Common Pricing Strategies in E-commerce - A Quick Guide for Store Owners
Updated: Jul 23, 2021
Choosing pricing strategies is undoubtedly among the most important decisions in business management because they set a general direction for the company and help managers to better allocate and prioritise tasks. There are a myriad of pricing strategies in the business. However, in this blog post, we will only discuss the 3 most commonly used in the ecommerce and dropshipping space. This article provides an overview of each tactic along with their pros and cons to assist you with the decision making process.
1. Cost-based pricing (or mark-up pricing)
Cost-plus pricing is the most straightforward strategy. As most people could have guessed, all you need to do is to decide on a (usually fixed) rate on the top of total costs of goods. Adding them up and that final number is how much you sell your products. The rate often depends on the amount of effort dedicated and risks taken by ecommerce store owners. For instance, consumer electronics have a relatively high mark-up because the shipping process involves more complications such as breakage. Business owners who prioritise sales over margins usually adopt this strategy as it enables them to sell in greater volume.
If you want to follow this tactic, it is important that you know all the costs involved in the production, distribution, and sale of your goods. They could include:
Costs of goods sold (purchase price from suppliers)
Shipping costs (from factories, to customers, if applicable)
Other operation and management costs such as advertising campaigns
Firstly, mark-up pricing does not require you to perform extensive market research, which saves you various types of costs and other resources. Secondly, it brings you predictable and consistent returns if the costs involved remain stable
However, this strategy comes with one major drawback, which is its business-centred nature. To simply put it, this approach does not view the problem from the consumer perspective, such as how much they are willing to pay for the products. Essentially, businesses who fail to appease and care about customers are simply driven out of the competition sooner or later. Furthermore, it does not put market conditions, such as the environment and competition, in the equation. As a result, you might find yourself less competitive compared to other market players.
2. Competition-based pricing (or market-based pricing)
This pricing strategy involves research on your competitors. For instance, you should have a thorough understanding about their niches, main types of products sold, and targeted markets. Generally, you could categorise your competitors into 2 groups:
Indirect competitors: Those who sell similar products and compete in the same market space as you.
Direct: Those who sell products that meet the needs and/or solve the pain points of your niches in a different way or manner. They might compete for part, but not all, of your market share.
Once you identify those who are most aligned and similar to you, you would create a list of their products together with their prices. Ideally, you would sell your products at a similar price level compared to your competitors’, and this would be adjusted according to the baseline of the market.
The biggest advantage of this strategy is that if you base your prices on established market players, your pricing strategy is unlikely to go wrong. This is because the established price levels have been tested (and in many cases, proven to work). In other words, you do not have to take much risk. Besides, market-based pricing acknowledges that your own business is not a stand-alone entity and takes into account various factors in the market. This is especially relevant in today’s world due to the rising popularity of online shopping. The Internet has made it much easier for consumers to compare prices across different retailers. In fact, 4 out of 5 online shoppers have a habit of doing this before spending their money on certain products or services.
Firstly, the business world is unpredictable, and there is still a chance that the pricing strategies of your competitors fail. As a result, you would suffer some losses. Secondly, solely relying on your competitors for strategic decisions does not sustain your business. Over time, they might implement certain changes and/or paradigm shifts, and purely following them would prevent you from achieving wild success. Moreover, this strategy assumes that you are able to find the necessary information for the decision making process, which is not always the case. For instance, you would not be able to know the prices of individual items if your competitors bundle their products and sell them together. Furthermore, if you are a small retailer, you might find it hard to compete on price with big corporations due to economies of scale.
3. Value-based pricing (or customer-based pricing)
Adopting this strategy allows you to price your products based on its perceived value (usually determined by consumers at large). In other words, products are marked up at the level where consumers believe them to be worth. Some situations where this tactic is commonly used include:
Products possess some special characteristics such as luxury, eliteness, or uniqueness (e.g. designer apparel).
Products are scarce under certain circumstances, and the need for the products are high. For instance, drinks in theme parks of closed concerts are usually charged 3-6 times higher than outside.
Some industries where customer-based pricing is popular are fashion, cosmetics, and technology.
Companies who want to pursue value-based pricing strategy must display some distinguished characteristics, be it high quality products, loyalty programmes, or brand missions, in order to attract customers.
The greatest advantage that customer-based pricing offers is that it enables businesses to earn more profit compared to the previous two. Also, as opposed to cost-based pricing, this strategy is customer-focused. If you are able to build a strong rapport with your customers, you would earn a higher profit and save more costs with the loyal customer base because acquisition of new customers, on average, costs 5x more.
Nevertheless, earning a higher profit margin means you would have to do more legwork. First of all, this strategy involves guesswork and continuous experimentation. The extensive research might eat up your resources, which could be dedicated to other aspects of business development. However, there is no guarantee that you accurately evaluate the perceived value of a product. Furthermore, choosing this method means you opt for sale over volumes and sacrifice the lower-end market segments.
For easier reference, we have compiled a table comparison of the pros and cons of the three strategies discussed in this article (shown below). We hope this article helps you have a better understanding about pricing strategies and inspire you to conduct further research to determine which method would work best for your ecommerce store.
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