Cost Based Pricing, Internal and External Factors of Pricing

Cost-Based Pricing

Cost-based pricing entails determining prices based on the costs of manufacturing, shipping, and promoting the product as well as an adequate rate of return for its risk and labor. Costs may play a significant role in a company's pricing strategy. Some businesses, like Ryanair and Walmart, strive to be the "low-cost producers" in their respective markets. Companies with lower expenses may charge lower pricing, which would lead to narrower profit margins but higher sales. Other businesses, like Apple, Steinway, and BMW, purposefully incur higher expenditures in order to advertise higher pricing and profit margins. The trick is to control the difference between expenses and prices—how much money the company makes relative to the value it provides to customers.

The act of setting a price based on what it costs a company to produce a good is known as cost-based pricing. A business should also take into account elements like its competitors, production costs, relevant governmental requirements, and customers. Cost-based pricing entails determining a price in such a way as to:

Price = (1+ Percent Markup)(Unit Variable Cost + Average FixedCost) .

Simply put, costs depend on sales, which in turn depend on prices. The calculations for costs, sales, and prices will become circular as a result. Consider a business whose average costs fall as revenues rise. Its costs will increase if it sells fewer units. In this situation, raising prices would be a panacea, but declining sales are hardly the ideal circumstance for such a step. Next, picture a business that operates on a small scale. Its costs will decrease if it can sell more. However, by pricing at a small-scale capacity average cost, the corporation might never find this out. The question of how the firm's pricing strategy will effect its cost structure must be asked instead of what prices the company needs to charge in order to cover its costs and achieve its profit objectives.

Internal and External Considerations Affecting Price Decisions

The company must take into account a number of extra internal and external aspects in addition to consumer value perceptions, costs, and rival strategies. The firm's overall marketing strategy, goals, and marketing mix, as well as other organizational concerns, are internal factors that have an impact on price. External factors include things like demand, market characteristics, and other environmental influences.

Overall Marketing Strategy, Objectives, and Mix

Price is just one element of the company's larger marketing plan. Therefore, the company should choose its whole marketing approach for the good or service before choosing the pricing. If the company has properly chosen its target market and positioning, its marketing mix strategy—including the price—should be fairly simple. For instance, charging a premium price was necessary when Honda created the Acura brand to compete with European luxury-performance cars in the upper income bracket. However, this positioning called for charging a cheap price when it debuted the Honda Fit model, which was marketed as "a pint-sized fuel miser with spunky giddy up." As a result, choices about market positioning heavily influence pricing strategy.

At several levels, pricing may significantly contribute to achieving organizational goals. A business may establish prices to entice new clients or profitably hold onto current ones. It could set prices aggressively low to keep rivals out of the market or aggressively high to maintain market stability. It may charge a fee to maintain the patronage and fidelity of resellers or to ward off government interference. Prices may be temporarily lowered in order to build excitement for a brand. Or, a product's price may be adjusted to boost sales of other items in the company's line.

A company uses a variety of marketing mix components, including price, to meet its marketing goals. In order to create a coherent and successful integrated marketing program, price decisions should be coordinated with those on product design, distribution, and promotion. Pricing selections may be impacted by choices made for other marketing mix components. For instance, choosing to emphasize high performance quality will need the vendor to raise prices in order to cover increased expenses. Producers who expect their resellers to support and advertise their goods may need to increase their reseller margins in their pricing.

Organizational Considerations

The company's management should decide who is responsible for setting prices. Pricing is handled in a variety of ways by businesses. Prices are typically established by top management rather than the marketing or sales divisions in small businesses. However, in a big company, product line or divisional managers are often in charge of pricing. Salespeople may be permitted to bargain with customers at specific price points in industrial marketplaces. Nevertheless, top management establishes the pricing goals and policies and typically accepts the prices suggested by lower level management or sales representatives. Corporations typically have pricing departments to set the best rates or may assist others in setting them in areas where pricing is a crucial aspect (airlines, steel, aerospace, oil companies, railways). These divisions will answer to either senior management or the marketing division. Sales managers, financial managers, production managers, and accountants are other individuals who have an impact on price.

The Market and Demand

We are all aware that understanding how consumers' perceptions of value impact the prices they are prepared to pay is the first step in developing appropriate pricing strategies. Buyers in both the consumer and industrial sectors weigh the costs of a given good or service against its advantages. Therefore, a marketer should be aware of the connection between product pricing and demand before determining prices.

The Economy

The company's pricing strategy may be significantly impacted by the state of the economy. Economic factors like recession or boom, inflation, and interest rates have an impact on pricing decisions because they change consumer spending, how customers perceive the value of a product, and how much it costs a company to produce and sell a product.

The most obvious reaction to the new economic reality involves price reductions and generous discounts. And thousands of businesses have followed suit. Prices that are lower will make things more accessible and aid in boosting immediate sales. Such price reductions could, however, have unfavorable long-term effects. Deep discounts may cause consumers to view a brand as being inferior. Additionally, once a company lowers prices, it will be challenging to raise them again when the economy improves. Instead of lowering costs, many businesses are moving their marketing emphasis to more reasonably priced items in their product lineups.

Other External Factors

The firm should take into account a number of additional aspects in its external environment when setting prices, in addition to the market and the economy. It ought to be aware of how its costs will affect other parties in its surroundings. How will retailers respond to different prices? The business should set prices that provide reasonable profits to resellers, inspire their loyalty, and aid them in successfully selling the goods. Another significant external factor that influences pricing decisions is the government. Social considerations may also need to be taken into account. A company's short-term sales, market share, and profit ambitions may need to be balanced when determining prices by broader societal factors.

References

Kotler, P., & Armstrong, G. (2013).Principles of Marketing.Chennai: Pearson India Education Services Pvt Ltd.

https://marketing-insider.eu/cost-based-pricing/