Cost based pricing

Managerial Economics

GROUP MEMBERS

o Mohan Xavier

o Muhammad Asif

o Nikita Anne Jacob

o Saichandra

o Sachin Bose

o Shamlu Shaji

price

Price is the amount of money

charged for a good or service

It is the sum of all the values that

consumers give up for the product.

pricing

Process of determining what a

company will receive in exchange of

its product.

Pricing objectives

Survival

Profit Maximization

Target Return on Investment (ROI)

Market Share Goals

Status Quo Pricing

Factors to Considerwhen Setting Prices

General Pricing Approaches

Cost-Based Pricing

Break-Even Analysis and Target Profit Pricing

Value-Based Pricing

Competition-Based Pricing

Cost based pricing

• Using the cost of production as the basis

for pricing a product.

• Here the selling price of product a will be

the cost to produce it.

• It includes :-

Direct and indirect costs

Additional amount to generate profit.

Cost based pricing

• Product• Product

• Cost• Cost

• Price• Price

• Value• Value

• Customers• Customers

Advantages

Super easy.

Flexible.

If costs go up, it is easy to adjust prices.

Super simple to calculate.

Is easy for a marketer to defend pricing.

May suit a manufacturer with scalable

production based on demand.

Disadvantages

Ignores product demand or the influence price may have

on demand.

Ignores what competitors are doing with their pricing.

If costs increase, so must the price.

Ignores brand positioning so may forfeit additional profit.

It provides no incentive to improve cost efficiency.

Classifications of cost based pricing

1. Cost plus pricing

2. Full cost pricing

3. Target profit pricing

4. Marginal cost pricing

Cost plus pricing

A fixed percentage of profit will be

added to the cost.

The fixed percentage of profit will be

taken by manufacturer, wholesaler

and the retailer.

Egg:-Fixed cost for making 10,000 shirts is

Rs.1,50,000.

Variable cost (P.U) = 30

Cost (P.U) = 45

Firm expects 30 % return on sales.

The mark up Price will be

= 45/(1-0.3)

= Rs. 64.28 p

Full cost pricing

Also called absorption cost pricing.

Attempting to set price to cover both fixed

and variable costs

Total cost will be computed by adding

variable and fixed cost incurred in the

product. The price of each product is dependant on

how many costs it creates.

Egg:-

• MM co. plan to produce 5000 widgets.

• Manufacturing labor = Rs. 50,000

• Material cost = Rs. 1,00,000

• Overhead cost= Rs. 20,000

• Direct labor (P.U)= 50,000/5000 = Rs.10

• Material cost (P.U)= 1,00,000/5000= Rs. 20

• Overhead cost (P.U)= 20,000/5000= Rs. 4

• Desired profit (P.U)= Rs. 8

Cont.

• Add all cost per units• = 10+20+4+8• Full cost price = 42 (P.U)• This means using full cost pricing,

MM company would sell its widgets at Rs.42 (P.U)

Target profit pricing

Also called rate of return pricing

Mark-up = Profit/Cost x 100

Setting price to ‘target’ a specified profit level

Estimates of the cost and potential revenue at

different prices, and thus the break-even have to be

made, to determine the mark-up

This method is possible when there is no competition

in the market.

Egg :-

• Sales price per unit = Rs. 250

• Variable cost per unit = Rs. 150

• Total fixed expenses = Rs. 35,000

• Target Profit = Rs. 40,000

• Q = Number (Quantity) of units sold

• How many units will have to be sold to earn a

profit of Rs. 40,000?

Cont.• Sales = Variable expenses + Fixed expenses + Profit

• Rs. 250Q = Rs. 150 + Rs. 35,000 + Rs. 40,000

• Rs. 100Q = Rs. 75,000

• Q = Rs. 75,000 / Rs. 100 per unit

• Q = 750 Units

• Thus the target profit can be achieved by selling 750 units per

month, which represents $187,500 in total sales ($250 × 750

units). This equation is also extensively used to calculate

break even point. When break even point is calculated the value

of profit in the equation is taken equal to ZERO.

Marginal cost pricing

This aims at maximizing the contribution towards

fixed cost.

In addition portion of the fixed cost will also

realized.

Marginal cost – the cost of producing ONE extra or

ONE fewer item of production.

Particularly relevant in transport where fixed costs

may be relatively high

EGG:-

Aircraft flying from Bristol to Edinburgh – Total Cost (including normal profit) = £15,000 of which £13,000 is fixed cost*

Number of seats = 160, average price = £93.75

MC of each passenger = 2000/160 = £12.50

If flight not full, better to offer passengers chance of flying at £12.50 and fill the seat than not fill it at all!

Demand-Based pricing

• Pricing that is determined by how much customers

are willing to pay for a product or service

• This method results in a high price when demand is

strong and a low price when demand is weak

• May be differentiated based on considerations such

as time of purchase, type of customer or distribution

channel

Price Elasticity of Demand

Competition-Based pricing

• Pricing that is determined by considering what competitors charge for the same good. Once you find out what your competition is charging, you must determine whether to charge the same, slightly more, or slightly less.

Customer

Product

Price

Cost

Value

Competition-Based Pricing

Pricing Strategies

• New-Product Pricing Strategies

• Existing-Product Pricing Strategies

• Psychological Pricing

• Promotional Pricing

New-ProductPricing Strategies

• Prestige Pricing

• Market-Skimming Pricing

• Market-Penetration Pricing

Setting Initial Product Prices

Market SkimmingMarket Skimming

>Setting a high price for a new product to skim maximum revenues from the target market.

>Results in fewer, more profitable sales.

>Popular night club charges a high cover charge

Market PenetrationMarket Penetration

>Setting a low price for a new product in order to attract a large number of guests.

>Results in a larger market share.

>New Marriott

Existing-ProductPricing Strategies

• Product-Bundle Pricing

• Price-Adjustment Strategies

– Volume Discounts

– Discounts Based on Time of Purchase

– Discriminatory Pricing

– Yield Management

• Non-Use of Yield Management

• Last-Minute Pricing

Product-Bundling Pricing

• Transfer surplus reservation price (the maximum price a

customer will pay for a product)

– Customer A will pay $60 for a Disney pass and $120 for a

hotel room. Customer B will pay $95 for the Disney pass

and $80 for the hotel room – A hotel selling a two night

package with pass for $350 will get both customer

• Price-bundling also reduces price competition – by making

it hard to figure price of components

– In an airline and hotel package it is difficult to determine

the price of the room

Psychological Pricing

• Price-quality relationship

• Reference prices

• Rounding

• Length of the field

Promotional Pricing

• Temporary pricing of products below list price and sometimes below cost

–Value Pricing

–Price Sensitivity Measurement