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Pricing Methods –Explained!

Updated: Jun 13, 2020

An organization has various options for selecting a pricing method. Prices are based on three dimensions that are cost, demand, and competition.

The organization can use any of the dimensions or combination of dimensions to set the price of a product.

The different pricing methods are discussed below;

Cost-based Pricing:

Cost-based pricing 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.

These two types of cost-based pricing are as follows:

Cost-plus Pricing:

Refers to the simplest method of determining the price of a product. In cost-plus pricing method, a fixed percentage, also called mark- up percentage, of the total cost (as a profit) is added to the total cost to set the price. For example, XYZ organization bears the total cost of Rs. 100 per unit for producing a product. It adds Rs. 50 per unit to the price of product as’ profit. In such a case, the final price of a product of the organization would be Rs. 150.

Cost-plus pricing is also known as average cost pricing. This is the most commonly used method in manufacturing organizations.

Demand-based Pricing:

Demand-based pricing refers to a pricing method in which the price of a 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; whereas, if the demand of a product is less, the low prices are charged to attract the customers.

The success of demand-based pricing depends on the ability of marketers to analyze the demand. This type of pricing can be seen in the hospitality and travel industries. For instance, airlines during the period of low demand charge less rates as compared to the period of high demand. Demand-based pricing helps the organization to earn more profit if the customers accept the product at the price more than its cost.

Competition-based Pricing:

Competition-based pricing refers to a method in which an organization considers the prices 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.

The aviation industry is the best example of competition-based pricing where airlines charge the same or fewer prices for same

routes as charged by their competitors. In addition, the introductory prices charged by publishing organizations for textbooks are determined according to the competitors’ prices.

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. It can deliver high- quality products at low prices by improving its research and development process. Value pricing is also called value- optimized pricing.

Target Return Pricing:

Helps in achieving the required rate of return on investment done for a product. In other words, the price of a product is fixed on the basis of expected profit.

Going Rate Pricing:

Implies a method in which an organization sets the price of a product according to the prevailing price trends in the market. Thus, the pricing strategy adopted by the organization can be same or similar to other organizations. However, in this type of pricing, the prices set by the market leaders are followed by all the organizations in the industry.

Transfer Pricing:

Involves selling of goods 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 low prices. Sometimes, transfer pricing is used to show higher profits in the organization by showing fake sales of products within departments.

Differential Pricing:

Differential pricing is a method that is used by some sellers to tailor their prices to the specific situation of buyers. The firm may charge the same or different prices for the same product. It is a practical device available to management to enlarge profits. It exploits the difference in demand elasticity.

The most common ones include quantity differentials, location differentials, product use differentials and time differentials. To achieve differential pricing, it is necessary to segment markets. The common techniques utilized for market segmentation are differences in product

design, quality, choice of channel, time of sale, patents, packaging and advertising.

Skimming Pricing:

Skimming pricing is known as charging high price in initial stages. This can be followed by a firm by charging skimming price for a new product in pioneering stage. When demand is either unknown or more inelastic at this stage, market is divided into segments on the basis of different degree of elasticity of demand of different consumers.

This is a short period device for pricing. The demand for new products is likely to be less price elastic in the early stages, that is, the initial high price helps to “Skim the Cream” of the market which is relatively insensitive to price.

Under this policy, consumers are distinguished by the producers on the basis of their intensity of desire for a commodity.

For example, in the beginning the prices of computers, T.Vs, electronic calculators, etc., were very high but now they are declining every year. A high initial price together with heavy promotional expenditure may be used to launch a new product if conditions are appropriate.


#pricingmethods #costefficiency #returns

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