Cost-Based Pricing Strategies

Pricing Approach #1: Cost-based pricing
There are essentially two models of Cost-Based pricing; ”break-even” and “markup“.
The break-even pricing approach is used to determine when you can expect a profit on your product or service. The point at witch you
will start making a profit is known as the “breakeven point”. To determine the breakeven point you will need to use the breakeven
formula.
To find the breakeven point, do so by dividing total cost by number of units produced plus variable costs.
Some major pitfalls of the breakeven formula and the breakeven point:
1. Lacks the complete picture – using the breakeven formula to calculate your breakeven point is a great place to start. However,
understanding your breakeven point is only useful if you can actually generate the appropriate consumer demand. In other
words, if you can’t generate enough consumer demand to actually hit your breakeven point, why even utilize the breakeven
formula to begin with? In most cases, it’s almost always best to consider how much consumer demand you can actually
generate.
2. Not 100% accurate over the long haul – the breakeven formula assumes that your “fixed costs” will always remain the same.
While this is true in the present, in most cases, your fixed costs will actually go up as you scale your business. That’s the goal,
right?
The markup pricing approach is often used by retailers due to its simplicity. The easiest and most common use is to speak in terms of
the “markup percentage”. For example, an investor may ask you, “what is your markup percentage on the product“.

To find the markup percentage of a product simply subtract the total cost from the sales price and divide again by the total cost.
Pricing Approach #2: Profit-based pricing
Probably the most popular model of profit-based pricing is what’s known as “target profit pricing“.
To use this pricing approach, take the following steps:
1. Determine the amount of profit you would like to make – the profit figure will be calculated into the pricing equation just like
an additional cost.
2. Find the sum of your total cost and profit.
3. Divide that number by the total number of units.
*As I mentioned before, the main concern with cost-based and profit-based pricing is that the competition and consumer demand is
ignored.
Pricing Approach #3: Demand-based pricing

There are many models of “demand-based pricing“. Let’s take a quick look at market skimming, penetration pricing, prestige pricing,
and bundle pricing.
1. Market skimming – market skimming is when the initial price is extremely high and reduced slowly over time. This allows for
businesses to recoup from production quicker but only in markets where consumers are willing to pay higher prices (think
about flat screen TVs).
2. Penetration pricing – penetration pricing is, essentially, the opposite of marketing skimming. Penetration pricing is when a
business is try to “penetrate” the market using pricing in order to capture market share. To increase their market share, a
company will typically offer discounts and rebates and then gradually remove them once they approach their market share
goal.
3. Prestige pricing – is used to try to communicate the value of the brand (think about Tiffany).
4. Bundle pricing – has become wildly popular due to the home cable and phone companies. Bundling combines complimentary
products to add to volume.
*A major benefit of “demand-based pricing” is just that; it takes into consideration consumer demand and your strategy for gaining
market share.
Pricing Approach #4: Value-based pricing
The last of the pricing approaches may have been the most relevant for the subject of the opening story. In value-based pricing it is
important to understand the use of the product and analyze the benefits. Sports teams use the value-based pricing option by charging
more for tickets versus major competitors.
Pricing is one of the most important elements of the marketing mix, as it is the only mix, which generates a turnover for the
organisation. The remaining 3p’s are the variable cost for the organisation. It costs to produce and design a product, it costs to
distribute a product and costs to promote it. Price must support these elements of the mix. Pricing is difficult and must reflect supply
and demand relationship. Pricing a product too high or too low could mean a loss of sales for the organisation. Pricing should take into
account the following factors:
1. Fixed and variable costs.

2. Competition
3. Company objectives
4. Proposed positioning strategies.
5. Target group and willingness to pay.
An organisation can adopt a number of pricing strategies. The pricing strategies are based much on what objectives the company has
set itself to
Types of Pricing Strategies

Pricing Strategy Definition Example
Penetration
pricing:
Here the
organisation sets a
low price to
increase sales and
market share. Once
market share has
been captured the
firm may well then
increase their price.
A television satellite company sets a low price to get subscribers then increases the price as their
customer base increases.
Skimming pricing:
The organisation
sets an initial high
price and then
slowly lowers the
price to make the
product available to
a wider market.
The objective is to
skim profits of the
market layer by
layer.
A games console company reduces the price of their console over 5 years, charging a premium at
launch and lowest price near the end of its life cycle.
Competition
pricing
Setting a price in
comparison with
competitors. Really
a firm has three
options and these
Some firms offer a price matching service to match what their competitors are offering.

