The number of pricing methods is used in marketing for setting prices of products and services by the different companies. Selections of the appropriate pricing method depending on overall corporate goals, marketing objectives of the firm and prevailing business environment.
The following methods are used for pricing in marketing:
Cost-Based Pricing Methods
In these pricing methods, the cost of manufacturing a product is the key factor in price determination.
Different cost-based pricing methods can be discussed under the following headings:
1. Cost Plus Pricing Method
In this method of pricing, an anticipated amount of profit is added to the cost of production to calculate the selling price.
The method is having the following advantages:
- The method is simple, having no complicated calculations in price determination.
- The method covers all the costs involved in the production.
- The firm can gt desired “Return on investment” on its capital employed by adding the required percentage of profit in the cost of production.
- Profitable sales volume can be generated.
However, the method is having the following drawbacks:
- It is an unrealistic and weak method of pricing.
- It ignores market demand and the influence of competition.
- The method does not take into consideration the price elasticity of demand. Price elasticity of demand is an important factor in pricing decisions in marketing.
- If the firm is supposed to use a market penetration strategy. then these pricing methods are useless.
Cost-plus pricing methods are best suited for those firms, who are operating in the sellers’ market. Seller’s market is a situation, where infinite demand is prevailing in the market and combined supply of all sellers’ is unable to meet it.
2. Marginal Cost Pricing Method
Marginal cost is the cost of producing one additional unit. The curve of the fixed cost will be horizontal, means that up to a specific level of production the fixed cost will remain the same.
If the company does not produce a single unit or produces up to its maximum capacity of production, the fixed cost will remain the same.
Fixed costs involve salaries, rent, minimum water and electricity expenditure, interest, etc. If the firm produces one additional unit, then the incremental cost will be an only variable or direct cost to produce that product.
Therefore, under the marginal cost pricing method, the firm only takes into consideration – the variable or direct cost involved in additional production and ignores the fixed cost.
The method is having the following merits:
- It is useful for market penetration.
- The firm may increase its turnover.
- Prices of the product or services can be made very competitive by using this method.
- The method is appropriate for price-sensitive markets. The firm may secure the customers by offering attractive prices of its products.
Following are the main disadvantages of this pricing method:
- If the company ignores the fixed cost for marketing, then it is to be recovered from the domestic market. It does not seem fair to penalize domestic customers, at the cost of foreign customers.
- The loading of the fixed cost of marketing may be done on other products, which can bear high costs. It may lead to cannibalization of its own products by the firm.
- The method is not useful, where the proportion of the variable cost is very high in the total cost.
- Under the penetration strategy, the firm may keep lower prices for getting itself established in the markets. But it may become difficult for the firm to increase the price substantially in the coming future.
- The firm may be charged for dumping its product in the foreign market if it is charging less price from foreign customers than its own country.
Marginal cost pricing method may be useful in the following circumstances:
- It is an appropriate method for those marketing firms operating in the construction or in turnkey projects. If they are asked to submit, quotations for new projects, while their other projects are the stage of completion. In this situation, there might be balance materials at different sites. The firm while preparing quotations for new projects may minus the prices of balance materials. If the balance material may be used and the firm may offer attractive quotations for new projects.
- This pricing method is also useful when the management wants to keep its manpower engaged during the slack season.
- Marginal cost pricing method is also appropriate when the domestic customer can afford the higher price. Some proportion of fixed costs may be recovered from domestic customers. this will be possible when the home market of the firm is vast, and having a good affordable capacity.
- The method is also appropriate when the firm is planning to spot techniques of mass production to reduce the gap between total cost and marginal cost.
- It is also useful when the capacity utilization ratio is low. the idle capacity may be used for exports. Pricing for foreign markets may be made attractive because the firm has to take into consideration only the variable costs.
3. Break-Even Pricing Method
Break-even pricing is no profit any loss marketing. a break-even point is calculated for pricing. A break-even point is that quantity of production at which total revenue equals total costs, assuming a specific selling price.
