8 common pricing models to optimise company profits

By Indeed Editorial Team

Published 26 April 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

One of the most important decisions you might make as a business leader is how to determine prices for the company's product. Collecting and analysing market data can help support this decision-making process. Pricing models are one way to analyse and apply this information, as they illustrate and predict the effects of various prices in certain market conditions. In this article, we define price modelling, explain the types of pricing models and share how to choose an effective pricing strategy.

8 common pricing models

Before learning the common pricing models, it's important to understand what price modelling is. Pricing modelling refers to the methods you can use to determine the right price for the company's products. Price models consider factors such as the cost of producing an item, the customer's perception of its value and the type of product. They're often visually represented on a chart such as a demand curve. Here are common types of pricing models:

1. Cost-plus pricing model

Cost-plus pricing can be a relatively straightforward yet powerful strategy for setting prices. Under this approach, you calculate the total cost of materials and labour overhead that goes into making a product. Then, add a markup so you earn a profit. To use this model, identify those costs that contribute to producing the company's product and perform a careful analysis of market factors to determine the appropriate markup percentage. Consider evaluating the standard markup in your industry. It's also important to evaluate the location and demand when deciding when and how to use this strategy.

Related: What is financial modelling for businesses? (With examples)

2. Value-based pricing model

Value-based pricing uses the customer's perception of the product's value to set prices. Using this strategy involves measuring and analysing the customer base's ideas about the product's worth. Since this strategy doesn't necessarily take the cost of production into account, it's ideal for products and industries where prices generally exceed costs by a healthy margin. For example, luxury goods and services may use a value-based pricing model because customers are willing to pay a premium for an indulgent experience or name-brand product, regardless of the cost of production.

3. Hourly pricing model

Hourly pricing is ideal for pricing services rather than goods or physical products. This pricing model often takes factors such as the value of the provider's labour and any associated expenses into account. Hourly pricing can require more documentation than other kinds of pricing, especially on the part of the service provider, because customers often like to know exactly the tasks the service provider has completed in the period of time they paid for. For example, an hourly freelance designer might specifically document the tasks they accomplished in a period of time according to type so the client can see the use of that billable time.

If you choose to charge by the hour, there are two things to consider when deciding your fee:

  • Non-billable hours: These often include tasks such as administrative work, managing your team, training and marketing your own services. When choosing your hourly rate, consider non-billable hours to make sure you don't end up working against yourself.

  • Blended rates: Sometimes, it's necessary to outsource work to contractors to free up your time availability. To not cut into your profits, you can charge a 'blended rate', which is your hourly rate plus contractors hourly rate, and charge based on the sum of the two rates.

4. Fixed pricing model

Fixed pricing, also known as project-based pricing, involves setting a price for an entire contract or project. This method offers consistency for the customer and might maximise profits if the business can complete the project efficiently. A wedding photographer, for example, might use fixed pricing when they charge a set price for a photo package. Although the cost of their transportation to the site, hours and equipment might change, the cost of that service remains the same. For this reason, it's important to analyse the total cost of a product or service and adjust the fixed price accordingly.

5. Equity pricing model

In some cases you may be willing to accept equity or stock in a company as compensation for the company's services or products. Choosing to offer equity pricing can depend on factors such as the size, success of a client company and the anticipated performance of their stock. You might also choose to use a combination of a different pricing model and equity pricing if your situation requires cash income and long-term value.

Related: What KPI stands for and how to use it in your career

6. Performance-based pricing model

In performance-based pricing, the company invoices its customers based on the performance of the service or product it delivers. This pricing model is ideal for certain clients and in specific situations, as it often requires significant agreement between the company and its client or customer. It's important to spend the time upfront setting guidelines for a performance-based pricing model and creating clear metrics to achieve objectives.

If you're in a rush or getting pressure from the client to move forward, it may not be a good idea to use a performance-based pricing model. This model is often complex and can support working relationships that incentivise performance. Because of the often subjective nature of project performance, you may wish to strongly consider using this model only if the organisation or business has strong legal support to review contracts ahead of time.

7. Retainer pricing model

A retainer pricing model is when a customer or client pays a company or business an agreed fee for a set amount of time or deliverables. This pricing model is ideal for clients with long-term goals or needs. They essentially buy the company's time and priority for a set amount of projects over a set timeframe. There are two prime examples of agency retainers:

  • Time-based: This is where a customer or client agrees to purchase a certain number of hours upfront per month. For instance, if a client or customer agrees to buy 50 hours per month at £90 per hour, the company's retainer fee would be £4,500, which may cover tweaking flows and maintenance costs.

  • Deliverable-based: This is where a client agrees to pay for a set amount of deliverables. For instance, if you're managing chat marketing for a client, you can set up a retainer that states for £1,500 per month, you plan and execute monthly SMS, email and instant messaging campaigns, manage analytics and write Botcopy.

8. The 'Working Backwards' pricing model

The phrase 'Working backwards' means starting at the end of a problem and undoing it step by step. This pricing model starts by focusing on a revenue goal. It considers factors such as how much revenue the company needs to produce each month, how many clients the company needs to reach that revenue and how much the company charges each client to get there. For instance, say you want to make £100,000 this year, that's £8,334 per month. If you want to charge £700 a month for your services, you need 12 clients on board to reach your goal.

Related: How to develop SMART goals

How to choose a pricing strategy

Selecting a pricing strategy involves considering several important factors, such as customer demand, market value and production costs. You can take the following steps to choose an effective pricing strategy:

1. Know the company's customers

The first step in selecting a pricing strategy is to anticipate the wants and needs of the company's customer base. Determine what they're looking for and what they can afford. This allows you to offer appealing services or products at a price they're willing to pay. To find out more about the company's customer base, consider issuing a customer survey that asks questions like:

  • Would you recommend this service or product?

  • What would you like about this service or product?

  • Is the value of the product or service equal to its price?

2. Understand the company's services or products

The next step is to know the unique value of the company's products. To do this, consider dedicating effort and time to market research. This typically involves comparing a service or product to similar products or services already on the market, conducting surveys to find out the best target demographic and considering competing prices. Determining the value of the company's services or products can help you choose a pricing strategy that guarantees a profit.

Related: What are unique selling points and how to work them out

3. Consider the company's industry

The best pricing strategy for each business or company varies greatly by industry. When you choose a pricing strategy, consider looking at other businesses or companies in the same industry that are marketing the same products or services. Chances are they're using a particular pricing strategy as it lends itself to their services or products or their business model. Observing the mistakes and successes of others can help you greatly increase the company's chances of success.

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