This document discusses various pricing methods used by firms. It covers cost-based methods like cost-plus pricing and mark-up pricing. It also discusses demand-based pricing, competition-based pricing, value pricing, target-return pricing, and breakeven pricing. The document provides examples and explanations of how different pricing methods are calculated and can be applied by organizations.

1. Pricing Policy
Lecture 4:Methods of pricing
policy
Azerbaijan State University
of Economics - UNEC

2. Content
 Preface
 Levels of price management
 Methodology of pricing
 Methods of pricing
 Cost-based pricing
 Demand-based pricing
 Other methods of pricing
 Conclusion

3. Preface
 In the world market prevail various methods
of price setting.
 In this respect, one of the major issues is
becoming analyzing of pricing methods in
order to evaluate one’s decision and take
appropriate actions.

4. Levels of price management
 There are three levels of price management:
 Industry strategy;
 Product/market strategy;
 Transaction.

5. Price level: Industry strategy
 Industry strategy is the first level in the price
management. It considers the influence of supply,
demand and cost dynamics to the overall industry
price level.
 Excellence in industry requires not only in-depth
knowledge of your own company and how your
actions will affect market prices, but also the feature
of competition.
 Capacities, cost structures, capital investments,
research and development expenditures and growth
aspirations of other companies are the key part of
this overall strategy.

6. Price level: Industry strategy
 Bringing all this knowledge together, companies
can anticipate industry price trends and become
proactive with regard to its operations rather than
just a pawn of the market “invisible hand”.
 They can adjust their tactics to take advantage of
this superior understanding.

7. Price level: product/market strategy
 At the second level of price management, a
primary issue is price positioning relative to
competitors. That is, within each market
segment that one serves, what price level
positions he or she occupies in customer’s
eyes.
 Price actions at this level tends to be quite
visible to the market, both to customers and
competitors.

8. Price level: product/market strategy
 At this level one is setting the following prices:
 “List prices” – is a basic published price or
advertised price;
 “Base prices” – is the initial price of something
(goods and services) without the additional
changes that may be added, such as handling
or transportation costs, sales tax and so on;
 “Target prices” – is a price that would result in
the best possible outcome for one’s investment.
It is the price at which a stockholder is willing to
sell his or her stock.

9. Price level: transaction
 Transaction – is the process based on which
goods, services, or money are passed from
one person, account to another one.
 At this level, a critical issue is how to manage
the exact price charged for each transaction.
 The objective of transaction management is
to achieve the right and best realized price for
each transaction.

10. Transaction: off-invoice and
pocket price
 Invoice price - is the price that appears on
the invoice that a manufacturer sends to a
dealer when a dealer receives a car from the
factory.
 Pocket price – the revenues that are actually
left in a company’s pocket from a transaction
to cover costs and contribute to profit.
 Pocket price = invoice price-invoice off price.

11. Transaction: off-invoice prices
 Annual volume discount-an end year bonus paid to customers.
 Cash discount-a deduction from the price if payment is made quickly.
 Online order discount-a discount offered to customers ordering over the
internet.
 Consignment costs-the costs of funds when a supplier provides consigned
inventory to a retailer and wholesaler. Consignment is a business arrangement,
in which a business, also referred to as a consignee, agrees to pay a seller, or
consignor, for merchandise after the item sells.
 Market-development funds-a discount to promote sales to a specific market
segment.
 Stocking allowance-a discount paid to wholesalers or retailers to make large
purchases into inventory.

12. Methodology of pricing
 Methodology of pricing - is the sum of
common rules, principles and methods. It
involves elaboration of pricing concept,
definition and assessment of pricing,
formulating of a price system, management of
prices.
 Through the methodology is developed a
pricing strategy, whereas methods include
recommendations and instruments for the
realization on this strategy in the practice.

13. Methods of pricing
 Currently, there are
different kinds of
price methods used
by firms. Based on
these methods firms
compare their costs
and profits.

14. Methods of pricing
 Pricing methods - are
the various tools of price
formation.
 Prices are based on three
dimensions that are costs,
demand and competition.
 The organization can use
any of the dimensions,
whereas combination of
dimensions in order to set
the price of product.

