Cost-plus pricing is the most popular among all the methods of pricing for its simplicity of calculation and understanding.
Pricing is the most critical part of a manufacturing business or any business for that matter. If you are a business owner and have your own product, you may already know how crucial it is to get the pricing of your product right. One wrong decision and the dream of capturing the market share is blown in the wind.
Now, however simple it may appear, there are many hidden threads of the methods of pricing, and one needs to carefully weave them before the product launch. If you want to know about the methods of pricing and the types of pricing strategies, this article is for you.
Pricing Methods are nothing but how the price of goods and services are calculated and decided, eventually. The method of pricing comprises some factors which one needs to consider, and these factors are –
The methods of pricing are crucial for the growth of a business. If you are launching a product, for example, it’s better you consider all types of pricing strategies beforehand. In a crowded and competitive market, it is very easy to get the pricing of the product wrong.
If you price it too low to cut the competition, the customers may lose all their interest in it. You price your product a bit too high to add the premium tag, and you run the risk of missing the entire market.
To reach the ideal pricing – the goldilocks zone – for your product, it is essential that you follow the methods of pricing.
Essentially, there are two dominant methods of pricing. –
Most businesses decide the pricing of their product based on the input cost. FMCG companies, for example, increase the price of their product with rising input costs to maintain the profit margin. Basically, the right pricing is the one that covers your production cost and makes some profit.
It is one of the basic methods of pricing where the manufacturer calculates the input cost and adds a certain percentage of markup to it to decide the selling price.
[The markup is the percentage of profit calculated on total cost, i.e., fixed and variable cost.]
Formula to Calculate Cost-Plus Pricing:
Selling Price = cost of production + [Cost of Production x Markup Percentage (%)]
Markup pricing method is a type of cost-plus pricing. In this pricing method, the seller or the product manufacturer decides on a profit percentage and adds it to the cost price to determine the selling price. For example, if you are producing a product for INR 100 and you want a 30% profit on the sales, the selling price would be INR 130.
Formula to Calculate Markup Pricing:
Selling Price= Unit Cost + [1 – Desired Return on Sale (%) ]
In this kind of pricing method, the business sets the price to yield a required Rate of Return on Investment (ROI) from the sale of goods and services. Suppose you have invested INR 10,000 in making 100 products and want to make a 30% return on investment. Then the selling price of the products should be INR 130.
Formula to Calculate Target Return Price
Target return price = Unit Cost + (Desired Return % x capital invested)/ unit sales
Target Return Price=100 + (0.30 x 10000)/100
Target Return Price= Rs 130
Bear in mind that achieving the profit would depend on your sales number. In case you don’t sell the desired number of products, you may have to recalculate your ROI and re-price the products.
The marginal cost pricing method is used to set the pricing of a product close to its marginal cost. Generally, this method of pricing is used by the public sector to create a monopoly. By using this policy, a business charges for each product unit sold, only the addition to the total cost resulting from materials and direct labor.
For example, if the price of a product is INR 100 and the marginal cost is INR 60, then the business earns a profit of INR 40 by selling each unit. This is when it maintains average cost pricing. However, if the demand of the product drops, the company can reduce the pricing to INR 70, which is close to the marginal cost despite bearing a 30% discount. It increases demand and still makes profit despite the heavy discount.
Break-even pricing is one of the popular methods of pricing. It is the amount of money for which a product or asset must be sold to cover the costs of producing, acquiring, or owning it. In simple words, break-even pricing does not make a loss nor does it make a profit.
To make a profit while following this method of pricing, the firm needs to ace its sales. Without selling in volumes, it is difficult to make a profit.
Some companies may fix a price to realize early recovery of investment involved. This type of method of pricing is adapted when the market forecasts suggest short life of the market. Fashion-related products or technology-sensitive products are priced following the early cash recovery pricing.
