Types of Pricing Methods

Pricing is one of the 4Ps of marketing; i.e., Place, Promotion, Price, and Product. Price is the only revenue-generating element. Pricing involves the activities and procedures that help in deciding the value, a company is going to charge in exchange for its product/service. Pricing Methods are the methods that help in determining the price of goods/services based on various factors.

Types of Pricing Methods

The pricing methods are broadly classified into two categories: Cost-Oriented Pricing Methods and Market-Oriented Pricing Methods. The Cost-Oriented Pricing Methods include Cost-Plus Pricing, Markup Pricing, and Target Return Pricing. However, the Market-Oriented Pricing Methods include Perceived Value Pricing, Value Pricing, Going Rate Pricing, Differential Pricing, and Auction Type Pricing.

I. Cost-Oriented Pricing Methods

1. Cost-Plus Pricing: 

Cost-plus pricing is the easiest and most basic method of pricing. Under this method, the seller adds a pre-specified percentage on the cost of producing one unit. This pre-specified percentage, also known as Markup Percentage, is used to determine the selling price. The markup; thus, is the profit percentage implied on the cost of production. Cost-plus pricing ensures the desired rate of return. Price determination under cost-oriented pricing is calculated as follows:

Total Cost = Fixed Costs + Variable Costs

Unit cost = [Tex]\frac{Total~cost}{Number~of~units}[/Tex]

Markup Price = Unit cost x Markup Percentage

Selling Price = Unit cost + Markup Price

For example, Assume that the cost of production of product A is ₹1,000 with a markup of 50% on the total cost, then the selling price will be calculated as:

Markup Price = Unit cost x Markup Percentage = ₹1,000 x 50% = ₹500

Selling Price = Unit cost + Markup Price = ₹1,000 + ₹500 

Selling Price = ₹1,500

2. Markup Pricing: 

Markup Pricing is the method where markup is calculated on the selling price of the product. In other words, it is the method of adding a profit percentage to the selling price of the product. Prices under markup pricing are considered as:

Marked Price = [Tex]\frac{Unit~Cost}{1-Desired~return~on~sale}[/Tex]

For example, Assume that the cost of production of product A is ₹1,000 and the seller wants to earn a profit of 20% on sales, then the markup price will be calculated as:

Marked-up Price = [Tex]\frac{Unit~Cost}{1-Desired~Return~on~Sale} [/Tex]

= [Tex]\frac{1000}{1-0.20} [/Tex]

Marked-up Price = ₹1,250

3. Target Return Pricing: 

Target Return Pricing is the method under which the firm decides to set up the prices of products according to the pre-specified required rate of Return on Investment (ROI).

Target Return Price = [Tex]Unit~Cost+\frac{Desired~Return\times{Capital~Invested}}{Unit~Sales} [/Tex]

For example, Assume that the manufacturer has invested ₹10,000 in business and is expecting an ROI of 20% i.e., ₹2,000, given that the unit price is ₹50 and the target sales is 100 units, then the target return price is given by

Target Return Price = [Tex]Unit~Cost+\frac{Desired~Return\times{Capital~Invested}}{Unit~Sales} [/Tex]

= 50+\frac{0.20\times{10,000}}{100}

Target Return Price = ₹70

II. Market-Oriented Pricing Methods

1. Perceived Value Pricing

Under this pricing method, the manufacturer undertakes the customers’ perception of goods and services. The customer’s expectation of the price of the product plays an important role in deciding the price of the product. For Example,

• Starbucks charges high prices for its coffee as compared to other coffee brands, relying on the perception of a unique coffee experience and ambience.
• Organic food products are often priced higher than non-organic food products, leveraging the perception of healthier and more sustainable options.

2. Value Pricing

Under this method of pricing, re-engineering is done to reduce the cost of production as well as maintain the high-end quality. The cost of product/services are thus low with better quality. For example,

• Walmart is known for its value pricing strategy, offering a wide range of products at lower prices than many of its competitors. This attracts budget-conscious consumers who prioritise affordability.
• McDonald’s offers a value-priced menu with items prices at low prices, catering to customers looking for affordable meal options.

3. Going Rate Pricing

Under this method of pricing, the firm undertakes the prices of rival firms and sets its prices accordingly. Generally, to end the price wars among the firms, the prices of all firms in an industry remain more or less the same when they adopt the going-rate pricing method. Oligopolistic firms like steel, fertilizers, paper, etc., practice going rate pricing. For example,

• Telecommunication firms like Jio, Airtel, and Vodaphone charge almost the same rates under the going rate pricing method.
• Ride-sharing companies like Uber and Lyft use dynamic pricing, adjusting fares based on factors like demand and supply.

4. Differential Pricing:

Differential pricing is practiced under price discrimination where the sellers charge different prices from different buyers. The prices can also vary from age, gender, location, customer standard, etc. For example,

• The price of Mineral Water charged is different in different places, hotels, restaurants, general stores, etc.
• Movie Theaters often use differential pricing based on factors like age, time of the day, and special occasions.

5. Auction Type Pricing:

This type of pricing method came into existence with the increased usage of the internet. Websites like OLX, Quikr, eBay, etc., practice auction-type pricing. There are three types of auctions:

• English Auctions: English Auctions consist of one seller and multiple buyers. The sellers tend to increase the price until the product reaches the best bid.
• Dutch Auctions: Under Dutch auctions, there may be one seller and many buyers or many sellers and one buyer. The former type consists of setting up the best price and adjusting it according to the capacity of bidders and the latter type undertakes the bidder asking for the product and multiple sellers offering reasonable prices.
• Sealed-Bid Auctions: Government and industrial purchases generally follow this method of pricing. Under this, potential buyers communicate their prices with suppliers only and do not disclose them to anyone else.