Cost consideration and consumer situation are the two fundamentals that impact price decisions. Unfortunately, there are many firms that do not have comprehensible pricing methods. Below mentioned are the general pricing methods :
Cost-based pricing
The most important variable as well as the basis of pricing a particular product, is the production cost of that product. Costs may be of different kinds like total cost, variable cost, fixed cost, marginal cost, average cost, etc. These costs must be critically analysed in order to set a product’s price. Methods for finding out the cost oriented price are as follows:
Mark-up/Cost-plus Pricing: This method requires the marketer to approximately calculate the total production or manufacturing cost of the product and after that adding a mark-up or the margin (that the firm intends to earn) to it. This is the most basic pricing method which is used to price a number of projects and services. The below mentioned formula can be used to calculate the mark-up price:
Markup price = α / (1 – r)
where, α = Unit cost (Fixed cost 4 Variable cost)
r = Expected sales returns (expressed as percent)
Full Cost/Absorption Cost Pricing: In absorption full cost pricing, the unit cost is finalised with reference to regular production and sales level. With the help of standard costing approach, variable as well as fixed costs concerning the production, sales, and administration orthe product are finalised. It is called full cost pricing as it aims to recover total costs incurred on the product from its sales.
Incremental Cost/Marginal Cost Pricing: In this method of pricing, the company strives to recover its marginal cost so as to aid its overheads. This pricing method gives best results in the market, where large firms operate or where there is extreme competition and the firm works with the sole aim of establishing itself in the market. The firm adopts this pricing method When it:
- Intense competition,
- Focuses on a new market, and
- Possesses unexploited capacity.
Break Even Point/B.E.P. Pricing: The sales volume, where the total cost becomes equal to the product’s total sales revenue is known as ‘break-even point’. In other words, the sales volume of the product, which neither witnesses profit nor loss, is break-even point. Hence, this method is also called ‘No Profit No Loss Method of Pricing’. In order to calculate price using this method, total production cost is divided into fixed and variable cost. The final price is same as the product’s production cost. It is believed that the firm will not earn any profits in the short-terrn, but in the long-term it will begin earning profits. The price of a competitive product can be easily calculated by using this method B.E.P can be calculated by the formula mentioned below:
B.E.P. (In Units) = Fixed Costs / (Selling Priceperunit – Variable costs per unit)
Target pricing/Rate Of Return pricing: In this pricing method, the company needs to calculate the desired rate of return on the capital it has invested in producing the product. This rate of return helps in calculating the desired quantity of profit. This ‘quantity of profit’ and ‘production cost’ are summed up to find the ‘per unit price’ of the product. A company can employ this pricing method, when it needs to get a specific return on the capital it has invested. This method can be used only in markets With no competition at all.
Customer Demand-based Pricing
The fundamental aspect of the demand oriented costing is that the cost involved does not have an impact on the profits but on the demand. This method, contrary to cost-based pricing, begins by finding out the price that the consumer market intends to pay for the product. Then, a backward estimation of the level of cost and profit (that the organisation can afford due to that price) is undertaken. Following methods are used to determine the customer demand-based pricing:
‘What the Tramc Can Bear’ Pricing: Using this method, the seller charges the customer with the maximum possible price that they will pay willingly under the present situation. This method is far from sophisticated and is followed by retail traders and few manufacturers. In the short-run, it provides the company with large profits but is an unsafe method in the long-run. Error in judgments can easily take place as it is based on trial and error. But in markets with monopoly/oligopoly and price-inelastic demand, it can conveniently be applied.
Skimming-based Pricing: Skimming pricing is the commonest pricing method. In this method, the companies by selling at premium prices fulfill their desire of skimming the market. The results are obtained in the below mentioned situations:
- When high price is supposed to be a testimony of high product quality, especially in an environment, where target market relates product quality with its price.
- When a customer willingly purchases the product at higher price, just in order to become the opinion leader.
- When the customer’s Status is believed to be increased by product.