Easy to calculate, easy to
Disregards demand and price elasticity
of demand. This reduces the
bargaining power and the importance
of the consumer
Ensures that a company generates
profits even when costs rise by
charging a markup that
meets all expenses
Turns a blind eye towards the
prices charged by competitors.
As a result, it ignores the competition
Covers all incurred costs such as
production and overhead costs
Ignores the demand, it is inflexible
when there are changes in demand
levels. Prices do not change with
changes in demand levels
Can be applied to different
services like customized
and even new and innovative products
Takes sunk costs and unavoidable
costs in its calculation as well
Offers a fair and logical way to price
products. If customers are
the costs of the product,
will understand such prices
Prone to underpricing or
Allows companies to bid for large
projects quickly as it simplifies
investment appraisal decisions
Reduces the incentive to be
A price increase can easily be
with this pricing method.
can inform its customers that
to produce the product or service
have increased. This is why the prices have too
Ignores the opportunity cost
or the cost of the following best
alternative foregone investments
Market-based pricing method allows businesses to calculate the price on the basis of market conditions. Following are the methods under this group:
In this case, the benchmark for setting prices is the price set by major competitors. If a major competitor changes its price, then the smaller firms may also change their prices, irrespective of their input costs or demand. Generally, the prices are more or less the same as that of the competitor, which eliminates the price war among businesses.
For example, in oligopolistic industries such as steel, paper, fertilizer, etc., the price of the products remains the same across the industry.
Competitor-based pricing method is very similar to the going-rate pricing method. In this pricing method, businesses fix the rate of their service or price of their product based on how much their competitors are charging.
Take the aviation industry for example. All airlines offer almost similar fares for the same route and same class of flight.
According to Business jargons, this kind of method is very common in the case of Government or industrial purchases, wherein tenders are floated in the market, and potential suppliers submit their bids in a closed envelope, not disclosing the bid to anyone.
There are various types of pricing methods, and if you are starting a new business, it is crucial that you gather more information on the topic. Similarly, a business owner should also know about GST Advantages and Disadvantages and how to file GST Input Credit.
Among many types of pricing strategies, the perceived-value pricing method allows the manufacturer to decide the price on the basis of the customer’s perception of the goods and services. As per Business jargons, the manufacturer considers the elements like advertising, promotional tools, additional benefits, product quality, the channel of distribution, etc., that influence the customer’s perception.
This type of pricing strategy can help in achieving customer loyalty, but keep in mind that reducing the price does not give a license to drop quality. That has to be the product’s USP. This is also known as the Customer Oriented Method of pricing.
● Ideal for supporting both competitiveness and revenue
● Considering the demand, the company
should be able to determine a selling price that maximizes sales
● Measuring consumer satisfaction,
tastes, or preferences is a difficult task
● Prices may only be suitable for
● Competition and demand are dynamic
There are several types of pricing strategies, and we have discussed a few of them so far. Keep reading to know more about them.
In this pricing strategy, the company sets a high selling price at the start of selling a new product. Slowly, as the customer base increases, the company will lower prices. Smartphone sellers use this price skimming. When a new technology is unveiled, the company launches the product at a premium. However, as the product gets popular with time, the sellers want to reach as many people as possible. So, they reduce the price, but by then, they have skimmed the top of the market.
Big players in the market use this pricing strategy to create their monopoly. Using the limit pricing strategy, they price their products so low that it becomes unprofitable for companies that want to compete. Limit pricing is illegal in many countries.
According to Business jargons, Peak Load Pricing is the pricing strategy wherein a high price is charged for the goods and services during times when their demand is at peak. In other words, the high price charged during the high demand period is called peak-load pricing.
Bundle pricing is nothing but selling two or more similar products or services clubbed together for one price. This type of pricing strategy can effectively upsell additional products to customers or add value to their purchases.
For example, restaurants, beauty salons, and retail stores are among the many businesses that apply this strategy. If you shop from Amazon, you might have noticed that sellers offer a reduced price if you purchase in bulk or club different products from one seller in your basket.
