Setting price for a product or service is not an easy task and your pricing approaches matters a lot in this regard. The price of a product or service is kept to a level that can generate both profit as well as demand. But generally the cost of the product or service provides the lower limit of the price and the perceived value by consumers provides the upper limit for setting price. Business Organizations should also take into account the prices of their competitors along with other internal and external factors. There are general Pricing Approaches that can be applied by businesses in setting prices for their products or services. These pricing approaches are of three types.
Types of Pricing Approaches
- Cost-Based Pricing Approaches
- Buyer-Based Pricing Approaches
- Competition-Based pricing Approaches
Each of the above is based on different dimensions of product or service.
- Cost Based Pricing Approach:
These pricing approaches are the simplest one in which the cost of product or service is added with a certain proportion of markup as profit to ascertain a certain price. Examples include construction businesses that estimate the cost of any project and submit their bid by adding a certain portion of profit to their estimated cost. Moreover Accountants, Lawyers and other professionals charge a price of their services by adding the cost of work with a certain proportion of markup.
Markup pricing is not regarded as an effective pricing model as it ignores both demand and the pricing of competitors. Therefore, it is almost impossible for a business to keep its price as best one by adopting this category of pricing. But still Cost based pricing is popular due to the following reasons.
- It makes pricing simpler so the marketers do not change the price of their product or service with the changing demand.
- When the majority of businesses in the market adopt this pricing model, there would be minimum price competition due to similarity in prices.
- Generally cost based pricing looks fairer for both buyers and sellers as buyers are not exploited under condition of higher demand and also the seller can earn a reasonable profit in such pricing.
Target Profit Pricing and Break-Even Analysis
Target profit pricing is also called break-even analysis in which the total cost and total revenue are forecasted at different levels of sales. In this way a reasonable profit can be availed at a reasonable price. The fixed cost remains unchanged even at zero level of production and sales. On the other hand variable cost changes with the level of production and sales. Both of these costs are combined to ascertain the expected total cost at certain sales volumes. When the sales volume increases the total cost decreases and the total revenue increases. Break-even is that point of sales volume where cost is equalized by the revenue and the profit is zero. The estimated demands, break -even points and profits are compared with different prices by the management of business.
- Buyer Based Pricing Approach:
These pricing approaches is extensively applied by many organizations in which the perceived value of buyer is regarded as a base for Setting Price for a product or service. In this pricing model the value of product or service is perceived by customers that give the guideline for the price of that product or service. In other words the price is not set after the production of product, but before the production. This means that the organization considers the customers along with their perception about certain product or service. On this basis, the business sets a certain price and then starts manufacturing that product. The expected value and price provide guideline for the cost and design of the product so that it can match the perceptions of the customers.
It is difficult for a business organization to ascertain the different perceived value by the customers on different products. For this purpose these organizations conduct surveys and experiments. If a business keeps the price of its product higher than the perceived value of customers, then its sales are affected. On the other hand, if a business keeps its product’s price lower, then maybe its sales increase, but the profit does not increase accordingly. Therefore, those organizations, which want to adopt this value-based pricing strategy, should keep the price of their products in accordance with their perceived value by customers. But more effective strategy is that the businesses should try to deliver more value to the customers than they perceived in order to retain them as loyal customers.
- Competition-Based Pricing Approach:
In this pricing model, businesses keep the price of their products or services on the basis of the prices of their competitors. Also, customers in the market perceived value to any product or service in relation to prices of similar products of competitors. So there is some sort of going rate pricing in which the prices of products are altered according to changes in the prices of competitors. For example, steel or fertilizer manufacturing businesses face oligopolistic competition in which they charge almost similar prices in the market same like the competitors. There is a market leader whose price is followed by all other smaller competitors. When the price of market leader is changed, other competitors in the market also adjust their prices accordingly. Some smaller business may keep a slight difference in their price as compared to the market leader, but this slight difference remains constant in different conditions.
There is one big advantage of adopting this ongoing rate of competition based pricing, which is the prevention of price wars in the market among competitors.
Another form of competition, pricing model is sealed bid pricing in which the price of a job is raised by keeping in view the prices set by competitors. In this case the pricing also ignores the cost and demand factor, but the businesses try to keep their prices little higher than their cost in order to earn a revenue. Pricing is not confined to only above categories rather there are other factors that affect the pricing decisions like environmental etc.