they worry they can’t compete with cheaper corporate chains. Take some time to understand what draws customers to your business and the true value of your products and services, and price your products accordingly.
Base Your Retail Pricing Strategy on Data, Not a Hunch
Making pricing changes at random can be disastrous for a business, especially if they have no way to monitor the results.
Instead, use the data on your point of sale system to make strategic pricing updates and gain visibility into your sales, marketing, and promotion performance. The reports on your POS system can help you understand things like:
- Best-selling products and product categories
- Price per square foot and which areas of your store perform well
- Profit margins of individual products and suppliers
- Inventory turnover rates
- Peak hours and seasonal trends
This data is invaluable for figuring out what products and promotional strategies will be most effective.
POS Nation specializes in matching retailers with industry-specific solutions that help their businesses stay competitive and find success.
Schedule a custom demo today to see how our solutions can help you create a winning retail pricing strategy.