Price calculation methods: calculation methods, economic feasibility and examples

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:42

Businesses can use different pricing strategies when selling a product or service. The price can be set to maximize profitability for each unit sold or from the market as a whole. It can be used to protect an existing market from new entrants, to increase market share, or to enter a new market segment.

Pricing as part of the marketing mix

The pricing method is one of the most important and sought-after components in marketing theory. This helps consumers understand the standards a firm sets for its products, as well as recognize companies that have an exceptional reputation in the market.

A firm's decision about a product's price and pricing strategy influences the consumer's decision to buy it or not. When companies decide to consider any pricing strategy, they should be aware of the following reasons in order to make the right choice that will benefit their business. Market methods of pricing today are tied to competition, which is extremely high, thereforeproducers must be attentive to the actions of their opponent in order to have a comparative advantage in the market.

The frequency and popularity of using the Internet has increased and developed significantly, so price comparison can be made by customers through online access. Consumers are very picky about the purchases they make due to their knowledge of monetary value. Firms should keep this factor in mind and price their products accordingly.

Pricing methods=

Absorption pricing

A costly pricing method where all investments are reimbursed. The price of a product includes the variable cost of each item plus a proportional amount of fixed costs.

Contribution of the margin price

Margin contribution pricing maximizes the profit earned from an individual product based on the difference between its cost and variable costs (product contribution margin per unit) and on assumptions about the relationship between product price and number of units that can be sold for it. The contribution of a product to the total profit of the firm is maximized by choosing a price that sums up the following: (marginal profit per unit) X (number of units sold).

In cost-plus pricing, the company's first price determines the break-even point for the product. This is done by calculating all costs associated with production, such as raw materials purchased and used in its transportation, marketing and distribution of the product. Thena mark-up is set for each unit based on the profit the company is expected to make, its sales goals, and the value it thinks customers will pay. Example pricing method: If a company needs a 15% profit and the breakeven price is $2.59, the price will be set at $3.05 ($2.59 / (1-15%)).

Skimming

In most skimming, goods have a higher value, so fewer sales are required to break even. Therefore, selling a product at a high price, sacrificing high sales for high profits, is skimming the market.

This method of calculating the price of a product is commonly used to recover the cost of original research investment in a product: typically used in electronic markets when a new range, such as DVD players, is first sold at a high price. This strategy is often used to target the "early adopters" of a product or service.

Early adopters tend to have relatively low price sensitivity - this can be explained by:

• their need for the product exceeds their desire to save money;
• better understanding of product value;
• just have higher disposable income.

This strategy is used only for a limited period of time in order to return the majority of the investment made in the creation of the product. To gain further market share, the seller must use other pricing tactics such as savings or penetration. This method may havesome shortcomings as it is able to leave the product at a high price compared to the competition.

Pricing Lure

A method of calculating the price of a product, in which the seller offers at least three of its names, and two of them have the same or equal price. Two products with the same prices must be the most expensive, and one must be less attractive than the other. This strategy will force people to compare similarly priced options, and as a result, sales of more attractive high-priced items will increase.

Double ticket

Form of fraudulent pricing method. This sells the product at the higher of the two prices communicated to the consumer when accompanying or promoting it.

Freemium

This is a revenue model that works by offering a product or service for free (usually digital offerings such as software, content, games, web services, etc.) while charging for advanced features, functionality or related products and services. The word freemium is a portmanteau of two aspects of the business model, "free" and "premium". It has become a very popular model with notable success.

High cost

The pricing methods of the services offered by the organization are regularly priced higher than those of competitors, but through promotions, announcements and/or coupons, lower prices are offered for keyproducts. The cost reduction is intended to attract customers to an organization where the customer is offered an advertising product, as well as regular more expensive counterparts.

Keyston

A retail pricing method that sets the price at twice the wholesale price. For example, if the price of a product for a retailer is £100, then for a sale it is £200.

In a competitive industry, this method is often not recommended as a pricing strategy due to relatively high profit margins and the fact that other variables need to be taken into account.

Price limit

This price is set by the monopolist to prevent competitors from entering the market economically and is illegal in many countries. The marginal price is the rate that the entrant will face upon entry until the incumbent firm reduces output.

It is often lower than the average cost of production, or just low enough to make it profitable. The quantity produced by the incumbent firm as a deterrent to entry is usually greater than would be optimal for the monopolist, but may still generate higher economic profits than would be earned under perfect competition.