Psychological pricing strategies, as the name suggests, play on the psychology of consumers. In a way, you are luring in customers by slightly altering price, product placement, or product packaging.
Some psychological pricing techniques include setting the price at INR 999 rather than INR 1000 or offering a “buy one, get one free” deal.
This pricing method, according to Business jargons, is adopted when different prices have to be charged from a different group of customers. The prices can also vary with respect to time, area, and product form.
Pricing strategies are the different approaches that businesses take to determine the cost of their goods and services. In order to adopt the appropriate pricing strategy, businesses consider factors like current product demand, cost of goods sold, consumer behavior, and market conditions.
Pricing strategies are important because they help in determining the price of a product, which is essential for profit maximization. There are different types of pricing strategies. Businesses choose the pricing strategy based on their sales objectives.
If you are a business owner, this is probably the most important question you can ask your product development team. However, had there been an easy answer, every business would have aced their sales and profit. There are more than a handful of things that one needs to consider, judge, and definitely, gather some knowledge about.
Here is what profitwell suggests –
● Evaluate Pricing Potential: A “value metric” is what you charge for. If you get everything else wrong in pricing, but you get your value metric right, you'll do ok. A pricing strategy based on a value metric (vs. a tiered monthly fee) is important because it allows you to make sure you're not charging a large customer the same as you'd charge a small customer.
● Determine your Customer Personas: The second key component of your pricing strategy is determining your target segment and ideal customer profile.
● Analyze Historical Data: Figuring out your price point involves researching those segments and then making decisions in the field.
● Strike a Balance Between Value and Business Goals: What you offer as your product and how much you expect it to achieve for your business should be in sync. Pricing a product high when it has better competitors will not be very helpful for business growth.
● Look at Competitor Pricing: Always look at the competitor pricing to see where you stand.
When it comes to methods of pricing, there is no one size fits all. Pricing strategies change with product and industry type. For example, the pricing strategy for an FMCG product may not be similar to the strategies of pricing for luxury items.
For example, value-based pricing strategies work for SaaS or subscription services. If your customers are convinced of the quality of your service and are willing to pay, you can increase the pricing of your service. Your pricing only has to justify the value proposition and will not be influenced by competitor pricing.
Here is a list of some industries that follow different pricing strategies than others –
Most small businesses use the cost-plus pricing model for its ease of calculation. It also helps them easily hit the profit margin in the short run. But it comes with its sets of caveats. Cost-based pricing method ignores the importance of the customers.
Value-based pricing, on the other hand, depends favors the customers’ discretion and alignment more than anything. Adopting value-based pricing, therefore, is more profitable in the long run.
More than everything, pricing is a process that needs constant monitoring and re-strategization. Realizing the value of your service/ product and the consumer base is crucial for all methods of pricing.
Before choosing from the different types of pricing strategies, define what type of business you’re pricing for. Selling a product to other businesses (B2B) is a lot different from selling it to final consumers (B2C).
Here are some successful pricing strategies employed by big brands. –
Price Skimming Strategy Employed by Apple
Apple launches a new smartphone every year. When the new smartphone series is first introduced, all the models come out with premium price tags. Right after the launch event, apple substantially brings down the pricing of the previous year’s models. It boosts the sale of the old models as it makes a lot more sense to the price-sensitive consumers.
Market-Based Pricing Strategy of OTT Platforms
Netflix, Amazon Prime, Disney+, and similar OTT platforms offer subscription packages in close price proximity. It is a prime example of market-based pricing or competitive pricing.
Accurately pricing your product requires a lot of research and expertise. You have to collect and analyze market data, consumer behavior, competitor analysis, identify the value of your product or service, etc., to figure out the pricing conundrum. However, with all the information furnished in this blog, we hope to help you draw the best pricing strategies that suit your line of business.