Therefore will be different break-even points for different selling prices. The minimum numbers of units to be sold by a firm can be termed as the break-even point.
Production up to break-even point recovers the fixed cost involved in the total cost. Sales or output at any stage below the break-even point will result in a loss and output in units beyond the break-even point will generate profits to the firm.
The break-even point in units can be calculated with the following formula:
Break-even points in units = Total Fixed Costs / Unit Contribution to Overhead
Because unit contribution to overhead equals selling price less the average variable cost, therefore, the working formula can be described as under:
Break-Even Point in Units = Total Fixed Costs / Selling Price – Average Variable Cost
To attain break-even point in sales volume, multiply the break-even point in units with the selling price.
Break-even pricing method provides the following advantages:
- The marketing company may safeguard against possible losses.
- The calculation of break-even point in units and break-even point volume is very simple.
Break-even pricing method is having the following drawbacks:
1. The basic assumptions of break-even analysis are generally not valid. this may happen due to the following two reasons:
- The first assumption that total fixed costs are constant, is not fully valid. In the long run, there may be changes in fixed costs. This may be possible due to several reasons.
- The second assumption is that variable costs remain constant per unit of production. In practice, average variable costs generally fluctuate. 19 Factors Influencing Entrepreneurship Development.
2. The method does not tell us whether we can actually sell the break-even amount. If the market does not accept the price set by the firm on the basis of this method, then selling the product below the break-even point will generate the loss. Therefore, the break-even pricing method is not insurance to prospective losses.
Though the break-even pricing method ignores marker circumstances, it is having its limited uses.
The method of break-even pricing may be useful in the following situations:
- It is appropriate for new entrant firms in marketing.
- This pricing method can be effectively used when the firm is following the market penetration strategy. Under market, penetration firm keeps the prices of its products below in order to get established in the market. After getting this objective firm gradually increase the prices of the product up to the predetermined level. Therefore, profit may be ignored for the purpose of penetration.
- If the stiff competition is prevailing in markets, then break-even pricing may be used to defeat competitors. The firm may be satisfied in very limited profit or can sell the product as no loss basis. Even the firm may think to bear some losses for a short period, by selling the product below the break-even pricing point. Therefore, the method is useful to defeat competitors.
Market Oriented Pricing Methods
Market-oriented pricing methods give proper weight to need of customers and different elements of external macro-environment.
These methods can be discussed under the following headings:
1. Pricing above the Market
Under this method, the firm charges higher prices for its product or service, in comparison to its competitors.
Marketing company, whose strategy is, non-price competition, generally, prices its products above the market price.
Above the market pricing method is useful in the following circumstances:
- The pricing above the market price is appropriate for those firms, who are operating in quality sensitive markets. It is the general assumption of customers that, there is a positive correlation between the quantity of the product and its prices. The first can psychologically satisfy them by providing quantity product and customers will never mind the high prices.
- The pricing method is also useful when the firm is pricing an innovative product in the market. By charging high prices of an innovative product, the firm may recover the huge expenditures incurred in research and development of that product and losses incurred in failure products.
2. Pricing Below the Market
Under this pricing method, the firm sets the prices for its product or service below the level of its competitors, or below to a standard price range accepted by the market.
Usually, market leaders refrain from this method because, if they do so, consumers may have doubts, regarding the quality of their products.
Below the market pricing method is appropriate in the following situations:
- The method is appropriate for the “Follower Firms” of the market.
- The pricing method is also having utility for those markets who are price sensitive.
- The method is useful for small marketing companies.
3. Pricing to Meet Competition
In this pricing method, the price of the product is set at the balancing point of prevailing demand and supply in the market.
Market-accepted prices for the product or service, serves a basis for price setting, under this product will be higher. When the supply is greater than demand, the prices will be lower.
Therefore, frequent changes in pricing are required by the firm, keeping in view the demand an supply position of the product.
The method is appropriate in free economics, having least government interference. In the free economies, the prices are set by the equilibrium of demand and supply.