are to price lower,
price the same or
price higher
Product Line
Pricing:
Pricing different
products within the
same product range
at different price
points.
An example would be a DVD manufacturer offering different DVD recorders with different features
at different prices eg A HD and non HD version.. The greater the features and the benefit obtained the
greater the consumer will pay. This form of price discrimination assists the company in maximising
turnover and profits.
Bundle Pricing:
The organisation
bundles a group of
products at a
reduced price.
Common methods
are buy one and get
one free
promotions or
BOGOF's as they
are now known.
Within the UK
some firms are now
moving into the
realms of buy one
get two free can we
call this BOGTF i
wonder?
This strategy is very popular with supermarkets who often offer BOGOF strategies.
Psychological
pricing:
The seller here will
consider the
psychology of price
The seller will therefore charge 99p instead £1 or $199 instead of $200. The reason why this methods
work, is because buyers will still say they purchased their product under £200 pounds or dollars, even
thought it was a pound or dollar away. My favourite pricing strategy.

and the positioning
of price within the
market place
Premium pricing
The price set is
high to reflect the
exclusiveness of
the product.
An example of products using this strategy would be Harrods, first class airline services, Porsche etc.
Optional pricing:
The organisation
sells optional extras
along with the
product to
maximise its
turnover. T
This strategy is used commonly within the car industry as i found out when purchasing my car.
Cost Based
Pricing:
The firms takes
into account the
cost of production
and distribution,
they then decide on
a mark up which
they would like for
profit to come to
their final pricing
decision.
If a firm operates in a very volatile industry, where costs are changing regularly no set price can be
set, therefore the firm will decide on their mark up to confirm their pricing decision.
Cost Plus Pricing:
Here the firm add a
percentage to costs
as profit margin to
come to their final
For example it may cost £100 to produce a widget and the firm add 20% as a profit margin so the
selling price would be £120.00

Pricing - Pricing Strategies
Author: Jim Riley Last updated: Wednesday 24 October, 2012
Marketing - Pricing approaches and strategies
There are three main approaches a business takes to setting price:
Cost-based pricing: price is determined by adding a profit element on top of the cost of making the product.
Customer-based pricing: where prices are determined by what a firm believes customers will be prepared to pay
Competitor-based pricing: where competitor prices are the main influence on the price set
Let’s take a brief look at each of these approaches;
Cost based pricing
This involves setting a price by adding a fixed amount or percentage to the cost of making or buying the product. In some ways this is
quite an old-fashioned and somewhat discredited pricing strategy, although it is still widely used.
After all, customers are not too bothered what it cost to make the product – they are interested in what value the product provides
them.
Cost-plus (or “mark-up”) pricing is widely used in retailing, where the retailer wants to know with some certainty what the gross profit
margin of each sale will be. An advantage of this approach is that the business will know that its costs are being covered. The main
disadvantage is that cost-plus pricing may lead to products that are priced un-competitively.
pricing decisions.

Here is an example of cost-plus pricing, where a business wishes to ensure that it makes an additional £50 of profit on top of the unit
cost of production.
Unit cost £100
Mark-up 50%
Selling price £150
How high should the mark-up percentage be? That largely depends on the normal competitive practice in a market and also whether
the resulting price is acceptable to customers.
In the UK a standard retail mark-up is 2.4 times the cost the retailer pays to its supplier (normally a wholesaler). So, if the wholesale
cost of a product is £10 per unit, the retailer will look to sell it for 2.4x £10 = £24. This is equal to a total mark-up of £14 (i.e. the
selling price of £24 less the bought cost of £10).
The main advantage of cost-based pricing is that selling prices are relatively easy to calculate. If the mark-up percentage is applied
consistently across product ranges, then the business can also predict more reliably what the overall profit margin will be.
Customer-based pricing
Penetration pricing
You often see the tagline “special introductory offer” – the classic sign of penetration pricing. The aim of penetration pricing is
usually to increase market share of a product, providing the opportunity to increase price once this objective has been achieved.
Penetration pricing is the pricing technique of setting a relatively low initial entry price, usually lower than the intended established
price, to attract new customers. The strategy aims to encourage customers to switch to the new product because of the lower price.

Penetration pricing is most commonly associated with a marketing objective of increasing market share or sales volume. In the short
term, penetration pricing is likely to result in lower profits than would be the case if price were set higher. However, there are some
significant benefits to long-term profitability of having a higher market share, so the pricing strategy can often be justified.
Penetration pricing is often used to support the launch of a new product, and works best when a product enters a market with relatively
little product differentiation and where demand is price elastic – so a lower price than rival products is a competitive weapon.
Price skimming
Skimming involves setting a high price before other competitors come into the market. This is often used for the launch of a new
product which faces little or no competition – usually due to some technological features. Such products are often bought by “early
adopters” who are prepared to pay a higher price to have the latest or best product in the market.
Good examples of price skimming include innovative electronic products, such as the Apple iPad and Sony PlayStation 3.
There are some other problems and challenges with this approach:
Price skimming as a strategy cannot last for long, as competitors soon launch rival products which put pressure on the price (e.g. the
launch of rival products to the iPhone or iPod).
Distribution (place) can also be a challenge for an innovative new product. It may be necessary to give retailers higher margins to
convince them to stock the product, reducing the improved margins that can be delivered by price skimming.
A final problem is that by price skimming, a firm may slow down the volume growth of demand for the product. This can give
competitors more time to develop alternative products ready for the time when market demand (measured in volume) is strongest.
Loss leaders
The use of loss leaders is a method of sales promotion. A loss leader is a product priced below cost-price in order to attract consumers
into a shop or online store. The purpose of making a product a loss leader is to encourage customers to make further purchases of
profitable goods while they are in the shop. But does this strategy work?

