After discussing the various considerations affecting pricing policies, it would be useful to discuss the alternative pricing methods most commonly used. These methods are:
- Cost–plus or Full–cost pricing
- Pricing for a rate of return also called target pricing
- Marginal cost pricing
- Going rate pricing, and
- Customary prices.
The first three methods are cost-oriented, as the prices are determined on the basis of costs. The last two methods are competition-oriented, as the prices here are set on the basis of what competitors are charging.
Cost–Plus or Full–Cost Pricing
This is the most common method used in pricing. Under this method, the price is set to cover costs (materials, labor, and overhead) and a predetermined percentage of profit. The percentage differs strikingly among industries, among member–firms, and even among products of the same firm.
This may reflect differences in competitive intensity, differences in the cost base, and differences in the rate of turnover and risk.
In fact, it denotes some vague notion of just profit.
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What determines the normal profit? Ordinarily, margins charged are highly sensitive to the market situation. They may, however, tend to be inflexible in the following cases:
They may become merely a matter of common practice.
Markups may be determined by trade associations either by means of advisory price lists or by actual lists of a markup distributed to members.
Profits are sanctioned under price control as the maximum profit margins remain the same even after the price control is discontinued. These margins are considered ethical as well as reasonable. Their inadequacies are:
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It ignores demand
There is no necessary relationship between cost and what people will pay for a product.
It fails to reflect the forces of competition adequately
Regardless of the margin of profit added, no profit is made unless what is produced is actually sold.
Any method of allocating overheads is arbitrary and may be unrealistic
Insofar as different prices would give rise to different sales volumes, unit costs are a function of price, and therefore, cannot provide a suitable basis for fixing prices. The situation becomes more difficult in multi-product firms.
It may be based on a concept of cost which may not be relevant to the pricing decision.
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