- When the entry as well as exit barriers are so low that there is almost no competition in the industry or the industry fears a threat from potential competition.
- When a visible technological advancement is displayed by the product, which makes the product a ‘high technology product’
- When the firm adopts skimming pricing technique, it aims to attain its break-even point at an early stage and takes lesser tinte to maximise its profits (or find a niche to earn profits).
Penetration-based Pricing: Contrary to skimming pricing, penetration-based pricing focuses on keeping the prices low as compared to current competitors. Market penetration or gaining initial market share in an intensely competitive market, is the main objective of this pricing method. Below mentioned are the situations in which this method gives results:
- When the market is large in size and is still growing,
- When the brands are bought by the customers not because of some definite inclinations but because of habit, i.e., customer loyalty is low,
- When a stiff competition dominates the market,
- When an entry strategy is employed by the firm,
- When the company has weak price-quality coordination.
Competitor/Market-based pricing
Under this method, prices are determined by observing the competitors’ prices in a particular market. Generally, small organisations follow such pricing method in presence of a market leader. For example, a small tyre manufacturer may follow the prices of Apollo Tyres. Also in case of entering a new market, a low-cost supplier may follow the market/competitor-based pricing. A large number of companies carefully analyse the price structure Of the competitors, before setting their product’s price. Firms formulate premeditated policies and choose a competitive market for selling their products. When a company prices its products using this method, it has four pricing options:
Going Rate Pricing/Parity Pricing: In this method, the competitor’s product is taken as the benchmark to set the price of the product. A firm follows this approach either When it is new in market or When an already established firm launches a new product in the existing market. This type of pricing is suitable for the markets with severe competition.
Pricing Below the Level Of Competition/Discount pricing: When a company sets the price of its product lower than the level of competition, i.e., below the price that the competitor is charging for a similar product, it is called ‘pricing below the level of competition’ or ‘discount pricing’. This method is effective in markets, where customers equate to price. It is implemented by firms that are new in the market.
Pricing Above the Level of Competition/Premium Pricing: When a company sets the price of its product upper than the level of competition, i.e., above the price that the competitor is charging for a similar product. it is called ‘pricing above the level Of competition’ or ‘premium pricing’. This is done to depict a better quality product by the company. This pricing policy can be implemented only by firms that have a good reputation in the market (as their image is that of a quality producer in the customer’s mind). This makes them the market leader.
Tender Pricing/Sealed Bid/Competitive Bidding: The sealed bid is another competitive pricing method followed by firms. There are numerous projects, government purchases and industrial marketing activities where suppliers are called to submit their quotations to get the tender. The prices that are quoted, show the cost incurred by the company and what it understands about competition. A firm that offers a price at the cost level may become the lowest bidder and bag the contract, but would not earn any profit from the deal. Thus, it is crucial for the firms to take into account expected profits at various price levels and finally quote the price that is most profitable.
Value-based pricing
Understanding the value offered to customers is essential for accurately pricing the product or service of an organisation. In this method, cost is not the determining factor for pricing. Customer’s perception of the value associated With the product or service is the key to pricing decision. Here, first the product or service is designed, thereafter the marketing strategy, and finally the price is set by analysing the Other marketing mix elements. It will be clearly seen in the analysis that the below mentioned conditions can be obtained with the cost-value-price chain:
- Value>Priee>Costs: In the first condition, price of the product is kept lesser than the value offered, to attract the potential customers. However, significant profit is generated by maintaining the price above the cost Of production.
- Price>Valu>Costs: In this condition, value offered to customers through product is more than its cost of production. In order to maintain a significant level of profit companies set price more than value offered.
- Price>Costs>Value: Sometimes, cost of production is more than the value offered through product. Profitability is maintained in this condition by setting the price above the production cost.
- Price=Value>Costs: A condition may also occur, where production cost is lower than value offered. A reasonable amount of profit is generated by setting the price equal to the value offered.