Cost oriented pricing
Cost-oriented pricing is the most basic method of pricing which is based on the cost incurred by the retailer in making the product available to the customer is the basis used for the cost-oriented valuation. Pricing shall be based on the retailers' cost understanding. It involves calculating all costs that can be attributed to the product and then adding to this number the desired mark-up specified by management[1]. There are two more pricing methods:
- demand-oriented pricing
- competitive pricing
Cost oriented pricing specification
As the name suggests, the basis for determining the price are the costs incurred by the company to provide the product or service. In general, companies want to set a price high enough to cover costs and make a profit[2].
Two types of costs can be included: fixed costs and variable costs. Fixed costs are the costs incurred by an enterprise to maintain a business that do not change depending on changes in sales volume. For example, restaurants must invest in buildings, kitchen equipment and tables before serving customers. Variable costs are the costs associated with running a business that change depending on changes in the volume of sales. For example, restaurants incur costs related to food, work and cleaning, which are directly related to the level of sales[3].
Advantages of cost oriented pricing
Its strength are its straightness,a cceptability and cohesion with a target rate of return on investment and the price stability in general. The simplicity of this method lies in the fact that it requires no other effort than reading the accounting or financial documentation[4].
Another important advantage of cost oreinted pricing is to defend price discrimination based on justification of costs, as repeated in the Robinson Patman Act. The seller may establish that the price difference is due to a different quantity sold or another method, there for other transport costs. What is more, the concept of costs and cost savings is an important justification for volume rebates, because cost savings per unit sold arise from savings corresponding to transport costs. As this method is simple, retailers, wholesalers and some producers use it to set prices. In addition to its simplicity, a cost-oriented approach can produce the desired results aproximately in short time. Because this method does not need going beyond the physical boundaries of the enterprise, the company's accountant or financial analyst can get the necessary cost data in a reasonably short time[5].
Weaknesses of cost oriented pricing method
Main weak points of cost oriented pricing is the lack of consideration of market demand, various competitors' pricing strategies and market purchasing potential[6].
The price an individual customers are willing to pay for a given product may have little to do with the cost of making it. Studies of consumer behavior have provided significant evidence that consumers,as a completely rational buyer, can consciously choose a product or service which is at a higher price, even if substitutes at a lower price may be available as a second option. The calculation of unit costs under the cost-oriented approach requires an estimation of sales volumes. The basic assumption here is that the estimated sales volume will actually materialise at the price level resulting from this cost plus approach.Another disadvantage of this method is that it uses incorrect or distorted cost information. The use of such information can seriously undermine both competitiveness and profitability. The main problem is costing one product in a company that produces many products[7].
Footnotes
References
- Atmanad (2009), Managerial Economics-2nd Edition , Excel Books India, New Delhi, s.416
- Brookg G (1975), Cost-Oriented Pricing: A Realistic Solution to a Complicated Problem, "Journal Of Marketing", nr 4, s.75-80
- Choudhry M (2011), Principles of Marketing Engineering, DecisionPro, Philadelphia, s.149
- Meyn P (2010), Efficiency and marginal cost pricing in dynamic competitive markets with friction, "Theoretical Economics", nr 5, s.215-239
- Nessim H (2017), Pricing: Policies and Procedures, Macmillan International Higher Education , London, s.51-55
- Prakashan N (2006), Retail and Distribution Management , Rachana Enterprises, Pune, s.49
- Reid R (2009), Hospitality Marketing Management , John Wiley and Sons, New Jersey, s.563
Author: Jakub Stachów