15. Pricing methods
 Cost-based pricing;
 Demand-based pricing;
 Value pricing;
 Target return pricing;
 Transfer pricing;
 Going-rate pricing;
 Competition-based pricing;
 Other pricing methods.

16. Pricing methods
 In order to set relevant
price the seller should
analyze the prices of
competitors, internal and
external factors.
 Based on these factors
the seller should choose
the appropriate pricing
method.

17. Various pricing methods

18. Cost-based pricing
 Cost-based pricing refers to a pricing method
in which some percentage (total cost) of
desired profit margin is added to the cost of
a product in order to obtain the final price
(selling price).
 Cost-based pricing can be of three types:
 cost-plus pricing;
 mark-up pricing;
 marginal-cost pricing.

19. Cost-plus pricing
 Cost-plus pricing method refers to the
simplest method of determining the price of a
product. In cost-plus pricing method, a fixed
percentage, also which is called a mark-up
percentage, of the total cost is added to the
total cost.
 Cost-plus pricing method is also known as an
average cost pricing.
 This is the most commonly used method in
manufacturing organizations.

20. Cost-plus pricing
 The pricing method based on full expenses
includes all expenses during the production a
commodity.
 This method allows one to set a price limit.

21. Cost-plus pricing
Advantages
 Requires minimum
information.
 Involves simplicity of
calculation.
 Insure sellers against
the unexpected
changes in costs.
Disadvantages
 Ignores price strategies of
competitors.
 Ignores the role of
customers.
 Much more oriented to
the production and less to
the market.

22. Mark up pricing
 Mark up pricing is
more common in the
retail industry in which
retailer sells a product
in order to earn profit.
 Mark up as a
percentage of
cost=(markup/cost)*1
00
 Mark up as
percentage of
selling
price=(Markup/selling
price)*100

23. Mark up pricing calculation
Mark up Selling price=$500
Cost =$400
Mark up as a % of selling price (100/500)*100=20
Mark up as a % to cost (100/400)*100=25

24. Marginal cost pricing
 Marginal cost pricing is the process of setting
an item's price at the same level as the extra
expense involved in producing another item.
 This method is useful in a specific situation
where a company can earn additional profits
from using up an excess production capacity.

25. Cost-based pricing: example 1
Company A Company B
Direct cost 370 340
Raw materials 55 45
Wage expenses 105 95
Other direct costs 210 200
Indirect costs 100 100
Total cost 470 440
Rentability (to expenses) 15% 12%
Profit 70 53
Price of product 540 493

26. Cost-based pricing: example 2
If the operational cost of the store accounts for 8 $, the net profit of
the wholesaler will be 2 $.
For example, if the wholesaler purchases a product for 20 $ and sells
it to for 30 $ he or she will gain 10 $ of profit
(50% addition to the price).

27. Cost based pricing
 The price OP is made up of three elements: average
fixed cost, average variable cost and a profit margin.

28. Demand-based pricing
 Demand-based pricing refers to a pricing
method in which the price of product is
finalized according to its demand.
 If the demand of a product is more, an
organization prefers to set high prices for
products to gain profit.
 Success of demand-based pricing depends
on the ability of marketers to investigate the
demand.

29. Demand-based pricing
 The named method
of pricing can be
used in the travelling
industry.
 To take an example,
airlines in a period of
low demand charge
less rates as
compared to a period
of high demand.

30. Competition-based pricing
 Competition-based pricing refers to a
method in which an organization considers
the price of competitors’ products to set the
prices of its own products.
 The organization may charge higher, lower,
or equal prices as compared to the prices of
its competitors.
 An aviation industry is the best example of
competition-based pricing, where airlines
charge the same or fewer prices for the same
routes as charged by their competitors.

31. Sealed bid pricing
 Sealed bid pricing is based on how the firm
considers competitors will price their products
rather than only on its own costs or demand.
 In this pricing method firms go for competitive
bidding through sealed tenders or quotations.
 Firms look for the best (lowest possible) price
consistent with minimum quality specification.

