# The 4 Ps – Price (2/2)

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The 4 Ps – Price (2/2)

In this lesson, you’re expected to learn:
– How consumers process and evaluate prices
– How a company initially sets prices for products or services
– How should a company adapt prices to meet varying circumstances?

Six popular methods exist to establish prices, including:

– Markup Pricing
– Target-return Pricing
– Perceived-value Pricing
– Value Pricing
– Going-rate Pricing
– Auction-type Pricing

(1) Markup Pricing Method

The markup pricing method, also known as the cost-plus method, is easy to determine and fair for both buyers and sellers.

This method results in similar prices when all firms in the industry use the same approach and price competition is, therefore, minimized.

Basically, this method takes all costs of producing a product and adds a standard markup for profit as the desired return on sales.

* A manufacturer’s unit cost is computed as follows:

1. Manufacturer’s Total Unit Cost = Variable Cost per Unit + (Total Fixed Costs / Expected Unit Sales)

2. Percent Markup on Cost = (Unit Price – Total Unit Cost) / Total Unit Cost

* A standard markup percentage is added to the total unit cost (fixed cost per unit plus variable cost per unit), giving the markup price:

1. Manufacturer’s Markup Price = Total Unit Cost / (1 – Percent Markup)

2. Percent Markup on Price = (Unit Price – Total Unit Cost) / Unit Price

(2) Target-Return Pricing Method

This method seeks a desired return on investment capital, which is based on an economic concept. The formula is:

Target-Return Price = Total Unit Cost + [(Desired Return x Invested Capital) / Expected Unit Sales]

A break even point in units can be computed and compared to the expected unit sales to determine how much effort is needed to reach the expected sales level to make the desired profit.

This method ignores external factors such as price elasticity and competitors’ prices because it is based on internal factors such as costs and profits.

(3) Perceived-Value Pricing Method

Based on what the customer, not the company thinks about the value of a product. Organisations use advertising to communicate and enhance perceived value in buyers’ minds.

The goal is to deliver more value to a customer than the competitor and to demonstrate this value to prospective buyers.

(4) Value Pricing Method

This method purposefully charges a low price for a high quality product with cost savings realized.

The savings are passed on to value-conscious customers through programs such as everyday low pricing, high-low pricing and extreme everyday low pricing.

(5) Going-rate Pricing Method

It focuses on meeting or beating competitors’ prices. Some companies adopt a follow-the-leader strategy, meaning changing the price when the competitor changes its price, not when the company’s demand or cost structure changes.

This method is appropriate when costs are difficult to estimate and when competition is uncertain.

(6) Auction-type Pricing Method

This method uses the internet as the primary medium to transact between buyers and sellers. The items that are auctioned include excess inventories and used goods of all kinds.

In general, online auctions are giving greater overall satisfaction to buyers and sellers due to a large number of bidders, greater economic stakes and less visibility in pricing.

Price Response Analysis

Price response analysis is the study of the effects of price decreases and increases on profits. Price response coefficients are usually collected from market research studies. Generally, price and sales volume varies inversely. This means that higher prices should result in a small number of units sold and vice versa.

For example, a price response coefficient of -2.0 means that if price falls by 5%, sales would be expected to increase by 10%. Similarly, a price response of coefficient of +1.5 means that if price falls by 6%, sales would decrease by 9%.

Relationship between Price, Profit and Market Share

The goal of a pricing strategy should be to increase profits, not to increase sales or volume. Lowering the price can increase sales revenue but it may not increase profits because fixed costs stay relatively constant.

The first question to ask is how much market share is needed to maintain the current level of profits before asking how much to lower or raise the price. Increasing the market share is difficult whereas changing the price is relatively easy. Also, competitors closely follow a company’s pricing strategy.

The market share needed to maintain the current level of profits, expressed as a percent, is calculated as:

Market Share Needed = Desired Gross Profit / (Market Demand) x (Unit Price – Unit Cost)

Philip Kotler recommends a useful way to analyze market share movements in terms of four components:
· customer penetration
· customer loyalty
· customer selectivity
· price elasticity

* Gross Profit = Customer Volume x Customer Margin

Break-Even Analysis

Break-even analysis entails the calculation and examination of the margin of safety for an entity based on the revenues collected and associated costs.

Analyzing different price levels relating to various levels of demand, an entity uses break-even analysis to determine what level of sales are needed to cover total fixed costs. A demand-side analysis would give a seller greater insight regarding selling capabilities.

Break-Even Price

Break-even price is the amount of money for which a product or service must be sold to cover the costs of manufacturing or providing it.

Break-even prices can be translated to almost any transaction.

For example, the break-even price of a house would be the sale price at which the owner could cover the home’s purchase price, interest paid on the mortgage, hazard insurance, property taxes, maintenance, improvements, closing costs and real estate sales commissions. At this price, the homeowner would not see any profit, but also would not lose any money.

[Optional] Pricing Strategies