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Cost-plus pricing. |
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The most straight-forward—and the most common—pricing method is to add a standard markup to the cost of the product. Cost-plus pricing is generally used by both manufacturers and retailers.
Markups can vary considerably among different goods. Academic research show some common markups (calculated on the price) in department stores range from 20% to 50% or more. In the retail grocery industry, coffee, canned milk, and sugar tend to have low markups, while frozen foods, jellies, and some canned products have high markups. Hardware manufactures typically calculate that the list price of a product as 3-7 times the cost of manufacturing.
Does the use of standard markups to set prices make logical sense? Generally, no. Any pricing method that ignores current demand and competition is not likely to lead to the optimal price. The corporate graveyard is full of companies that insisted on using standard markups in the face of competitors that had implemented more sophisticated pricing models. |
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Break-even analysis and target-profit pricing. |
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Target profit pricing is another cost-oriented pricing approach. The company tries to decide the price that would generate a set return. Some automobile manufactures use target profit pricing, in an attempt to achieve a 15 to 20 percent return on investment. Target-profit pricing is also used by public utilities that are constrained to make a fair return on their investment.
Target profit pricing is calculated using a break-even model. A break-even model shows the total cost and total revenue expected at different sales-volume levels. The challenge with target-profit pricing is that the success of target-profit pricing depends on the price elasticity of demand. The company must consider different prices and calculate approximately their impacts on sales volume and profits. A failure to accurately determine the demand curve will render the target-profit calculation useless. |
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Perceived-value pricing |
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Companies are increasingly basing their prices on the product's perceived value to the consumer. The buyers' perception of value, not the seller's cost, is the key to this pricing method. Using the marketing mix to build up the perceived value in the buyers' minds, prices are set to be inline with the perceived value.
Modern product-positioning thinking and perceived-value pricing go hand in hand. The objective of perceived-value pricing is to correctly establish the market's perception of a product's or service’s value. An exaggerated view of the value will lead to an overpriced product—and lower sales; an underestimation of the perceived value will leave money on the table. |
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Going-rate pricing |
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Companies base their prices on competitors' prices, ignoring their own costs or demand. In commodity industries, companies normally charge the same price. The smaller companies "follow the market leader" and change prices when the market leader's prices change.
The simplicity of going-rate pricing makes it popular. Where costs are difficult to measure, or competitive response is uncertain, firms feel that the going price represents a good solution. The going price is thought to reflect the collective wisdom of the industry as to the price that would yield a fair return and not disturb industrial harmony. |
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Psychological pricing |
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Sellers should consider the psychology of prices and not simply their economics. Many consumers use price as an indicator of quality. When a distiller raised the price of its gin by 22%, its liquor store sales went up, not down. Prestige pricing is especially effective with ego-sensitive products such as perfumes and expensive cars. A $100 bottle of perfume may contain $10 worth of scent, but people are willing to pay $100 because this price suggests something special.
Many sellers believe that prices should end in an odd number. Instead of pricing a washing machine at $300, it should be priced at $299.99. The customer sees this as a price in the $200 range rather than $300 range. |
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