32. Value pricing
 Value pricing implies a method in which an
organization tries to win loyal customers by
charging low prices for their high quality
products.
 The organization aims to become a low cost
producer without sacrificing the quality.

33. Value pricing
 It can deliver high-
quality products at
low prices through
improving its rese-
arch and develop-
ment process.
 Value pricing is also
called value opti-
mized pricing.

34. Perceived-Value Pricing
 In perceived-value pricing a firm sets price
based on a customer’s perception of goods
and services taking into account all the
elements such as advertising, promotional
tools, product quality and other that influence
a customer’s perception.

35. Perceived value vs Cost-based pricing

36. Target-return pricing
 Target return pricing helps in achieving the
required rate of return on investment done for
a product. In other words, a price of a product
is fixed on the basis of expected profit.
 The target return price can be calculated as:
 Target return price = unit cost + (desired
return * invested capital) / unit sale.

37. Return Investment
 Return on investment (ROI) is the benefit to
an investor resulting from an investment of
some resource.

38. Target-return pricing calculation
 Suppose a TV manufacturer invested 1 million
dollars in a business and wants to set a price
to earn a 30% ROI. The manufacturing cost of
per TV is 20$. Assuming that the sales can
reach 50,000 units.
 Target return price will be = 20 + (0.3 *
1000000)/ 50,000 = 26$

39. Transferring prices
 Transferring prices involves selling of good
and services within the departments of the
organization. It is done to manage the profit
and loss ratios of different departments within
the organization.
 One department of an organization can sell
its products to other departments at a low
prices.

40. Going-rate pricing
 Going-rate price implies a method in which
an organization sets the price of a product
according to the prevailing price trends in the
market.
 In most cases the pricing decisions adopted
by an organization can be the same or similar
to other organizations.

41. Breakeven pricing
 Breakeven pricing -associated with breakeven
analysis, which is a forecasting tool used by
marketers to determine how many products
must be sold before the company starts
realizing a profit.

42. Breakeven pricing
 For instance, assume a company operates a single-
product manufacturing plant that has a total fixed cost
(e.g., purchase of equipment, mortgage, etc.) per
year of $3,000,000 and the variable cost (e.g., raw
materials, labor, electricity, etc.) is $45.00 per unit. If
the company sells the product directly to customers
for $120, it will require the company to sell 40,000
units to breakeven.
B/E pricing=

43. Breakeven pricing
 The calculation presented above is a measure of units that need
to be sold. Clearly it is easy to turn this into a Revenue
Breakeven Analysis by multiplying the units needed by the
selling price. In our example, 40,000 units x $120 =
$4,800,000).

44. Price leadership method
 Price leadership prevail in the case when a
firm that is the leader in its sector determines
the price of goods or services and others
follow this price.
 These methods are practiced in the markets
where prevail several firms. The firm with
high market shares takes initiative.

45. Stackelberg price leadership
 Stackelberg price leadership assumes that
one firm has knowledge or foresight of its
competitor’s reaction to its price policies.
 As a result, the firm may credibly announce a
price in anticipation of competitor’s reaction.
 Stackelberg price leader benefits from this
foresight and is normally better off than in the
simultaneous game.

46. Tender price methods
 Tender usually refers to the process whereby
governments and financial institutions invite
bids for large projects that must be submitted
within a finite deadline.
 Tender price methods-are used in the cases
when several firms have serious competition
for obtaining contract.

47. Auction type pricing
 Auction type pricing method is growing
popular with the more usage of the internet.
Several online sites such as eBay provides a
platform to customers where they buy or sell
the commodities.

48. Parametric methods of pricing
 Unit price method - price formation based on one of
the major quality characteristics of a commodity.
 Pricing method of bands - refers to the use of
expert valuations of the significance of products. It
involves using of bands in the process of basic
parameters of a product.
 Regressive analysis method - is based on the
technical-economic parameter of a product. One can
built here also correlation dependence.
 Aggregate methods - refers to the summing of
separate constructive parts of products.

49. Summary
 Pricing methods are common tools and
procedures used on the world market by
producers and manufacturers.
 Based on pricing methods entrepreneurs
formulate their tactics with regard to the
products and services.