Basic methods of price determination
Following points must be taken into consideration before fixing the price of a product.
Elements of Marketing Mix etc.
However, major determinants of price are - Costs, competition and demand. Based on this there are three major approaches to setting the price of a product. They are:
1. Cost oriented pricing
2. Competition oriented pricing
3. Demand oriented pricing
Cost oriented pricing
In Cost oriented approach to pricing or cost based pricing the selling price of a product is determined by adding a percentage of profit to the product cost. There are two methods in cost oriented pricing. They are
1. Cost plus pricing and
2. Target profit pricing or break-even analysis.
Cost plus Pricing
Selling price of a product is calculated by aggregating all the costs of the product such as manufacturing cost, marketing cost and distribution cost plus a predetermined margin of profit. Giving below an example of cost plus pricing: Particulars
Promotional and selling cost
In this method the product cost include fixed and variable costs. It can be represented as follows:
Selling price = Variable Costs + Overhead Costs (Fixed Cost) + Profit.
Changes in the cost while changing the volume of production also needs to be taken into consideration before fixing the selling price. This method will help the manufacturer to secure his position in the market without any loss to the business. This method protect the interests of both the seller as well as the buyer and can be justifiable. The rate of profit margin vary from industry to industry and seller to seller. This method is useful when pricing the government contracts, where pricing of a contract needs to be estimated in advance. It can reduce the risk and uncertainties. This method is mostly used for pricing services. Break even analysis and Target profit pricing.
It is to be noted that as the production increases the fixed cost reduce. For example the fixed cost of a production unit is USD 100 per month.
If the manufacturing unit produce 10 units/products in a month then the cost per unit is USD 10. If the manufacturing unit produce 100 units/products in a month then the cost per unit is USD 1.
From the above we can understand that as the production increases the fixed cost reduce. Fixing the price by assuming that the production for the month is 10 units, then the cost will be high and price also will be on the higher side. On the other hand fixing the price by assuming that the production for the month is 100 units then the cost and price of the product will be low. A marketer needs to balance this issue while fixing the price. Keeping this truth in mind certain manufacturers fix the prices accordingly. Here the firm has to determine the volume of sale through which it can cover the fixed as well as variable cost. This point of sale or revenue is called break even point. What ever revenue comes above this point will generate profit.
A break even analysis relates to total cost to total revenue. A break even point is that level of production at which the total sales revenue (TR) equals the total cost (TC). In other words, a break-even point is the level of production or supply where the firm neither earns any profit nor suffers any loss. There are different break even points for different selling prices. Any amount of sale below the break even point gives loss to the firm. If the amount of sale is above the break even point, the business will be profitable.
We can calculate the break even point by using the following equation
Break Even Point =
P - V
F is the Total fixed Cost per month, P is the selling price per unit and V is the average variable cost per unit.
Suppose Adidas is making...
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