Pricing is a key competitive weapon and a very flexible part of the marketing mix.
If a business undercuts its competitors on price, new customers may be attracted and existing customers may become more loyal. So,
using a loss leader can help drive customer loyalty.
One risk of using a loss leader is that customers may take the opportunity to “bulk-buy”. If the price discount is sufficiently deep, then
it makes sense for customers to buy as much as they can (assuming the product is not perishable).
Using a loss leader is essentially a short-term pricing tactic for any one product. Customers will soon get used to the tactic, so it
makes sense to change the loss leader or its merchandising every so often.
Predatory pricing (note: this is illegal)
With predatory pricing, prices are deliberately set very low by a dominant competitor in the market in order to restrict or prevent
competition. The price set might even be free, or lead to losses by the predator. Whatever the approach, predatory pricing is illegal
under competition law.
Psychological pricing
Sometimes prices are set at what seem to be unusual price points. For example, why are DVD’s priced at £12.99 or £14.99? The
answer is the perceived price barriers that customers may have. They will buy something for £9.99, but think that £10 is a little too
much. So a price that is one pence lower can make the difference between closing the sale, or not!
The aim of psychological pricing is to make the customer believe the product is cheaper than it really is. Pricing in this way is
intended to attract customers who are looking for “value”.

Competitor-based pricing
If there is strong competition in a market, customers are faced with a wide choice of who to buy from. They may buy from the
cheapest provider or perhaps from the one which offers the best customer service. But customers will certainly be mindful of what is
a reasonable or normal price in the market.
Most firms in a competitive market do not have sufficient power to be able to set prices above their competitors. They tend to use
“going-rate” pricing – i.e. setting a price that is in line with the prices charged by direct competitors. In effect such businesses are
“price-takers” – they must accept the going market price as determined by the forces of demand and supply.
An advantage of using competitive pricing is that selling prices should be line with rivals, so price should not be a competitive
disadvantage.
The main problem is that the business needs some other way to attract customers. It has to use non-price methods to compete – e.g.
providing distinct customer service or better availability.
Pricing Strategies
Lesson
Exercise
Answer
In terms of the marketing mix some would say that price is the least attractive element. Marketing companies should really focus on
generating as high a margin as possible. The argument is that the marketer should change product, place or promotion in some way
before resorting to price reductions. However price is a versatile element of the mix as we will see.
Our financial objectives in terms of price will be secured on how much money we intend to make from a product, how much we can
sell, and what market share will get in relation to competitors. Objectives such as these and how a business generates profit in
comparison to the cost of production, need to be taken into account when selecting the right pricing strategy for your mix. The
marketer needs to be aware of its competitive position. The marketing mix should take into account what customers expect in terms of
price.

There are many ways to price a product. Let's have a look at some of them and try to understand the best policy/strategy in various
situations.
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Premium Pricing.
Use a high price where there is a unique brand. This approach is used where a substantial competitive advantage exists and the
marketer is safe in the knowledge that they can charge a relatively higher price. Such high prices are charged for luxuries such as
Cunard Cruises, Savoy Hotel rooms, and first class air travel.
Penetration Pricing.
The price charged for products and services is set artificially low in order to gain market share. Once this is achieved, the price is
increased. This approach was used by France Telecom and Sky TV. These companies need to land grab large numbers of consumers
to make it worth their while, so they offer free telephones or satellite dishes at discounted rates in order to get people to sign up for
their services. Once there is a large number of subscribers prices gradually creep up. Taking Sky TV for example, or any cable or
satellite company, when there is a premium movie or sporting event prices are at their highest – so they move from a penetration
approach to more of a skimming/premium pricing approach.
Economy Pricing.
This is a no frills low price. The costs of marketing and promoting a product are kept to a minimum. Supermarkets often have
economy brands for soups, spaghetti, etc. Budget airlines are famous for keeping their overheads as low as possible and then giving

the consumer a relatively lower price to fill an aircraft. The first few seats are sold at a very cheap price (almost a promotional price)
and the middle majority are economy seats, with the highest price being paid for the last few seats on a flight (which would be a
premium pricing strategy). During times of recession economy pricing sees more sales. However it is not the same as a value pricing
approach which we come to shortly.
Price Skimming.
Price skimming sees a company charge a higher price because it has a substantial competitive advantage. However, the advantage
tends not to be sustainable. The high price attracts new competitors into the market, and the price inevitably falls due to increased
supply.
Manufacturers of digital watches used a skimming approach in the 1970s. Once other manufacturers were tempted into the market and
the watches were produced at a lower unit cost, other marketing strategies and pricing approaches are implemented. New products
were developed and the market for watches gained a reputation for innovation.

