Setting the price for a product or service is not an easy task. The price of a product or service is kept at a level that can generate both profit as well as demand. Generally, the cost of the product or service provides the lower limit of the price, and the perceived value by consumers provides the upper limit for setting the price. Business organizations should also take into account the prices of their competitors along with other internal and external factors.
Different Types of Pricining Approaches
There are general pricing approaches that can be applied by businesses in setting prices for their products or services. These pricing approaches are of three types:
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Cost-Based Pricing Approach
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Buyer-Based Pricing Approach
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Competition-Based Pricing Approach
Each of the above is based on different dimensions of a product or service. Each of these is now discussed one by one.
Cost-Based Pricing Approach:
This pricing approach is the simplest approach in which the cost of a product or service is added to a certain proportion of markup as profit to determine a price. Examples include construction businesses that estimate the cost of a project and submit their bid by adding a certain portion of profit to their estimated cost. Moreover, accountants, lawyers, and other professionals charge a price for their services by adding the cost of work with a certain proportion of markup.
Markup pricing is not regarded as an effective pricing model as it ignores both demand and the pricing of competitors. Therefore, it is almost impossible for a business to keep its price as the best one by adopting this category of pricing. However, cost-based pricing is still popular due to the following reasons:
• It makes pricing simpler, so marketers do not change the price of their product or service with changing demand.
• When the majority of businesses in the market adopt this pricing model, there is minimum price competition due to similarity in prices.
• Generally, cost-based pricing looks fairer for both buyers and sellers, as buyers are not exploited under conditions of higher demand, and sellers can earn a reasonable profit through such pricing.
Target Profit Pricing and Break-Even Analysis:
Target profit pricing is also called break-even analysis, in which the total cost and total revenue are forecast at different levels of sales. In this way, a reasonable profit can be earned at a reasonable price.
Fixed costs remain unchanged even at zero levels of production and sales. On the other hand, variable costs change with the level of production and sales. Both of these costs are combined to determine the expected total cost at certain sales volumes.
When sales volume increases, total cost per unit decreases and total revenue increases. Break-even is the point of sales volume where cost is equal to revenue and profit is zero. The estimated demand, break-even points, and profits are compared with different prices by business management.
Value-Based Pricing Approach:
This pricing approach is extensively applied by many organizations in which the perceived value of buyers is regarded as a base for setting the price of a product or service. In this pricing model, the value of a product or service as perceived by customers provides guidelines for pricing.
In other words, the price is not set after the production of the product but before production. This means that the organization considers customers along with their perceptions about a certain product or service. On this basis, the business sets a certain price and then starts manufacturing that product. The expected value and price provide guidelines for the cost and design of the product so that it can match customer perceptions.
It is difficult for business organizations to determine the different perceived values of customers for different products. For this purpose, organizations conduct surveys and experiments. If a business keeps the price of its product higher than the perceived value of customers, its sales are affected. On the other hand, if a business keeps its product’s price lower, sales may increase, but profit does not increase accordingly.
Therefore, organizations that want to adopt this value-based pricing strategy should keep the price of their products in accordance with their perceived value by customers. A more effective strategy is that businesses should try to deliver more value to customers than they expect in order to retain them as loyal customers.
Competition-Based Pricing Approach:
In this pricing model, businesses set the prices of their products or services on the basis of competitor pricing. Customers in the market also perceive the value of any product or service in relation to the prices of similar products offered by competitors.
There is a type of going-rate pricing in which product prices are adjusted according to changes in competitor pricing. This means that price does not take into account the cost or demand of the product or service.
For example, paper, steel, or fertilizer manufacturing businesses face oligopolistic competition in which they charge almost similar prices in the market. There is a market leader whose price is followed by smaller competitors. When the market leader changes its price, other competitors also adjust their prices accordingly.
Some smaller businesses may keep a slight difference in price compared to the market leader, but this difference remains constant under different conditions. A major advantage of adopting this going-rate competition-based pricing is the prevention of price wars among competitors.
Another form of competition-based pricing is sealed-bid pricing, in which the price of a job is determined by considering competitor prices. In this case, pricing also ignores cost and demand factors, but businesses try to keep their prices slightly higher than their costs in order to earn revenue.
Pricing is not confined to the above categories; there are other factors that affect pricing decisions, such as environmental factors, etc.
