Pricing is another big part of the marketing mix. Choosing the right price and the right pricing strategy is crucial to the marketing process.
The price of the product is not something that is fixed. On the other hand the price of the product depends on many other factors. Some times the price of the product has got nothing to do with the actual product itself. The price may act as a way to attract target customers.
The price of the product is decided keeping many things in mind. To understand what all this means, let us look at the different possible pricing strategies one can adopt.
Cost based pricing:
This the simplest form of pricing. In this pricing strategy, you take the "Cost Price" of the product and you add to it how much profit you would like to make per unit sold. What you get is the “Selling Price”.
It's very simple logic: Cost Price/unit + Profit/unit = Price/unit or Selling Price/unit
To understand this better, consider you make 100 units of a product and it costs you Rs.10 per piece. Now you decide that you would like to make a 2% profit. So you charge Rs.2 extra per product and keep that is your profit.
This seems to make sense. However, this pricing strategy is very crude. This pricing strategy is independent of the market and your target consumer.
Besides this, in the production of product, these must be some "fixed cost" that is independent of the quantity produced. This cost may not be directly accounted for in this system.
Contribution pricing:
This type of pricing method is a modification on the above pricing method. In this pricing, the equation is something like this:
Cost Price/unit + Small contribution to "Fixed Costs" = Price/unit
To understand how this equation works consider this. Suppose there is some plant that makes a product that has a Cost price/unit of Rs.30. Assume that per month there is a fixed cost of Rs.10,000 for the businesses running, marketing, advertising etc. Also assume that the per unit contribution to fixed costs for the plant is Rs.10. This makes the total cost or price of the product Rs.40.
Now assuming you sell 500 units of the product. Your total sales will be:
"Rs.40 x 500 = Rs.20,000"
"Rs.40 x 500 = Rs.20,000"
Out of this Rs.30 per unit will go into replenishing the "Cost Price/unit". Since the cost per unit was Rs.30/unit the money spent as cost price is recovered. Also Rs.10 per unit will go toward the contribution for the "fixed costs".
That makes Rs.10x500 = 5000 toward the fixed costs. But the total fixed costs are Rs10000. So selling of 500 units gives the manufacturer a loss of Rs.5000.
On the other hand if he were to sell 1000 units, as we have seen above the cost price/unit of Rs.30 will take care of its self. The contribution per sale to the fixed costs would be Rs.10 x 1000 = 10000. This would also take care of the fixed costs. But in this situation even though there may be no loss for the business, there shall be no profit either.
Consider the case where the business manages to sell 1500 units of the product. In this case the Cost price per unit would be taken care of as seen above. But the contribution to the fixed costs would be Rs10 x 1500 = 15000. This exceeds the fixed costs of Rs.10000 by Rs.5000. So the business would make a profit of Rs.5000.
In this method of pricing, the more sales you make the more profit you make. If you make sales below a certain amount, in this case sales below 1000 units you will face a loss.
This pricing method is also independent of the target market, competitors, consumer buying capacity etc. However, it does account for all the costs that are taken up by the business.
Companies generally use this pricing strategy when they have a whole range of products. They will sell the products that are doing well at a higher price with a greater contribution to the fixed costs, and they will sell the products that are not doing so well with a smaller or no contribution to the fixed costs. They use the products that are doing well to make up for the fixed costs and generate profit. On the other hand the lower pricing on the other products will be targeted at increasing the market share of these products or penetrating a already competitive market.
Work back method of pricing:
This method is a strategy that is most useful for small businesses. Say a business sells 100 products each month and the total costs (fixed, promotion, total cost price etc.) for the month are Rs.1000. Suppose the business owner expects to cover all his costs and also make a return (or profit) of 50% (being a total of Rs.1500). Therefore the business owner sells his products at: Rs.1500 / 100 units = Rs.15 per product.
If this price seems too expensive compared to prices of other similar products, or is a price that will effectively reduce demand, the most feasible solution would be to try and sell more units. This is so that the costs and expected return can be spread over a larger number of products consequently lowering the price.
This is very similar to how increasing the units sold increased the profits in the previous situation. In another scenario if a competitor was charging Rs.100 for, say, a car service, and your business, as a result of using this pricing method, charges Rs.120. To stop the effect of losing customers to the cheaper business, you could upgrade your service to cleaning the car also. It may require slightly longer hours, but the extra quality in the service will compensate for the extra in price. In this case you could always use positioning and product packaging, labeling etc. to justify the extra price for your customer.
Market skimming:
Market skimming is a pricing strategy that can be used if the product you bring to the market is a completely new innovation. Since there are no competitors. The consumers will be willing to pay even a large amount for the product if required. So the product highly priced. The idea is that so long as the competitors do not bring the same product into the market, you can enjoy monopoly and hence a huge profit margin so you rather enjoy it.
If you decide to use this pricing method and enjoy large profits you could use one of the above mentioned price determining methods with a large profit margin to decide your price. Once the competition enters the market you price will have to fall so that you stay competitive. The major advantage you will have is a strong positioning in the minds of the consumers as the only maker of the innovative product you introduced.