If you’re trying to make your store more profitable, your first reaction is not usually to raise prices. It seems too risky. But, it’s a great way to increase your profit margin. More often than not, you’ll focus on cutting costs. Raising prices can be a great move when done in a thoughtful way. And the start of a new year is a great time to do it.
In this guide, we’re showing you methods that help raise prices and improve the way products appear to customers, resulting in more cash profit. This section of our Profit Guide covers pricing strategies, psychology behind them and numerous ideas for you to test out.
- The How and Why of Pricing Strategies and the Impact on Profit Margin
- Common Price Strategies
- Cost Plus – Issues and Best Practices
- Cost Plus and Profit Margin
- Value-Based Pricing
- Value-Based Pricing
- High-Low / Discount Pricing
- Pricing Experiments to Try Out on Your Store
- Short Term Thinking?
- Price Anchoring with Premium Options
- Offer Bundle Pricing to Increase Profit Margin
- Set Different Prices
- Decoy Pricing
- The Bottom Line for your Profit Margin
- About This Guide
The How and Why of Pricing Strategies and the Impact on Profit Margin
Adjusting your pricing strategy isn’t all bad news for the customer – in some cases the best way to increase your profit margin may even involve lowering prices.
Let’s assume you know a little about pricing. Hopefully, you already have a store and want to try to find ways to increase your profit margin through more advanced pricing strategies.
One thing to note is – like with most subjects in this guide – there are not always hard and fast rules that work in every situation. A great deal of your pricing strategy can depend on your brand positioning. Are you a fairly regular ecommerce business selling items from $10-$200? Or are you are selling monthly subscription boxes? Heavily-researched big ticket items? All of this affects your pricing strategy.
For the purposes of this guide we are going to assume you are in the first camp, but some of the ideas here could be applied to other types of business.
Pricing is a critical subject. However, many companies do not even have a defined pricing strategy they could repeat to you, let alone dedicate time to real price experimentation. My experience suggests that is a waste, because they are leaving money on the table and more importantly, not considering the impact pricing strategy can have on customer satisfaction.
Common Price Strategies
Most ecommerce stores that we see usually have one of the following pricing strategies.
- Cost Plus: Add the same markup percentage to each of your product’s costs.
- Value-Based Pricing: Price is set based on how much value you think your product brings to customers.
- High-Low or Discounting: Setting a high base price which the customer rarely pays because of sales and coupons.
Of course there are others, like subscription models, that aren’t covered here – but some of the psychology will still apply.
First, we explain how each one commonly works and a few tactics you can use to improve your margin in each situation.
Cost Plus – Issues and Best Practices
This is popular because it’s easy. But it can often lead to leaving money on the table. Here’s why – and it might even seem obvious upon reflection – if all your prices are designed to hit a certain margin on top of your cost pricing… what are you doing about customers who may not be so price-sensitive? They would be willing to buy at a higher price.
Conversely, what are you doing to about people who are price sensitive? Are you putting them off in your quest to maintain an arbitrary margin? We believe it’s better to consider each customer’s perception of your product when setting prices.
Having said that, cost plus is not so bad as a baseline to work from when setting prices. Take your cost price and add your 50% (or whatever consistent markup you choose), and you get a sense of what is likely to be a fair retail price. But next you should improve on the price accuracy by considering things such as:
- Add loss leaders: Some of your best selling or most popular “entry-level” products could benefit from low pricing to tempt buyers away from the competition. Sacrifice margin to market these low prices to draw people to your business.
- Premium or unique items: Some products can’t be purchased anywhere else, or are specifically marketed as luxury goods. By charging a higher price you reinforce the value of the product – you could sell more and earn more profit by increasing these prices above your required margin.
But once you start doing this, you might be better off working on value-based approach instead.
Cost Plus and Profit Margin
An ‘okay’ strategy to start with but to actually succeed in profit maximization, requires you to experiment to find ways to adapt your pricing to earn more profit. Do not just set your desired markup and leave it at that.
Value-based pricing can be a very effective way to price your products so that you maximize profits. It doesn’t work for every industry though, and can be tricky to calculate.
We recommend value-based pricing over the other strategies. Once you follow the steps below you can create a situation where the customers are happy and you are capturing the most profits.
Keep in mind that the main goal is to set a price that earns you the most customers that are willing to pay, without alienating others.
The key is to decide who your customers are and only go after that target audience. If your products have broad appeal, you might need to use other methods – or try to calculate the value of each product, which might be too time consuming.
The easiest thing to do here is to assess competitor product pricing. (Of course, if they haven’t done their homework either, it’s not going to give optimal results, meaning you’ll have to experiment further).
To assess the competitor pricing, you need to conduct research by interviewing customers (we have had success using Typeform for this). Ask them questions like “What would you buy if my product wasn’t available?” The answer to that can help you determine a base price for an alternative. Just look up the pricing of that item!
The next questions you need to ask are “What differentiates my product from the alternative? How much would you pay for that improvement?”
The answer you get from this is what fancy economists call your Differentiated Worth. Don’t just ask one person – do your best to conduct high quality research for this. BigCommerce has a fantastic article on conducting high quality research to set value based pricing.
Works best if you do research to understand your product’s true value. Use the research to set a price that a customer will be happy to pay as it accurately represents the value of your product, and generates your maximum profit.
