Smart E-Commerce Pricing Strategies for Your Online Store

Graeme Caldwell
Tue, 02 Jul 2024 10:00:00 +0000
Competitive-pricing, Cost-analysis, E-commerce-pricing, E-commerce-pricing-strategy, Ecommerce-pricing, Ecommerce-pricing-models, Marketing-tactics, Pricing, Pricing-models, Pricing-strategies, Pricing-strategy, Profit-margins, Retail-pricing-strategies, Pricing-merchandising

By Graeme Caldwell

Retail is easy to describe. A company buys a product. They sell it for more than they paid. The difference is their profit.

In reality, retail is complicated because everyone involved seeks to maximize the difference between a product’s value and what they pay for it. Manufacturers want to sell for as much as possible. Customers want to buy for as little as possible, or, more accurately, they want to feel as good as possible about their purchase—that doesn’t always mean paying the least. The retailer is in the middle, competing with other retailers playing the same zero-sum game.

Pricing is a critical factor in deciding the winner of that game, especially in the e-commerce world where customers can easily compare prices. Every e-commerce retailer has to answer the same question: How much should I charge for this product?

Let’s look at some of the strategies retailers use to decide. We’ll consider a widget bought from a wholesaler for $10 per item—how much should an e-commerce retailer charge a customer who wants to buy our $10 widget?

Basic pricing strategies for e-commerce stores

Keystone pricing is the most straightforward strategy. The retailer doubles what they paid for the product, and that’s the price they charge customers. Expressed differently, the retailer puts a 100% markup on their products. Our widget costs $10, so we sell it for $20.

This gives us a gross profit margin of 50%. The net profit is lower because we haven’t accounted for marketing costs and other overheads, but for many retail businesses, the net profit from keystone pricing is acceptable. Keystone pricing has the advantage of being simple. It’s easy to decide how much to charge.

But there are obvious problems with this pricing model. As I’ve mentioned, it doesn’t account for marketing costs or overheads. It also ignores competitor pricing. Blanket keystone pricing is a bad idea because some products won’t sell at double the amount a retailer paid, especially when alternatives are readily available. Keystone pricing is, however, an effective way to establish a baseline, a reasonable price point that can move up or down depending on other factors.

Many retailers use a more complex method that accounts for cost, overheads, and an acceptable profit margin. If we’re happy with a 20% net profit, and we spend an average of $5 on marketing and customer acquisition for every sale, and our overheads are $2 per sale, we’d charge the following:

($10 + $5 + $2) * 1.2 = $20.40

It’s easy when we’re making up figures, but it can be challenging for a business to itemize its costs and overheads. And, once again, this pricing model fails to account for the competitive landscape. It’s a viable model for stores that sell unique goods that aren’t available elsewhere, but if you’re in a competitive market, both of these models might leave you trailing the competition.

Competitive pricing strategies

No retailer is an island, and it’s a rare e-commerce merchant who can ignore their competitors. In the offline world, retailers have a little more flexibility with competitor prices. Customers remember prices for a small number of products and few are diligent comparison shoppers. But, on the web, it’s easy to compare prices, and price comparison sites make it even easier.

The naive approach is to build a list of competitors, track what they charge for the products you also sell, and make sure your prices are always the same or lower. Some sectors act this way, but the result is almost always a race to the bottom and razor-thin margins. Businesses that depend entirely on price competition are in a precarious position.

A better approach is to identify key value items (KVIs) and key value categories (KVCs), the products and groups of products that have the biggest impact on the metrics we care about: sales, profit, customer loyalty, and so on. As McKinsey says in an article on pricing strategy, “To optimize value perception, a retailer will price KVCs and KVIs most sharply relative to the relevant competition … retailers have been able to effectively shape shoppers’ value perceptions by pricing competitively on the items that matter most.”

A store’s best-selling products will typically be on their list of KVIs if they are part of a competitive market. But there are other factors to consider:

Some products are more likely to figure in customer value calculations because they are more memorable or essential. A convenience store must track the price of milk, even if it makes more money on jars of pesto. Shoppers know the value of milk, but pesto is more difficult to price intuitively.

Products that attract traffic should be closely monitored. Again, these may not be your most profitable products. Our widget store may make more money from widget accessories than from the widgets themselves, but it’s the widgets that drive traffic. Once they have bought a widget, customers are far more likely to buy the accessories, whether or not they are priced to undercut the competition.

After having identified the most important products in their market, retailers track the prices of those items on specific competitor’s sites and adjust their prices to match or undercut the competition. In some cases, it is worth reducing the price of KVIs beneath the level at which they generate a profit. Loss-leader pricing is common and works, but it should be approached with care. A store that becomes identified with “low, low prices” is locked into a pricing strategy that can cause profitability problems.

Premium pricing strategy in e-commerce

Finally, some retailers may choose to price products higher than their competitors. Apple is a prominent example of premium pricing. Their laptops cost more than their competitors’ for equivalent specifications, and their high price is a signal of quality. That signal is backed by Apple’s manufacturing perfectionism, but the company has margins that are higher than any other phone or computer manufacturer.

Premium pricing establishes a product as high-value in the minds of customers. It’s useful when used in concert with branding and marketing strategies that emphasize quality and luxury over cost. It can also be useful when customers struggle to attribute a real value to a product: Diamonds are worth whatever people will pay for them, regardless of whether they are intrinsically valuable.

RELATED: 5 Ways to Raise Your Prices Without Losing Customers

About the Author

Post by: Graeme Caldwell

Graeme Caldwell is a writer and content marketer at Nexcess, a global provider of hosting services; he has a knack for making tech-heavy topics interesting and engaging to all readers. His articles have been featured on top publications across the net, from TechCrunch to TemplateMonster.

Company: Nexcess
Website: www.nexcess.net