Methods of Pricing
Pricing Methods, What is Pricing, Methods of Pricing, Different Pricing Strategies, Types of Pricing Strategies, Tips to Apply Best Pricing Strategy, How to Price Product, New Product Pricing Strategies, Pricing New Product, Product Pricing Methods,

The Best Methods of Pricing: 4 Ways To Determine Price Tag

Explore Various Methods of Pricing & Learn the Types of Pricing Methods, Importance & Effective Tips to Apply Best Pricing Strategies for your Business Now.
By Amazon Business Editorial Desk Published on May 16, 2022

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.

In case you are starting an online business, follow our articles on MSME benefits, HSN Code, GST Registration Process, and E-invoicing GST.

Pricing

What are Pricing Methods?

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 type of product/service
  • Competition analysis
  • Target audience
  • Product’s life cycle
  • Firm’s vision of expansion

 

 Importance of Pricing Methods

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.

 

Different Types of Pricing Methods with Example

Essentially, there are two dominant methods of pricing.  –

  1. Cost-oriented pricing method
  2. Market-oriented pricing method

 

Cost-Oriented Pricing Method

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.

 

Cost-Plus Pricing

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

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 (%) ]

 

Target-Return pricing

 

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.

 

Marginal Cost Pricing

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

 

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.

 

Early cash recovery pricing

 

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.

 

Advantages and Disadvantages of Cost-Oriented Pricing Methods

 

Advantages

Disadvantages

Easy to calculate, easy to

understand

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

products and

services like customized

products

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

aware of

the costs of the product,

then they

will understand such prices

Prone to underpricing or

overpricing

Allows companies to bid for large

projects quickly as it simplifies

investment appraisal decisions

Reduces the incentive to be

more efficient

A price increase can easily be

justified

with this pricing method.

A company

can inform its customers that

the costs

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-Oriented Pricing Method

Market-based pricing method allows businesses to calculate the price on the basis of market conditions. Following are the methods under this group:

 

Going-Rate Pricing Method

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

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.

 

Sealed Bid Auction or Sealed-Bid Pricing Method

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.

 

Perceived-Value Pricing

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. 

 

Advantages and Disadvantages of Cost-Oriented Pricing Methods

 

Advantages

Disadvantages

● 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

some consumers

● Competition and demand are dynamic

 

 

Other Pricing Methods

There are several types of pricing strategies, and we have discussed a few of them so far. Keep reading to know more about them.

 

Market skimming Pricing

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.

 

Limit Pricing

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.

 

Peak Load Pricing

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

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

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.

Psychological Pricing

 Differential Pricing

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.

 

What Is Pricing Strategy?

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.

 

What Is The Importance of Pricing Strategies?

 

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.

 

How to Create a Winning Pricing Strategy?

 

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.

 

Pricing Strategies for Different Industries

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 –

  • Product Pricing Model
  • Digital Product Pricing Model
  • Restaurant Pricing Model
  • Event Pricing Model
  • Services Pricing Model
  • Nonprofit Pricing Model
  • Education Pricing Model
  • Real Estate Pricing Model
  • Agency Pricing Model
  • Manufacturing Pricing Model
  • Ecommerce Pricing Model

 

3 Steps to Improve your Pricing Strategies

 

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.

3 Steps to Improve your Pricing Strategies
  • Consistently deliver more value:  When you adopt the value-based pricing strategy, the only part you need to care about is adding value consistently. A valuable product does not need to worry much about its pricing.
  • Price strategically, not opportunistically: It is a big challenge in a market that is crowded with price-conscious customers. Such price-sensitive customers are more inclined to buy a cheaper option, ignoring its value proposition. Therefore, if you are confident about your product’s value proposition, identify your core customers and maintain the pricing integrity of that market.
  • Diplomacy with the competition: Value-based methods of pricing can avoid, if not eliminate, price war among competitors. For example, if you are a service provider offering great value to your customers, the chances of creating a loyal customer base are high. Therefore, you may not need to worry about your competitors’ pricing while determining the pricing of your service.

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.

 

Which Pricing Strategy is Right For You?

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).

 

Examples of Successful Businesses adopting Pricing Strategies

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. 

 

Conclusion

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.

 

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FAQs

  • Cost-plus pricing is the most popular among all the methods of pricing for its simplicity of calculation and understanding.

  • Strategic sourcing requires integrating purchasing into the design of a project rather than viewing it simply as buying goods and services that different departments need. It requires recruiting and training employees and also redesigning the entire business in such a way that purchasing transforms into a strategic function.

  • The tools required for strategic procurement are

    ●       Spend analytics

    ●       eSourcing

    ●       Contract management

    ●       eProcurement

    ●       Collaboration and workflow management

    ●       eRFX

    ●       eAuctions

  • Strategic sourcing focuses on achieving the lowest TOC i.e. total cost of ownership with minimal supply chain risk.

  • You can create a strategic procurement process through the following steps:

    ●       Assess your business

    ●       Invest in procurement software

    ●       Define company goals and priorities

    ●       Set procurement policy

    ●       Fine tune your sourcing strategy

    ●       Define success metrics

  • The top strategic sourcing process challenges for any business are:

    1) Accurate forecasting of demand.

    2) Managing margins.

    3) Managing suppliers.

    4) Managing the purchasing process.

    5) Risk management/mitigation.

  • Below are some of the KPIs that every business must keep track of:

    ●       Price competitiveness

    ●       Procurement ROI and benefits

    ●       Supplier lead time

    ●       Supplier defect rate

    ●       Supplier compliance rate

    ●       Emergency purchases

    ●       Vendor availability

    ●       Invoice and PO accuracy

    ●       PO cycle time

    ●       Cost per invoice and PO

  • There are many factors that determine whether and when a product’s price needs to be increased. If the product is newly launched, the manufacturer may opt for either aggressive pricing to capture market share, or high pricing for price skimming. Once the product gains popularity, you can readjust the pricing.

  • There are so many ways to price your goods and services. The most popular pricing strategy is cost-plus pricing, where you can price the product depending upon its manufacturing cost. Another popular pricing strategy is value-based pricing, where you price the product based on its value proposition.

  • It totally depends on the value of your product. If you think the competitor is offering more value than your product, you can consider lowering your prices.

  • Price wars are common in every industry. If you have rightly valued and priced your product, a price war may not affect your business substantially.

  • There is no fool-proof way to increase the price of your product without losing your customer base. Even with the cleanest measures, you run the risk of losing a fraction of your customer base if you are operating in a cost-sensitive market. Here are some ways that can work in your favor –

    ·       Offer better value

    ·       Think about timing

    ·       Consider dynamic pricing

    ·       Readjust packages to give customers the option to stay subscribed without paying the extra

    ·       Clearly communicate the reason for price hikes

    ·       Make price hikes a habit for customers

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