How to Choose the Right Pricing Strategy for Your Business

From Cost-Plus to Value-Based: The Pricing Strategies That Shape Profit, Positioning, and Growth

In my previous pricing blog, "Pricing and Profitability: The Make-or-Break Decisions for Your Business", we explored how pricing for sales growth and pricing for profitability differ, as well as their impact on profitability. However, deciding whether to chase sales growth or profit is only the beginning in setting the right price. Once you are clear on what you aim for, the next question is how to set prices to achieve that goal. This is where specific pricing strategies come into play — from straightforward approaches like cost-plus or competitive pricing to penetration and value-based pricing. Each pricing strategy has its place depending on the product or service you offer, the market you operate in, you’re your (aspired) market position and your business objective.

In this blog, I’ll unpack these common pricing strategies for small to medium-sized Australian businesses, explain when to use them, and demonstrate how they align with your growth or profit strategy.

Strategy 1: Cost-Plus Pricing

Cost-plus pricing is the most straightforward pricing strategy there is. Small businesses often start here because it’s simple and safe (safe in the sense that you are looking at your costs). The idea is exactly as it sounds: calculate your costs, add a markup, and that’s your price. No guesswork — just a formula that ensures your costs are covered and your profit is built in.

In retail, supermarkets and other shops typically price products based on their cost of goods sold (COGS). Store overheads, like rent and wages, are recovered through the gross margin applied across all products.

Example:

Let’s say you are a chocolate maker and want to determine the price of your chocolate. Your variable costs are $6. You aim for a contribution margin of 40%.

Depending on whether you’re using margin or markup as your target, this is how you set your selling price based on cost plus pricing:

Option 1: Start with a target profit margin

First, calculate the selling price that yields your desired margin. Then, you can derive the markup from that if needed.

Formula:
Selling Price = Cost / (1 – Target Margin)

Example:
Cost = $6.00
Target margin = 40%
Selling Price = $6 / (1 – 0.40) = $10

Then, derive markup:
Markup = (Selling Price – Cost) / Cost = ($10 – $6) / $6 = 66.7% 

Option: Start with a markup goal

You apply the markup directly to your cost to calculate the selling price.

Formula:
Selling Price = Cost × (1 + Markup)

Example:
Cost = $6
Markup = 66.7%
Selling Price = $6 × (1 + 0.667) = $10

This results in the same final price as the margin example above, but the logic flows differently.

Note: Clearly define what is included in your cost base, so that your markup accounts for costs and profit that are not included. To keep it simple, I used variable costs (such as raw materials + direct labour + packaging) as my common base for cost-plus pricing. You could also opt for COGS (all variable production costs + allocated factory overheads).

The Benefits and Drawbacks of Cost-Plus Pricing

This method ensures that all costs are covered (provided your cost base is accurate) and profit is built into every sale, which is why cost-plus pricing remains a favourite among retailers, wholesalers, and manufacturers. It’s simple, transparent, and easy to manage.

However, it does have limitations. If customers value your chocolate more than expected, you might leave money on the table by not charging a higher price. On the other hand, if competitors offer similar chocolates at lower prices, a rigid cost-plus price could make the product uncompetitive.

That’s why cost-plus pricing should be seen as a starting point. Once your costs and markup are locked in, it’s smart to layer on a market perspective — considering competitor pricing and customer willingness to pay — to fine-tune your final price.

In summary

Pros

• Simple and ensures cost coverage
• Provides stable and predictable margins (if sales hold)
• Easy to calculate and implement

Cons

• Ignores market demand and perceived value
  
• Can lead to overpricing or underpricing
  
• Not responsive to competition

Best for
Wholesale, manufacturing, and stable or commodity products

That’s why it’s smart to treat cost-plus pricing as a starting point. Once your costs and markup are set, you can layer on a value-based perspective (considering competitor prices and customer willingness to pay) to fine-tune your final price. 