The diagram depicts four key pricing strategies namely premium pricing, penetration pricing, economy pricing, and price skimming
which are the four main pricing policies/strategies. They form the bases for the exercise. However there are other important
approaches to pricing, and we cover them throughout the entirety of this lesson.
Psychological Pricing.
This approach is used when the marketer wants the consumer to respond on an emotional, rather than rational basis. For example Price
Point Perspective (PPP) 0.99 Cents not 1 US Dollar. It's strange how consumers use price as an indicator of all sorts of factors,
especially when they are in unfamiliar markets. Consumers might practice a decision avoidance approach when buying products in an
unfamiliar setting, an example being when buying ice cream. What would you like, an ice cream at $0.75, $1.25 or $2.00? The choice
is yours. Maybe you're entering an entirely new market. Let's say that you're buying a lawnmower for the first time and know nothing
about garden equipment. Would you automatically by the cheapest? Would you buy the most expensive? Or, would you go for a
lawnmower somewhere in the middle? Price therefore may be an indication of quality or benefits in unfamiliar markets.
Product Line Pricing.
Where there is a range of products or services the pricing reflects the benefits of parts of the range. For example car washes; a basic
wash could be $2, a wash and wax $4 and the whole package for $6. Product line pricing seldom reflects the cost of making the
product since it delivers a range of prices that a consumer perceives as being fair incrementally – over the range.
If you buy chocolate bars or potato chips (crisps) you expect to pay X for a single packet, although if you buy a family pack which is 5
times bigger, you expect to pay less than 5X the price. The cost of making and distributing large family packs of chocolate/chips could
be far more expensive. It might benefit the manufacturer to sell them singly in terms of profit margin, although they price over the
whole line. Profit is made on the range rather than single items.
Optional Product Pricing.
Companies will attempt to increase the amount customers spend once they start to buy. Optional 'extras' increase the overall price of
the product or service. For example airlines will charge for optional extras such as guaranteeing a window seat or reserving a row of

seats next to each other. Again budget airlines are prime users of this approach when they charge you extra for additional luggage or
extra legroom.
Captive Product Pricing
Where products have complements, companies will charge a premium price since the consumer has no choice. For example a razor
manufacturer will charge a low price for the first plastic razor and recoup its margin (and more) from the sale of the blades that fit the
razor. Another example is where printer manufacturers will sell you an inkjet printer at a low price. In this instance the inkjet company
knows that once you run out of the consumable ink you need to buy more, and this tends to be relatively expensive. Again the
cartridges are not interchangeable and you have no choice.
Product Bundle Pricing.
Here sellers combine several products in the same package. This also serves to move old stock. Blu-ray and videogames are often sold
using the bundle approach once they reach the end of their product life cycle. You might also see product bundle pricing with the sale
of items at auction, where an attractive item may be included in a lot with a box of less interesting things so that you must bid for the
entire lot. It's a good way of moving slow selling products, and in a way is another form of promotional pricing.
Promotional Pricing.
Pricing to promote a product is a very common application. There are many examples of promotional pricing including approaches
such as BOGOF (Buy One Get One Free), money off vouchers and discounts. Promotional pricing is often the subject of controversy.
Many countries have laws which govern the amount of time that a product should be sold at its original higher price before it can be
discounted. Sales are extravaganzas of promotional pricing!
Geographical Pricing.
Geographical pricing sees variations in price in different parts of the world. For example rarity value, or where shipping costs increase
price. In some countries there is more tax on certain types of product which makes them more or less expensive, or legislation which

limits how many products might be imported again raising price. Some countries tax inelastic goods such as alcohol or petrol in order
to increase revenue, and it is noticeable when you do travel overseas that sometimes goods are much cheaper, or expensive of course.
Value Pricing.
This approach is used where external factors such as recession or increased competition force companies to provide value products
and services to retain sales e.g. value meals at McDonalds and other fast-food restaurants. Value price means that you get great value
for money i.e. the price that you pay makes you feel that you are getting a lot of product. In many ways it is similar to economy
pricing. One must not make the mistake to think that there is added value in terms of the product or service. Reducing price does not
generally increase value.

Cost-Based Pricing Strategies

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