Cost based pricing Managerial Economics
Nov 15, 2014
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