Methods of pricing

Having established the strategy it intends to follow, the business now needs to work out the price it will charge. This will depend on the costing method it decides to use, which in turn will be dependent on the market in which it is operating and its target profit.

  1. Full cost pricing. Total production costs are added together, the required profit added to this, and the result divided by the output. At first sight this method of pricing appears to take little account of the market. A variation of total cost pricing might decide what the market will bear, subtract the desired profit from it and then decide whether or not the good can be made by that business for that price. If the answer is in the negative there may be an investigation into the way in which costs can be reduced; perhaps by changing the quality of the item. This carries with it the danger of accidentally eliminating just those qualities which appeal most to the customer.

  2. Contribution pricing. When a business has excess capacity or when it produces a number of products it may decide upon the price for a product by contribution pricing. Provided the price covers the direct costs of production and makes a contribution to fixed costs then it will be accepted. In the short term a business with excess capacity might accept orders at below full cost provided the price offered makes a contribution to fixed costs. A business which sees the opportunity of exploiting an additional market through price discrimination may be prepared to price at less than full cost.

  3. Geographic pricing. The practice of charging a different price in different countries or regions of the same country reflects the cost of transport of the goods. Rather than change prices in one particular country a business might be prepared to take varying levels of profit form different transactions. Another business exporting to Europe could charge different prices according to the region. Of course not all the variations in price between geographical areas will depend on transport costs. The other constraints on pricing must also be taken into account.

  4. Discounts. Various discounts can be offered:

    • Bulk discounts for purchases in large quantities.

    • Promotional discounts or ‘money off’ offers are part of the general promotional package of the business.

    • Seasonal discounts may be offered to extend the sales of goods which tend to vary seasonally. The discounts will be offered in the season in which demand for goods is low.

    • Trade discounts in this case a manufacturer will set a market price. This is known as the recommended retail price(RRP). Wholesalers and retailers can then purchase from the manufacturer at a price perhaps 20 per cent lower than this price. The RRP has the advantage of allowing the final customer to compare this price with the one being offered by the retailer and so compare the discounts retailers are offering.