Pricing Models Explained

During any diligence process the challenge becomes explaining to Purchasers or Investors and more importantly to their Professional Teams how your business operates and why. A key point is the Company’s Pricing Model. We delve into some types of Pricing Models as defined in the marketplace so you know which bucket you fall into and how to explain how you got to where you got to.

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Cost-Plus Pricing

This model involves adding a markup to the cost of production to determine the selling price. It ensures that a business covers its costs and generates a profit. So if your business wants to operate at a 30% Gross Profit Margin and the cost of goods is €100.00, you will have to charge €130.00 to achieve your target margin. (example excludes VAT).

Value-Based Pricing

In this approach, the price is set based on the perceived value of the product or service to the customer. It often allows for higher prices for products with unique features or benefits. Its often used to determine what a customer or potential customer might be willing to pay for the actual benefit they receive.

Competitive Pricing

Prices are set based on what competitors are charging for similar products or services. This can involve pricing higher, lower, or matching the competition. This way you are showing that you are on top of the market value for your goods or services, but you want to avoid a competitive race to the bottom, whereby no one makes any money in the sector.

Dynamic Pricing

Prices fluctuate in real-time based on various factors such as demand, time of day, or customer behavior. This is common in industries like airline tickets and hotels. It is also the harsh reality of the construction sector, where elevated quotes are made as the builder has more work than they can carry out and they simply chase the higher value business.

Subscription Pricing

Customers pay a recurring fee at regular intervals, often monthly or annually, to access a product or service. This model is popular in software, streaming services, and more. The benefits to this model can be that while you quote on a monthly sub basis, the fee might be taken as an annual bill, thus improving your cash flow and can reduce the reliance on fund raising.

Freemium Pricing

A combination of “free” and “premium,” where a basic version of the product or service is offered for free, with premium features available for a fee. A great example of this was that door to door salesman of Gelatin in the early 1900’s in America would deliver free recipe books to households. The recipes relied on the ingredient Gelatin and when they called next the household would buy Gelatin from them.

Penetration Pricing

This involves setting a low initial price to gain market share quickly. Once a customer base is established, prices may be raised. This can be a double edged sword as you may be familiar with Hubspot who offer a 90% discount in year one, only for a huge drop off in Start Up Users as the pricing is considered unsustainable.

Price Skimming

The opposite of penetration pricing, this strategy involves setting a high initial price to maximize profit from early adopters. Prices are then gradually lowered to attract a broader customer base.

Bundle Pricing

Products or services are bundled together and sold at a lower overall price than if each item were purchased individually. This can encourage customers to buy more. The business can still protect its target Gross Profit Margin with this method.

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Pay-What-You-Want (PWYW)

Customers can choose the price they want to pay for a product or service, often with a suggested price. This model is used in some charitable contexts and by digital content creators. This isn’t typically an Investor friendly model.

Auction Pricing

Products are sold to the highest bidder in an auction format. Online marketplaces like eBay use this pricing model.

Time-Based Pricing

Prices are determined by the time of purchase, with discounts or surcharges based on factors like seasonal demand or peak hours.

These are just a few examples of pricing models, and businesses may use a combination of them or adapt their pricing strategies over time to suit their goals and market conditions. Make sure you know what your pricing model is and have a clear pitch as to your strategy for the business and explain how you got there to your target audience.

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