The problem with limit pricing as a strategy is that once a participant enters the market, the quantity used as a deterrence threatentry is no longer the best incumbent response. This means that for a price cap to be an effective deterrent to entry, the threat must be credible in some way.

One way to achieve this goal is for the incumbent to force itself to produce a certain amount of a good, whether entry occurs or not. An example of this would be if a firm enters into a union contract to employ a certain (high) level of labor for an extended period of time. In this strategy, the price of the product becomes the limit according to the budget.

Leader

A loss leader is a product that is sold at a low price (i.e., cost or below) to stimulate other profitable sales. This will help companies expand their overall market share.

The loss-of-leader strategy is commonly used by retailers to encourage customers to buy products with higher margins to increase profits, rather than those sold at a lower price. When the cost of a “recommended brand” is offered at a low price, retailers tend not to sell large volumes of loss leader products, and they tend to purchase smaller quantities from the supplier to prevent losses to the firm. Supermarkets and restaurants are a great example of retailers that are adopting a loss of lead strategy.

Marginal cost

In business, setting the price of a product is practiced,equal to the additional cost of producing an additional similar unit. Under this policy, the manufacturer charges only the value added to the total cost of materials and direct labor on each item sold.

Companies often set prices close to marginal cost during periods of poor sales. If, for example, the marginal cost of an item is $1.00 and the normal selling price is $2.00, the firm selling the item can lower the price to $1.10 if demand has decreased. A business would choose this approach because an extra 10 cents on a transaction is better than no sales at all.

Cost plus prices

This is a cost-based pricing method for goods and services. In this approach, direct material inputs, labor costs, and product overheads are summed up and added to a markup percentage (to create a rate of return) to arrive at the optimal price.

Odd options

In this type of pricing, the seller seeks to lock in a price whose last digits are just below a round number (also called just below pricing). This is to ensure that buyers/consumers don't have a bargaining gap as prices appear to be lower but are actually too high and take advantage of human psychology. A good example of this can be seen in most supermarkets, where instead of a price of £10 it will be listed as £9.99.

Pay whatwant

This is a pricing system where customers pay any amount they want for a given item, sometimes including zero. In some cases, a minimum price and/or a recommended price may be set and provided as a guide to the purchaser. The latter can also choose an amount higher than the standard price of the item.

Giving buyers the freedom to pay what they want may seem pointless to a seller, but in some situations it can be very successful. While the majority of the fee's uses have been during the downturn in the economy or for special promotions, efforts are being made to expand its usefulness to a wider and more regular use.

Guaranteed Max Price Contract

CMC is a cost type contract (also known as an open book contract) in which the contractor is compensated for the actual investment, plus a fixed fee based on the maximum price.

The contractor is liable for cost overruns unless the GMP has been increased through a formal change order (only as a result of additional customer capability and not cost overruns, errors or omissions). Savings resulting from underestimating costs are returned to the owner.

CMS is different from a negotiated price contract (also known as a lump sum) where cost savings are usually retained by the contractor and are essentiallybecomes additional profit.

Infiltration

Penetration pricing involves setting a low price to attract customers and gain market share. The value will be raised later once this market share is increased.

A firm that uses a penetration pricing strategy prices a product or service at a lower quantity than its normal long-distance market price in order to gain market acceptance or increase its existing market share. This strategy can sometimes discourage new competitors from entering a market position if they misperceive the penetration price as a long range option.

The penetration price comparison strategy is typically used by firms or businesses that are just entering the market. In marketing, this is a theoretical method used to reduce the price of goods and services that cause high demand for them in the future. This penetration pricing strategy is vital and is recommended for a variety of situations a firm may face. For example, when the level of production is lower compared to competitors.

Predatory prices

Predatory pricing, also known as aggressive (or under-pricing), is designed to drive competitors out of the market. It is illegal in some countries.

Companies or firms that tend to engage in predatory pricing strategies often set themselves the goal of setting a cap or barrierto access other new businesses in the applicable market. This is an unethical act that is against antitrust laws.

Predatory pricing mainly occurs during price competition in the market. By using this strategy, in the short term, consumers will benefit and be satisfied with cheaper products. Firms often do not benefit in the long run, as other businesses will continue to use this strategy to drive down competitors' profits, contributing to significant losses. This strategy is dangerous because it can be destructive to the firm and even lead to the complete failure of the business.