High-Low / Discount Pricing
As a customer, I find this one confusing, annoying and stressful. How do I know I am getting a good deal? Will there be a better discount next week?
I also can’t help but question the quality of the product – you don’t see Apple doing this kind of strategy. Nevertheless, it is proven to work well on the majority of customers, who are just happy to “get a deal”. Many online shoppers nowadays love finding deals, and some won’t buy anything without searching first for a discount code.
This strategy has been used by many national mass-market brands, such as Shutterfly in e-commerce or JC Penney in brick and mortar retail.
To succeed as a ‘discounter’, we recommend a few tactics.
- Always launch your new products at a high price and high margin. This establishes a base price from which to offer discounts. Also, you can earn a high profit margin from a group of customers who want to have the newest products at any price. Another benefit of launching products at a high price is that in some jurisdictions, you can’t offer a discount without having established the product’s original price in the market for a certain time frame. (Otherwise it’s not legally a discount).
- Once you publicly offer a discount on the new items – customers will frequently not purchase unless they can obtain the discounted price themselves. You need to provide a way your customers can find the deal price, either on the homepage, or in email marketing A good way to get this done is by continually announcing new “deals” that expire with seasonality. (Halloween Special! 10% off. Thanksgiving Special! 10% off). This works because you create a reason to keep messaging your customers and keeps the brand in mind.
- Practice up-selling. Once you have a “hero” product with a discount applied in someone’s shopping cart, they often are receptive to add-on purchases because they already “saved some money” on the first discount. This can help you build back whatever margin you lost on the original deal. There are great Shopify Apps for this like Bold Upsell – you and also get some good ideas from our guide to maximizing customer lifetime value.
Pricing Experiments to Try Out on Your Store
Before you start price experimentation – you should make a backup of your current pricing. If you run your site on Shopify or WooCommerce you might want to export all your current products & pricing to a spreadsheet, so you can revert back quickly.
Here are a few different pricing ideas you can try that have been proven to work. I believe some knowledge of these tools should be in every marketers arsenal. Not are will work for your brand but they are all interesting to think about!
One more thing to remember: some of these ideas might lower sales volume on some items. Don’t be afraid of that, because we are trying to make the most cash profit, not the most volume sales. You need to have a way to measure your net profit in real time to see how these are going for you.
Short Term Thinking?
A counterpoint to the quest for short term profits through pricing experimentation is for some business owners, maximizing volume sales can be a viable profit strategy. Consider adding loss leaders or performing sampling campaigns can help you gain market share and eventually more profit in the long term.
Price Anchoring with Premium Options
Make more money by listing cheaper, high profit items next to much more expensive items. The proximity of a super high price can make the product you really want to sell seem cheaper by comparison.
Try adding a higher priced item to your assortment, and then see what happens to sales of your core product. Studies have shown most people are happier to buy products at higher prices as long as it’s not the most expensive option.
Offer Bundle Pricing to Increase Profit Margin
Often people will pay more for items bundled together if they feel they are getting the individual items cheaper. This can even apply when people were not planning to buy one of the items in the bundle. A bundle often will make someone increase their spend just to get a deal on something they didn’t even want!
Consider creating bundles and (this is critical) show the customer how much they save on each item.
Set Different Prices
If many of your items are priced the same, you might find sales increase by changing the price of each item. Customers have been proven to see two items at the same price as less desirable. If the two items are at different prices, people spend more time considering which they want.
The simple act of making a choice, or even just acknowledging there is a choice, leads to increased sales.
If you list 3 items in a row, studies have shown that humans more often prefer the item in the middle. It seems simple, and it is. Take advantage of this by placing your highest profit items in the middle of a 3-product row.
You will notice many of these strategies revolve around how humans make decisions. An absolute classic of the pricing-psychology studies is the decoy product. You might have seen the classic TED talk by Dan Ariely about how we are manipulated to make decisions. If not, stop here and go watch it now!
In the talk, you hear an example of how The Economist magazine offered 3 levels of subscription.
The middle option is clearly a bad deal and no-one chose it. So why is it there?
Dan tested what happens without it – and far more people chose the cheaper $59/year subscription. Simply the presence of a bad deal to “frame” the more expensive option as a better deal increased sales for The Economist greatly.
Could you do something similar with your store?
The Bottom Line for your Profit Margin
There are many many more pricing strategies out there, like pay-what-you-want, dynamic pricing, and pricing based on A/B testing. But for most ecommerce businesses, we recommend Value Based Pricing. It allows you to capture the most market value the most efficiently. But if it doesn’t work for your brand for other reasons – it’s critical to choose a strategy and methodology for how your business sets prices.
If you haven’t yet, choose one of these models and then run some experiments. With a concrete strategy and these concrete ideas you’ll have a better idea of some action you could take to improve your margin.
Contact us at OrderMetrics if you want some advice – we will be happy to take a look at your business and suggest improvements you could make.
About This Guide
The OrderMetrics Profit Guide is designed to help you unlock the most profit for your e-commerce business.
Additional help was provided by Hank Kronick, founder of Order Metrics and data analysis specialist.
We’ve got a combined 16 years of e-commerce experience and have personally used every technique described in this guide and seen the results in practice.