The Consequences of Overpricing
Setting prices too high can damage your product or service’s market potential in several ways:
1. Reduced Market Penetration and Volume
High prices can deter price-sensitive customers, shrinking your total addressable market (TAM). Particularly for physical products, where substitutes are often widely available, customer loyalty is unlikely to sustain inflated pricing unless your offering has a truly unique value proposition.
Example: When the first-generation Microsoft Zune launched in 2006 at $250—on par with the Apple iPod—it failed to convince customers of its value superiority. Lacking differentiation, Microsoft struggled to justify its premium pricing in a highly competitive market.
2. Slow Inventory Turnover
Overpricing physical products means they may sit unsold in warehouses longer, tying up working capital. For startups and SMEs, this can create a cash flow crunch, hindering further growth or innovation investments.
Statistics: According to Bain & Company, up to 40% of a manufacturer’s working capital can be tied up in unsold inventory when pricing misses the mark, particularly for consumer goods.
3. Brand Misalignment
Price sends a signal about your brand. If your product is priced too high versus the experience it delivers, customers may see your offering as overpriced rather than premium. Over time, this erodes trust and customer satisfaction.
The Dilemma of Underpricing
If overpricing is problematic, underpricing is equally dangerous. Low prices may result in short-term sales boosts, but they can undermine long-term viability in several ways:
1. Low price set as baseline
Unless it is the strategic direction to use low prices as one of the value proposition to customers, that low price will be your baseline moving forward. It is easy to drop prices to drive revenue, and unless it is macro-economic induced (e.g inflation or increase of interest rates or taxes), it is very difficult to raise prices after.
2. Eroded Margins and Profitability
While lower pricing may drive volume, razor-thin margins mean your business struggles to stay profitable. For physical products, where costs like raw materials, logistics, and inventory are significant, this is particularly risky.
Example: The downfall of Forever 21 partially stemmed from its underpricing strategy in the fast-fashion market. Aggressive discounts eroded margins over time, which, combined with high operational costs, contributed to bankruptcy in 2019.
3. Perceived Low Quality
Underpricing can inadvertently signal a lack of quality, limiting your ability to attract higher-value, discerning customers. For instance, customers often equate price with craftsmanship, especially in industries such as electronics, furniture, and luxury goods.
4. Price Wars and Competitive Pressure
Underpricing often triggers harmful price wars with competitors. While large players may have the resources to withstand prolonged price battles, smaller firms often cannot.
Statistics: Research by McKinsey & Company shows that cutting prices by 5% to increase sales volumes only works sustainably for businesses that can reduce costs by an equal or greater percentage, which is rare for most physical product providers.
Finding the Sweet Spot: The Impact of Pricing on Revenue
The effects of pricing on revenue can be profound. A 1% improvement in price can increase operating profits by 11%, according to McKinsey research, illustrating the outsized impact of this single lever. The right pricing balances customer value, costs, and market dynamics to optimize revenue and profitability.
Best Practices for Pricing Physical Products and Services
Given the challenges of pricing, how can businesses strike the right balance? Below are pricing best practices, supported by insights from Bain, McKinsey, and BCG:
1. Understand Customer Willingness to Pay (WTP)
Develop a deep understanding of what your target customers are willing to pay for your product or service. Conduct customer interviews, deploy surveys, and analyze historical purchasing behavior.
Example: Apple’s premium pricing strategy reflects its deep understanding of customers’ willingness to pay for design, innovation, and ecosystem. The iPhone consistently commands high price points while maintaining strong demand.
2. Focus on Value-Based Pricing
Pricing should reflect the value your product delivers to the customer rather than simply adding a margin to costs. Value-based pricing allows you to align price with customer benefits, enabling higher margins without alienating customers.
Case Study: Bayer’s Aspirin is priced higher than generic alternatives despite having the same active ingredients. Bayer justifies its premium through brand trust and guaranteed quality, underscoring the role of value-based pricing.
3. Test Before You Commit
Use test markets, A/B pricing experiments, and focus groups to evaluate customer responses to different price points. Data-driven pricing decisions reduce the risks of misalignment.
Example: Netflix constantly tests price changes in specific geographies to evaluate elasticity and optimize its subscription tiers.
4. Factor Total Costs (Not Just Margins)
For physical products, pricing must account for the full cost structure, including raw materials, manufacturing, logistics, and retail margins. Underestimating costs can lead to revenue losses despite high sales volumes.
5. Avoid the Race to the Bottom
In competitive markets, resist the temptation to engage in aggressive price wars—with rare exceptions. Competing on differentiation (e.g., quality, convenience, or sustainability) is often more sustainable than competing solely on price.
Example: Dyson continues to dominate the premium vacuum market by justifying its pricing with superior technology and design, rather than competing on cost with cheaper alternatives.
6. Leverage Pricing Analytics
Invest in pricing analytics tools to simulate different scenarios, predict customer behavior, and anticipate competitor reactions. These insights help refine pricing strategies and protect profitability.
Conclusion: Pricing as a Strategic Lever
Setting the right price for a physical product or service is not just about covering costs or achieving profitability—it is a strategic choice that directly impacts brand perception, market positioning, and long-term results. Businesses that take a thoughtful, data-driven approach to pricing, rooted in customer insights and market dynamics, are better positioned to succeed.
Pricing should never be static. It must evolve with market conditions, customer expectations, and competitive pressures. By avoiding the traps of overpricing and underpricing, and instead focusing on value, businesses can unlock sustainable growth and profitability.
Getting pricing right isn’t just about what you charge—it’s about knowing what price your customers are willing to pay.