Pricing should be a strategic choice, not a mathematical one. Learn what pricing strategy is and how it’s impacted by behavioral science, supply, and demand.
Pricing strategy determines how value creation is incentivized and shared between buyers and sellers—reflecting a company’s philosophy for acquiring, retaining, and satisfying customers by sharing value with them fairly. How much a company can share depends on the characteristics of its market and how it chooses to use its competitive advantages in that market. How much value a business leader wants to share depends on their company’s short- and long-term objectives.
A strong pricing strategy recognizes that the size of any market—especially how that pie gets divvied up—is the direct result of countless pricing decisions companies and customers make every day. Strategic pricing decisions help leaders identify the imbalances in their markets, assess the resulting opportunities and risks, and then frame their options depending on how they want to direct the flow of money in the market.
A pricing model is the manifestation of a pricing strategy, defining the ways in which a pricing strategy is implemented along all pricing levers—from pricing architecture to price variation to pricing adjustment.
The secret to building a powerful pricing model lies in the answers to three questions.
All pricing decisions are based on three fundamental inputs: the cost of production of the product or service, the value that customers get from it, and how competitors price comparable alternatives. The price needs to be above the production cost, below the value customers receive, and in range of competitors’ prices.
Cost, value, and competitors are never constant. They will vary depending on where the product is sold, when it is being sold (based on season, month, or even time of day), and fluctuations in customers’ needs, willingness to pay, scarcity, and so on. Understanding the combined effects of these variations and how to take advantage of them is the essence of pricing strategy.
Price elasticity measures how the demand for a product or service will vary in response to a change in its price. This framework offers data-driven answers to questions about pricing decisions, such as “What happens if we raise or lower prices by 5%?”
Price elasticity addresses cost and value, as cost and willingness to pay are the two inputs necessary to calculate an optimal price based on elasticity.
Game theory is a framework for analyzing strategic interactions, where the outcome for each company depends on the action of its competitors. When a company’s prices depend on the pricing decisions of a few individual competitors whose offerings all have very similar value, a company only needs costs and competitor price information to define optimal prices that maintain a market equilibrium.
The game theory framework allows leaders to make better-informed pricing decisions by helping them understand the effects their moves will have on both competitors and their own company.
Pricing strategies based in behavioral science analyze the ways customers choose from among either a company's various offers or its competitors’ offers. Behavioral science studies highlight numerous biases humans have when making buying decisions that transcend the numerical rationality of pure economics.
A pricing strategy based on behavioral science is especially helpful for companies that leverage available data on customers—their demographics, behavior, and needs—to create personalized offers with segment-specific pricing.
A market’s supply curve is based on the costs, capacities, and prices of every competitor. The demand curve is a function of either the aggregated willingness of individual customers to pay or the value that those customers derive.
The supply and demand framework addresses all three sources of information (cost, competition, and value) and is built on the idea that market equilibrium pricing exists at the point where a demand curve and supply curve intersect. The demand curve slopes downward because a given offer becomes less attractive as its price rises, and vice versa. At the same time, the supply curve slopes upward, indicating that production becomes more attractive to more competitors as prices rise, and vice versa.
Sophisticated algorithms and robust data—often AI-driven—make it possible to disaggregate demand down to individuals at a specific moment. These emerging technologies are making aggregate supply-demand matching and average prices obsolete because companies can now make pricing decisions at an individual level.
We have defined the following seven approaches to pricing—what we call “pricing games”—that are essential to any pricing strategy. Deciding which of the seven games you play is one essential part of creating your pricing strategy:
It’s time to look at pricing decisions in a new light. Game Changer: How Strategic Pricing Shapes Businesses, Markets, and Society not only exposes the flaws in current pricing models, it also explains how the right pricing strategy can change the trajectory of your business, your industry, and in many cases, society as well.
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