5.5 Pricing Approaches

	Some companies set their price either too high to increase demand of buyers or too low to cover costs.
	Generally, pricing should be in between the two extremes.
	Kotler and Armstrong (2004) discuss the three main approaches for setting prices by companies.
	These are Cost-based approach, the buyer based approach, and the competition based approach.

Cost based Approach

	Cost-plus pricing is the simplest method in pricing.
	A company will basically look at the total cost and add marks-up as the reward of the business.
	Usually professionals use this approach to price their products or services.
	Accountants, medical doctors etc. add just certain percentage on their cost and that is the price.
	Sometimes companies mention specially their mark-up, depending on the market situation.
	The formula for calculating the cost and mark-up is as follows:

5.5 Pricing Approaches

	Desired return on sales here means how much percentage a company wants have as a return.
	A company can also use break-even analysis to price its product.
	Break-even pricing also called target profit pricing is similar to cost based in orientation.
	The company tries to cover cost and target a certain percentage of profit.
	The graph below demonstrates the use of break-even pricing.

5.5 Pricing Approaches

Figure 5.2: Break-even Diagram

5.5 Pricing Approaches

	One can observe from the above diagram that at initial stage, total cost is greater than total revenue.
	With increase in production per unit cost falls and so the total cost.
	At the centre the total cost and total revenue cost curves meet and that is break-even point.
	At that point all expenses are covered.
	Subsequently the total revenue becomes greater than the total cost curves and profits become bigger and bigger.

Value-Based Pricing

	Contrary to cost-based pricing approach, value-based pricing emphasizes the customer`s perception about the product.
	It considers at the beginning the value attached to the product by the customers and not the seller’s cost as the main determinant of pricing.
	Value pricing strategies involves offering just the right combination of quality and good service at a fair price (Kotler and Armstrong, 2004).
	The following figures show the differences between cost based and value based pricing strategies as demonstrated by Kotler and Armstrong (2004).

5.5 Pricing Approaches

Figure 5.3
Competition Base Pricing

	This approach take into considerations the role a competitor’s price and product quality plays in customer’s decision making.
	Instead of just focusing on value attached to the product or cost of production the approach look at the market situation with respect to the product so as to price.
	The decision on what exactly the firm will charge depends on its strength and power, objectives and long-term strategies.
	The firm can decide to charge same as in the market, high or low.
	It can decide to follow the market leaders.