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
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.
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
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.
The goal is to deliver more value to a customer than the competitor and to demonstrate this value to prospective buyers.
The savings are passed on to value-conscious customers through programs such as everyday low pricing, high-low pricing and extreme everyday low pricing.
This method is appropriate when costs are difficult to estimate and when competition is uncertain.
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.
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%.
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.
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
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 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.
Watch this 5-minute video to learn more about pricing strategies.