Setting a price for a product or service is not an easy task and your pricing approaches matter a lot in this regard. The price of a product or service is kept to a level that can generate both profits as well as demand. However, generally, the cost of the product or service provides the lower limit of the price. Although 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 ones in which the cost of a product or service is added. Actually with a certain proportion of markup as profit to ascertain a certain price. Examples include construction businesses that estimate the cost of any project.
Therefore, submit their bid by adding a certain portion of profit to their estimated cost. Moreover, Accountants, Lawyers, and other professionals charge a price for their services. Basically by adding the cost of work with a certain proportion of markup.
Markup pricing is not regarded as an effective pricing model. So as it ignores both demand and the pricing of competitors. Therefore, it is almost impossible for a business to keep its price the best one by adopting this category of pricing. However, 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. Then there would be minimum price competition due to similarity in prices.
- Generally, cost-based pricing looks fairer for both buyers and sellers. Since buyers are not exploited under conditions of higher demand. In addition, 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. So 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. Therefore the estimated demands, break-even points, and profits are compared with different prices by the management of the business.
Buyer-Based Pricing Approach
These types of pricing approaches are extensively applied by many organizations. Although in which the perceived value of the buyer is regarded as a base for Setting Price for a product or service. In this pricing model, the value of a product or service is perceived by customers. Particularly that gives the guideline for the price of that product or service.
In other words, the price is not set after the production of the product but before the production. So this means that the organization considers the customers along with their perception of certain products or services. On this basis, the business sets a certain price and then starts manufacturing that product.
Thus the expected value and price provide guidelines 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 values of 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.
However, 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. Especially in accordance with their perceived value by customers. However, a more effective strategy is that the businesses should try to deliver more value to the customers. Actually, 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 the value of any product or service in relation to the prices of similar products of competitors. So there is some sort of going rate pricing in which the prices of products are altered. Since according to changes in the prices of competitors.
For example, steel or fertilizer manufacturing businesses face oligopolistic competition. So in which they charge almost similar prices in the same market as the competitors. There is a market leader whose price is followed by all other smaller competitors.
When the price of a market leader is changed, other competitors in the market also adjust their prices accordingly. Some smaller businesses 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 competitive 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 a little higher than their cost in order to earn revenue. So the types of pricing are not confined to only the above categories rather there are other factors that affect the pricing decisions like environmental etc.
Hello everyone! This is Richard Daniels, a full-time passionate researcher & blogger. He holds a Ph.D. degree in Economics. He loves to write about economics, e-commerce, and business-related topics for students to assist them in their studies. That's the sole purpose of Business Study Notes.
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