Methods of price determination (selecting a pricing method)

Methods of price determination (selecting a pricing method)

There are mainly three approaches companies undertake to set prices

1.       Cost oriented pricing

2.       Competition-oriented pricing

3.       Value-oriented pricing

Cost oriented pricing

In this method prices are based on costs. The methods can be

Mark-up pricing

A desired profit margin is added to the unit cost of a product. The formula is

Mark up price = unit cost + profit margin
suppose: unit cost is Rs 100 and profit margin is 20%
Then,
mark up price = 100+20 = 120 Rs.

This is a simple method. Reseller and small manufacturers widely use it. But this method ignores market demand, competitor’s prices, output levels, and customer’s willingness to pay.

Target return pricing

A desired return on investment (ROI) is added to the total cost to set price. This is the target return of the organization

The formula is:

Target return price = total cost + desired ROI
                                                   unit sales

For instance
total investment is Rs. 100,000
target return on investment is 20 %( i.e. 20000)
total costs Rs. 500,000
total sales 10000 unites

Then,

Target return price per unit = 500,000 + 200000 = Rs. 70
                                                            10000

Break even pricing

The break-even analysis (BEA) is done to calculate break-even point (BEP). The break-even point is where cost equals revenue. It is a no profit no loss situation.

The formula used for calculating BEP is:

BEP (in units or volume) =                      total Fixed Cost                                 .
                                                Selling price per unit – variable Cost per unit

BEP (in sales value) = BEP sales in units x selling price per unit

Example for BEP:

Suppose total fixed costs = Rs 100000
variable cost per unit = Rs. 60
Selling price per unit = Rs 100

BEP in volume = 100000 = 2500 units
                               100-60

BEP in sales = 2500 units x 100 = Rs 250,000

Hence, profit is made when sales increase beyond the break-even point. In the above example, sales should exceed 2500 units to make profit.

Competition oriented pricing (going rate pricing)

They focus on the market price. The price is set in relation to the competitor’s price. The methods can be:

·         Meet competition Method: price is set to match the prevailing market price. This method is used when the market has many sellers (perfect competition) or few sellers (oligopoly) and the products are similar.

·         Below competition Method: price is set below the competitor’s price level. The aim is to attract more customers.

·         Above competition method: price is set above the competitor’s price level. This is generally done for high cost prestigious brands. Rolex watch and Mercedes Benz car use this method.

Auction type pricing

Auction is a process of buying and selling where the price is neither initially set nor arrived at by means of negotiation but is set or decided by bidding.

There are generally three types of auctions

1.       Ascending auction: it is a form of auction where the price is set at the highest bid.

2.       Descending auction: it is a form of auction where the price is set at the lowest bid

3.       Sealed bid auction: here the bidding process aren’t publicized.

Demand or value oriented pricing methods:

They focus on customer’s value perception. The pricing methods can be:

·         Customer value pricing

Value is the ratio of benefits to costs. Low price is charged for quality products to attract a large number of value-conscious customers. It is providing high value at low price.

·         Perceived value pricing

Price is based on customer’s perceived value of the product. Customer’s perception of product value is found through market research.