PRICING METHODS
A. Cost-oriented Method
- refers to a pricing method in which some percentage of desired profit margins is
added to the cost of the product to obtain the final price. In other words, cost-based
pricing can be defined as a pricing method in which a certain percentage of the total
cost of production is added to the cost of the product to determine its selling price.
Cost-based pricing can be of two types, namely, cost-plus pricing and markup pricing.
1. Cost Plus Pricing
- involves adding a certain percentage to cost of goods and services to arrive at a
selling price.
2. Mark-up Pricing
- is a variation of cost pricing. In this case, mark-ups are calculated as a percentage of
the selling price and not as a percentage of the cost price. Firms that use cost-oriented
methods use mark-up pricing.
Since only the cost and the desired percentage markup on the selling price are known,
the following formula is used to determine the selling price:
Average unit cost/Selling price
3. Break-even Pricing
- In this case, the firm determines the level of sales needed to cover all the relevant
fixed and variable costs. The break-even price is the price at which the sales revenue is
equal to the cost of goods sold. In other words, there is neither profit nor loss.
The following formula is used to calculate the break-even point:
Contribution = Selling price – Variable cost per unit
4. Target Return Pricing
- is a method wherein the firm determines the price on the basis of a target rate of
return on the investment.
The target return price can be calculated by the following formula:
Target return price = Total costs + (Desired return x ROI investment)/ Total sales in
units
- the limitation of this method (like other cost-oriented methods) is that prices are
derived from costs without considering market factors such as competition, demand
and consumers’ perceived value. However, this method helps to ensure that prices
exceed all costs and therefore contribute to profit.
5. Early Cash Recovery Pricing
- when it comes to rapidly growing technological products or the ones with a short life
cycle, the cost needs to recover as early as possible. This method is very similar to target
return pricing; the only difference is that it considers a high value of return on
investment owing to a short recovery period.
6. Marginal Cost Pricing
- the primary aim of the company adopting this pricing method is to meet its marginal
cost and overheads. The marginal cost method is suitable for entering the industries
which are dominated by giant players, posing a fierce competition for the organization
to sustain in the business.
7. Price-Floor Pricing
- is used to determine the lowest price at which it is worthwhile for a company to
increase the amount of goods and services it makes available for sale.
B. Market-oriented Methods
1. Perceived value pricing
2. Going-rate pricing
The going-rate pricing can be further divided into three sub-methods:
a. Competitors ‘parity method:
- a firm may set the same price as that of the major competitor.
b. Premium Pricing:
- a firm may charge a little higher if its products have some additional special features
as compared to major competitors.
c. Discount Pricing:
- a firm may charge a little lower price if its products lack certain features as compared
to major competitors.
3. Sealed-bid Pricing:
- this pricing is adopted in the case of large orders or contracts, especially those of
industrial buyers or government departments. The firms submit sealed bids for jobs in
response to an advertisement.
- in this case, the buyer expects the lowest possible price and the seller is expected to
provide the best possible quotation or tender. If a firm wants to win a contract, then it
has to submit a lower price bid. For this purpose, the firm has to anticipate the pricing
policy of the competitors and decide the price offer.
4. Differentiated Pricing
C. Demand Based-Pricing
- A firm sets prices after studying consumer desires and ascertaining the range of prices
acceptable to the target market. This approach is used by firms that believe price is a
key factor in consumer decision making.
a. Demand-Minus Pricing
- In demand-minus (demand-backward) pricing, a firm finds the proper selling price
and works backward to compute costs.
b. Chain-Markup Pricing
- it extends demand-minus calculations from resellers all the way back to the suppliers.
It determines the final selling price, examines markups for each channel member, and
computes the maximum acceptable costs to each other.
c. Price Discrimination
D. Competition-based Pricing
- a firm uses competitors’ prices rather than demand or cost considerations as its main
pricing guideposts.
a.Price Leadership exists in situations where one or a few firms is usually the first to
announce price changes and others in the industry follow.
b. Competitive bidding is where two or more companies independently submit prices
to a customer for a specified good, project, and/or service. Bids are usually sealed and
each seller has one chance to make its best offer.
E. Combination Pricing
- Here, cost-, demand, markup-, and competition-based pricing techniques are
combined.