Ten Pricing Models to Help Raise Margins - dummies

Ten Pricing Models to Help Raise Margins

By Jim Muehlhausen

Part of Business Models For Dummies Cheat Sheet

Great business models command better margins than the competition. Sometimes, a business model can be improved simply by clever pricing strategies. The list below offers some methods to potentially raise prices and corresponding margins.

  • Premium pricing: You can’t help but think that expensive products are better. Tiffany’s, Starbucks, Rolls-Royce, and high-end New York restaurants have used premium pricing to create a perception of luxury to generate high margins.

  • Penetration pricing: Using artificially low pricing to gain distribution makes sense if you’re trying to establish a beachhead or build economies of scale.

  • Economy pricing: This model uses the perception of thrift. However, just because the product is priced lower than other offerings doesn’t mean that margins must be lower. Generic brands earn more for grocery stores than name brands earn. In other instances, economy pricing is necessary to drive the initial sale and thereby secure add-on sales. Low gasoline pricing is needed to secure cigarette and soda sales for instance.

  • Price skimming: Charging a high price when an item is new or has little competition. As demand and competition increase, prices are lowered. For instance, when DVD players were new to market, they cost around $800. As demand increased, pricing decreased in kind.

  • Psychological pricing: Human beings can’t help but feel that $499 is cheaper than $500. Walmart uses sevens instead of nines because consumers have become savvier.

  • Product line pricing: For decades, General Motors used the same body style and components to brand the same vehicle under more profitable lines. The Chevy Cavalier, Buick Skyhawk, Pontiac Sunbird, Olds Firenza, and Cadillac Cimarron were virtually the same automobile with differing emblems on the hood.

  • Optional product-pricing: The base-model or initial purchase is sold at lower margin but related items are sold at much higher margins. Mobile phones have low margins but adaptors and cases have very high margins. A plain cup of Starbucks coffee isn’t particularly expensive, but start adding milk, spices, and some froth and it doubles in price.

  • Captive product pricing: Movie theaters, amusement parks, resorts, and airlines have customers trapped and can charge much higher pricing as a result.

  • Product-bundle pricing: Microsoft increased overall margins by bundling all its Office software. Southwest is attempting to bundle all the costs of airline travel while other airlines nickel and dime customers. Another example is highly profitable service agreements bundled with copiers and other equipment.

  • Geographical pricing: If you have a geographic advantage, such as remote markets with little competition, you may be able to charge a premium. Examples include “last gas for 100 miles,” and “prices higher in Alaska and Hawaii.”