How to Choose the Right Pricing Strategy for Your Small Business Discover how your small businesses can navigate the challenging terrain of pricing strategy in a post-inflation economy

Since reaching a peak of over 9% in 2022, inflation appears to finally be cooling for the average consumer. As costs rose over the last two years, companies across the globe have worked to protect their profit margins by increasing prices. For new small business owners, this has created several challenges, and many consumers are still facing the pressures as wages haven't kept pace with inflation rates. As a result, consumers are more cautious than ever about each dollar they spend.

Many companies realize they need to be more competitive with their pricing to retain and attract new customers. For small business owners, defining the right pricing strategy can feel overwhelming. Here are some tips to help you find the right pricing balance.

Related: Did You Price Your Product Right? How to Know

How to price your product or service

Pricing your product is one of the most critical business decisions you can make. Although you can always adjust, setting your price correctly early on will greatly impact your revenue — especially if you're a new business, working on a side hustle or bringing an entirely new product to market. Before you set your price, consider the following factors.

Determine your value

Within any market, it's essential to analyze how valuable your product is compared to others. For instance, did you use better materials, or are you solving a problem that no other product can? If so, your value may be higher than any other brand can offer, so you might be able to set a higher price. Some companies will use a formula to determine a specific value.

Related: Stop Competing on Price — Compete on Value

Review your customer base

Knowing who your customers are is an essential function of any business, and it's particularly important for pricing. For instance, are you catering to people who purchase high-end goods? Are you targeting people who are more likely to value a bargain? By performing customer research, you'll know how to set prices better.

Evaluate pricing potential

It's important to determine exactly how much you could charge for any product. This doesn't mean you will charge that amount, but by considering factors including your customer base, your competition and the cost to produce your product, you can determine the high end of your pricing potential.

Determine a price range

You'll need to know the minimum price you can charge for a product and still make money — the low end of your range — as well as the high point based on customer research. Once you've determined a range, you can adjust your prices based on peak buying seasons, discount opportunities and other factors.

Evaluate the competition and industry

Your competition can provide guidance when it comes to pricing strategies. Within each industry, there are standard markups or profit margins that are typically recognized as normal ranges. Evaluating these can help small business owners understand if their costs are too high or low relative to their sales price. But it's important that you don't price your product by simply copying your competitors. While your competition's pricing might help determine if you are within the acceptable ranges of the market, picking an arbitrary number is a losing strategy.

Gather feedback from customers

The sales volume you generate will give you insight into if you're pricing fairly, but if you need more data, it's always wise to talk to your customers. By providing opportunities for surveys, reading reviews or conducting direct outreach, you'll better understand what matters to your customers and if they see value in your product.

Be transparent

Consumers often want to support companies they believe are trustworthy. Shady pricing and hidden fees can damage a relationship with your customers, so it's best to be upfront and transparent about your product pricing. If sharing your price scares away customers, it's a good indication that you need to revisit your pricing strategy or do a better job of demonstrating the product's value.

Related: An Entrepreneur's Guide to Startup Pricing Strategies

Types of pricing strategies

Cost-plus pricing

This strategy refers to a relatively straightforward markup formula. Businesses determine how much it costs to produce a product (including materials, labor and overhead) and add a fixed percentage to that price to meet their desired margin.

Premium pricing

Selling your product at a premium means deliberately pricing it higher than your competitors. Typically, premium pricing aims to convince would-be customers that your product is of a higher quality than any other on the market and, therefore, worth shelling out more money. This strategy can be risky, as it may lead to a decline in sales.

Economy pricing

Some businesses use the "economy" tactic of setting lower prices than competitors to increase their sales volume. This tactic often attracts customers, but to guarantee their profit margins, businesses reduce product costs (and create a lower-quality product) when using economy pricing.

Competitive pricing

One way to set prices is to monitor competition. With competitive pricing, companies essentially set their prices relative to what their rivals are doing. This commonly happens in a market where a product has existed for a long time, and there's consensus about what it should cost.

Price skimming

When a company launches a new product, it may initially set the price high before gradually reducing it over time. This practice, called price skimming, lets businesses cater to different types of customers. Some people will be willing to shell out more money to have the latest version of a product, while others will purchase only once the price drops.

Penetration pricing

Companies that are new to a well-established market may use penetration pricing to attract an early volume of customers. With this strategy — sometimes called loss-leader pricing — a business sets prices extremely low to lure customers away from other brands. However, keeping prices low is often not sustainable, and customer loyalty may be hard to build as prices ultimately rise.

Psychological pricing

The practice of psychological pricing comes in many different forms. In short, it refers to a strategy in which a business convinces customers they're spending less. It's the reason many products are listed for, say, $4.99 instead of $5. The one-cent difference can make a big impact on a customer's mind. Psychological pricing also commonly appears with short-term sales, which makes customers think they need to purchase something in the moment or they'll miss out on savings.

Value-based pricing

When businesses have a new product they'll often rely on value-based pricing to determine how much they think a customer will be willing to pay for it. Instead of applying a standard markup (like cost-plus pricing), the price is set based on how potential customers perceive the product's value.

Keystone pricing

With keystone pricing, companies set the price of a product to double its cost to produce. So, if it costs $20 to produce the product, you would list it for sale at $40. Retailers often use this strategy.

Subscription pricing

With a product that requires repeated sales, many businesses choose to introduce some form of recurring or subscription pricing. This not only helps keep revenue flowing into your business but also provides long-range visibility into your anticipated revenue. This is helpful for both strategic planning and securing better financing through investors or a bank line of credit.

Related: The Price Is Right: How to Price Your Product for Long-Term Success

Flexible or tiered pricing/dynamic

Most businesses serve a wide range of customers. Offering flexible or tiered pricing can increase revenue by enabling businesses to reach a wider range of customers. Tiered pricing also supports a sales strategy known as price anchoring. By offering three or more pricing tiers, businesses can position their premium options as the best value, encouraging more upsells.