Strategy 2: Competitive Pricing 

When customers can easily compare products, price becomes a critical part of your strategy. That’s where competitor-based pricing steps in — a straightforward approach where your price is guided by what others in the market are charging.

This method is especially useful in competitive markets, where products are similar and price is a key decision driver. By staying aligned with market expectations, you reduce the risk of pricing yourself out.

How Competitor-Based Pricing Works

Unlike cost-plus pricing, competitor pricing doesn’t start with your costs. Instead, you look outward at what similar products are selling for, and position your price accordingly.

You can choose to:

• Match competitors → Stay in line with market prices to remain competitive.
• Price below competitors → Attract price-sensitive customers and drive volume.
• Price above competitors → Signal higher quality, better service, or exclusivity.

The right approach depends on your brand, your target market, and how you want to be perceived.

Example: 

Let's revisit our chocolate maker example. To set your price, you now look at similar chocolates already in the market:

• Competitor A sells at $7
• Competitor B offers theirs for $9
• Competitor C positions premium at $11

You decide to price at $10.5 – a price just below your closest competitor, whilst still signalling premium quality.

The Benefits and Drawbacks of Competitor-Based Pricing

Competitor pricing keeps you grounded in the market and reduces the risk of being priced too high or too low.
However, it has limitations. If you focus only on competitors, you risk ignoring your costs and profit requirements. Pricing too low can erode margins, while missing opportunities to price higher can limit profitability if customers perceive more value in your product.

That’s why competitor pricing should not stand alone. It works best when combined with cost analysis and value-based thinking to ensure your prices are competitive and profitable.

In summary

Pros

• Simple and easy to apply
• Keeps your prices aligned with market expectations
• Helps maintain your competitive position

Cons

• Ignores your own costs and profit targets
• Can lead to price wars and margin pressure
• May overlook customer-perceived value and willingness to pay

Best for

Highly competitive markets, commoditised products, and price-sensitive customers

In short, competitor-based pricing helps you stay market-relevant, but should be part of a broader pricing strategy. By layering competitor insights with your costs and your product’s value, you can set prices that protect your margins while still winning customers.

Strategy 3: Value-Based Pricing

In today’s market, pricing isn’t just about covering costs or beating competitors.
It’s about understanding what your product is really worth to your customers.

That’s the idea behind value-based pricing. Instead of anchoring your price to what it costs you to produce or what others charge, this approach focuses on what your customers are actually willing to pay. That price is based on how much they value your product — the experience, the quality, the story — not just the ingredients or materials.

For businesses offering premium, unique or purpose-driven products, value-based pricing can unlock higher margins and better reflect what makes you different.

How Value-Based Pricing Works

Value-based pricing starts with a key question: What does my product mean to my customer, and what is that worth to them?

Your price should reflect the benefits and experiences your product delivers.
Customers often pay more for:

• Quality and craftsmanship
• Ethical sourcing or sustainability
• Brand values and storytelling
• Unique or exclusive offerings

It’s not about guessing — it’s about really understanding your audience and how much they value what you offer. That insight allows you to set prices that feel right to them and make sense for your business.

Example:

Let's revert to our chocolate maker. The business sources its cocoa beans directly from small organic farms and pays a premium. The business also holds Fairtrade and B-Corp certifications, which provide the conscious consumer with an additional layer of trust, as greenwashing has unfortunately become the norm rather than the exception.

A cost-plus approach might suggest pricing at $10. Competitor prices might suggest $10.50. However, loyal customers who prioritise sustainability, craftsmanship, and supporting ethical businesses often perceive more value. Through feedback and market insights, the brand realises that those customers are happy to pay $12.

That becomes the value-based price, not based on production cost or competitor pricing, but on the true value the product holds for the right customer.

The Benefits and Drawbacks of Value-Based Pricing

Value-based pricing lets you capture your product’s full potential. It helps you to avoid underselling and to build stronger margins, while reinforcing your brand’s positioning.

