General Pricing Approaches Cost-Based Pricing Break-Even Analysis and Target Profit Pricing Value-Based Pricing Competition-Based Pricing
Cost based pricing• Using the cost of production as the basis for pricing a product.• Here the selling price of product a will be the cost to produce it.• It includes :- Direct and indirect costs Additional amount to generate profit.
Cost based pricing Product Cost Price Value Customers
Advantages Super easy. Flexible. If costs go up, it is easy to adjust prices. Super simple to calculate. Is easy for a marketer to defend pricing. May suit a manufacturer with scalable production based on demand.
Disadvantages Ignores product demand or the influence price may have on demand. Ignores what competitors are doing with their pricing. If costs increase, so must the price. Ignores brand positioning so may forfeit additional profit. It provides no incentive to improve cost efficiency.
Classifications of cost based pricing1. Cost plus pricing2. Full cost pricing3. Target profit pricing4. Marginal cost pricing
Cost plus pricing A fixed percentage of profit will be added to the cost. The fixed percentage of profit will be taken by manufacturer, wholesaler and the retailer.
Egg:- Fixed cost for making 10,000 shirts is Rs.1,50,000. Variable cost (P.U) = 30 Cost (P.U) = 45 Firm expects 30 % return on sales. The mark up Price will be = 45/(1-0.3) = Rs. 64.28 p
Full cost pricing Also called absorption cost pricing. Attempting to set price to cover both fixed and variable costs Total cost will be computed by adding variable and fixed cost incurred in the product. The price of each product is dependant on how many costs it creates.
Egg:-• MM co. plan to produce 5000 widgets.• Manufacturing labor = Rs. 50,000• Material cost = Rs. 1,00,000• Overhead cost= Rs. 20,000• Direct labor (P.U)= 50,000/5000 = Rs.10• Material cost (P.U)= 1,00,000/5000= Rs. 20• Overhead cost (P.U)= 20,000/5000= Rs. 4• Desired profit (P.U)= Rs. 8
Cont.• Add all cost per units• = 10+20+4+8• Full cost price = 42 (P.U)• This means using full cost pricing, MM company would sell its widgets at Rs.42 (P.U)
Target profit pricing Also called rate of return pricing Mark-up = Profit/Cost x 100 Setting price to ‘target’ a specified profit level Estimates of the cost and potential revenue at different prices, and thus the break-even have to be made, to determine the mark-up This method is possible when there is no competition in the market.
Egg :-• Sales price per unit = Rs. 250• Variable cost per unit = Rs. 150• Total fixed expenses = Rs. 35,000• Target Profit = Rs. 40,000• Q = Number (Quantity) of units sold• How many units will have to be sold to earn a profit of Rs. 40,000?
Cont.• Sales = Variable expenses + Fixed expenses + Profit• Rs. 250Q = Rs. 150 + Rs. 35,000 + Rs. 40,000• Rs. 100Q = Rs. 75,000• Q = Rs. 75,000 / Rs. 100 per unit• Q = 750 Units• Thus the target profit can be achieved by selling 750 units per month, which represents $187,500 in total sales ($250 × 750 units). This equation is also extensively used to calculate break even point. When break even point is calculated the value of profit in the equation is taken equal to ZERO.
Marginal cost pricing This aims at maximizing the contribution towards fixed cost. In addition portion of the fixed cost will also realized. Marginal cost – the cost of producing ONE extra or ONE fewer item of production. Particularly relevant in transport where fixed costs may be relatively high
EGG:- Aircraft flying from Bristol to Edinburgh – Total Cost (including normal profit) = £15,000 of which £13,000 is fixed cost* Number of seats = 160, average price = £93.75 MC of each passenger = 2000/160 = £12.50 If flight not full, better to offer passengers chance of flying at £12.50 and fill the seat than not fill it at all!
Demand-Based pricing• Pricing that is determined by how much customers are willing to pay for a product or service• This method results in a high price when demand is strong and a low price when demand is weak• May be differentiated based on considerations such as time of purchase, type of customer or distribution channel
Competition-Based pricing• Pricing that is determined by considering what competitors charge for the same good. Once you find out what your competition is charging, you must determine whether to charge the same, slightly more, or slightly less.
Competition-Based Pricing Product Cost Price Value Customer
Setting Initial Product Prices Market Skimming Market Penetration> Setting a high price for a new product to > Setting a low price for a skim maximum new product in order to revenues from the attract a large number target market. of guests.> Results in fewer, more > Results in a larger profitable sales. market share.> Popular night club > New Marriott charges a high cover charge
Existing-Product Pricing Strategies• Product-Bundle Pricing• Price-Adjustment Strategies – Volume Discounts – Discounts Based on Time of Purchase – Discriminatory Pricing – Yield Management• Non-Use of Yield Management• Last-Minute Pricing
Product-Bundling Pricing• Transfer surplus reservation price (the maximum price a customer will pay for a product) – Customer A will pay $60 for a Disney pass and $120 for a hotel room. Customer B will pay $95 for the Disney pass and $80 for the hotel room – A hotel selling a two night package with pass for $350 will get both customer• Price-bundling also reduces price competition – by making it hard to figure price of components – In an airline and hotel package it is difficult to determine the price of the room
Psychological Pricing• Price-quality relationship• Reference prices• Rounding• Length of the field
Promotional Pricing• Temporary pricing of products below list price and sometimes below cost – Value Pricing – Price Sensitivity Measurement