What is pricing strategy?

One of the toughest decisions a small business owner has to make in their sales process is how much to charge for their services. As with so many strategic decisions along the way, it’s essential to think about what you, as the business owner, are trying to achieve and where you’re at in your longer-term goals of success in your business plan. Considering a few different approaches to small business pricing strategy and what sort of effect they typically deliver is a great place to start.

Let’s start with a light definition of pricing strategy: from our perspective, a pricing strategy is the approach that a business takes to set the pricing of its goods and services in the marketplace. A simple and very common example would be the cost-plus pricing model: calculate your total expenses to deliver the job and then adding a markup. An effective pricing strategy should allow your business to close enough sales to operate and sustain your business while supporting your goals for growth and profit.

Sustainability of your business means that while you’re focused on your day-to-day work of sales and delivery of services, you also need to be taking a longer view of what it means to keep your business financially healthy. It means maintaining a healthy cash flow that supports your material needs (such as supplies, vehicles, fuel) but also ensures that you take good care of your employees, partners, and yourself as the business owner.

While your pricing strategy should keep you competitive in the marketplace, don’t get caught in the trap of thinking that you need to be the cheapest in town in order to win business. How much a potential customer is willing to pay has everything to do with the value they perceive for the outcome your business is delivering to them.

So let’s have a look at a few pricing strategies and match them to some potential goals you may have for your business.

Four common pricing strategy types:

1. Cost-plus pricing

As mentioned above, this is a common and straightforward way of approaching pricing. You add up all of your costs associated with delivering the work, tack on a markup, and that becomes the price.

Pros –This pricing strategy likely puts you squarely into the competitive marketplace, neither too high nor too low. This simplifies your sales process and is a great way to close business with a price-minded buyer.

Cons – Many small business folks, especially when they are just starting out, may underestimate expenses for time and materials and end up underbidding in an attempt to close the sale.

2. Competitive pricing

This refers to the strategy of setting your prices based on what the competition is offering and then looking for other ways to add value to help win the business. An example might be an installer who charges the same price as her competitor but also offers to take away the old unit free of charge. You might also offer consumer loans to help your clients better afford your services.

Pros –This is a great strategy when there is little competition and high demand. None of the competitors has an incentive to lower their price as long as they are staying busy at the current rate.

Cons – If a business is too focused on its competitors and what they are up to, it’s very likely they are creating gaps somewhere in their own business.  Competitive pricing can also prevent you from considering additional profit opportunities from other pricing strategies.

3. Penetration pricing

This is another price model that heavily considers what the business’ competitors are up to and involves undercutting the competitors in order to win more deals. If your business is new to a marketplace, you might consider penetration pricing to win some early deals to build up your reputation and gain referrals.

Pros – There will always be a market of consumers who simply buy from whoever offers the lowest price.  In fact, according to the Global Consumer Insights Survey 2019 by PwC, as many as 60% of shoppers say that price is the main deciding factor for them in how they purchase.

Cons –The problem with competing on price is that while it is suitable for quick, easy wins, it does little to support the long-term health of the business with sufficient profit margin.

4. Value-based pricing

If you’re looking for a sustainable, winning small business pricing strategy, value-based pricing is a great model to consider. In its simplest terms, value-based pricing is the strategy of setting prices at what your customers believe the service is worth.

Pros –While many prospective customers identify as being price-sensitive, that doesn’t mean that your services have no value to them. Establishing a high value for your services during your sales process makes it easier to build a higher margin into each deal that you close.

Cons –Supporting this strategy means putting extra thought into how you establish value with the prospect as you sell. This additional work in building an excellent sales presentation is well-worth the upfront effort, and if you’ve done a great job of building value, your price should sound fair to them at the end of the sales pitch.

How to build a pricing model

While there are many other pricing strategies for small business out there to consider, the four above are most relevant to contractors delivering services such as HVAC, home renovations and installations, kitchens, roofing, etc. As you think through what strategy is best for your business, there are a couple important elements you must consider helping guide the way:

1. Business lifecycle & goals

How old is your business? Are you brand new and searching for your first job? Are you established and trying to grow through building a bigger team or expanding into new territories? Considering where you’re currently at and where you want to go will help you decide which approach is best for your business.

2. Who are your customers?

Your pricing strategy needs to be aligned with what your target market is willing to pay.  That means it’s not necessarily about what you think is a fair price, but more about what the market will bear, which is often more than you may think.

Helping you to determine your small business pricing strategy is part of our job for this blog, which is to make it as easy as possible for you to serve your customers successfully.

Boost your sales by offering your customers financing.