But it does require more effort. You need to have a deep understanding of your customers and your market. If you misread their willingness to pay, you could price too high and hurt sales, or too low and miss valuable revenue.

In summary

Pros

• Maximises revenue potential by aligning with customer-perceived value
• Reinforces brand and product differentiation
• Avoids price wars and undercutting

Cons

• Harder to determine the right price — requires strong customer insight
• Risk of mispricing if the perceived value is misunderstood
• May not appeal to price-driven customers

Best for

Premium, differentiated and purpose-driven products — where customers buy for values, experience, or exclusivity. This pricing strategy often supports a profit-maximising business goal.

In short, value-based pricing helps businesses charge what their product is truly worth.
Yes, it takes work understanding your customers and communicating your value clearly, but when done well, it leads to stronger pricing power, healthier margins, and deeper customer connection.

Strategy 4: Penetration Pricing

When launching a new product or entering a competitive market, getting attention and winning over customers can be tough. That’s where penetration pricing comes in.

Penetration pricing is all about starting low to get noticed. By setting your price lower than competitors (or lower than your long-term target), you make it easier for customers to say 'yes' and try your product. Once you've built awareness, loyalty, and volume, you can gradually increase prices over time.

This approach is often used by new brands or when entering markets crowded with established players.

How Penetration Pricing Works

With penetration pricing, the idea is simple: Start low → win customers → build volume → increase prices later.

You deliberately set your price at the lower end of the market — sometimes even at cost or slightly above — to attract customers quickly and encourage them to switch from competitors or try something new.

Once customers are familiar with your product and the demand is established, you then have the option to gradually lift prices or introduce higher-margin versions.

This approach works best when:

• Your product has mass appeal
• The market is competitive and price-sensitive
• Building customer loyalty and market share is a priority

Example:

Imagine you're launching a new everyday chocolate range to complement your premium artisan collection. Your goal? Attract supermarket shoppers who usually buy well-known brands.

Similar chocolates of your competitors retail for $7 - $7.50. You decide to enter the market at $6.50 — low enough to grab attention and entice people to give your chocolate a try.

Once customers discover the taste and quality, and your brand gains traction, you plan to gradually increase the price closer to the $7-$7.50 mark, bringing it in line with the market while retaining your new customer base.

The Benefits and Drawbacks of Penetration Pricing

Penetration pricing can be a fast track to market share. By making your product more affordable at launch, you reduce the barrier to trial and can build a loyal customer base quickly.

But there are trade-offs. Starting low means lower profit margins in the early stages. If prices stay low for too long, it can be difficult to lift them later without pushback. There’s also a risk of attracting bargain hunters rather than loyal, long-term customers.

In summary

Pros

• Attracts customers quickly with affordable prices
• Helps build market share and brand awareness
• Discourages competitors from entering

Cons

• Low margins in the short term
• It can be difficult to increase prices later
• Risk of attracting price-sensitive buyers who may not stick around

Best for

New product launches, entering competitive markets, and businesses looking to build volume and awareness fast.

In short, penetration pricing can be an effective way to enter the market and win customers quickly. But it’s most powerful when used strategically, as part of a plan to move towards higher prices once your brand is established and valued.

Final thoughts

Choosing the right pricing strategy isn’t a one-size-fits-all decision — it depends on your product, market, business goals, and customer base. Whether you're launching a new range, competing for shelf space, or positioning your brand as a premium offering, pricing plays a defining role. Start with a clear understanding of your costs, your market, and your customers’ values. Then choose the strategy that not only aligns with your goals but also helps you build a business that’s profitable, resilient, and valued.

In my next pricing blog, I’ll unpack behavioural pricing — a powerful set of tactics drawn from behavioural economics — and show how small businesses can use psychology to present prices more effectively, increase perceived value, and boost conversions without lowering prices.