4 Types of Pricing Methods

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An organization has various options for selecting a pricing method.

Prices are based on three dimensions that are cost, demand, and
competition.

The organization can use any of the dimensions or combination of

dimensions to set the price of a product.

Figure-4 shows different pricing methods:

he different pricing methods (Figure-4) are discussed

below;

Cost-based Pricing:

Cost-based pricing refers to a pricing method in which some

percentage of desired profit margins is added to the cost of the
product to obtain the final price. In other words, cost-based pricing
can be defined as a pricing method in which a certain percentage of
the total cost of production is added to the cost of the product to
determine its selling price. Cost-based pricing can be of two types,
namely, cost-plus pricing and markup pricing.

These two types of cost-based pricing are as follows:

i. Cost-plus Pricing:

Refers to the simplest method of determining the price of a product.

In cost-plus pricing method, a fixed percentage, also called mark-up
percentage, of the total cost (as a profit) is added to the total cost to
set the price. For example, XYZ organization bears the total cost of
Rs. 100 per unit for producing a product. It adds Rs. 50 per unit to
the price of product as profit. In such a case, the final price of a
product of the organization would be Rs. 150.

Demand-based Pricing:

Demand-based pricing refers to a pricing method in which the price

of a product is finalized according to its demand. If the demand of a
product is more, an organization prefers to set high prices for
products to gain profit; whereas, if the demand of a product is less,
the low prices are charged to attract the customers.

The success of demand-based pricing depends on the ability of

marketers to analyze the demand. This type of pricing can be seen
in the hospitality and travel industries. For instance, airlines during
the period of low demand charge less rates as compared to the
period of high demand. Demand-based pricing helps the
organization to earn more profit if the customers accept the product
at the price more than its cost.

Competition-based Pricing:

Competition-based pricing refers to a method in which an

organization considers the prices of competitors products to set the
prices of its own products. The organization may charge higher,
lower, or equal prices as compared to the prices of its competitors.

The aviation industry is the best example of competition-based

pricing where airlines charge the same or fewer prices for same
routes as charged by their competitors. In addition, the introductory
prices charged by publishing organizations for textbooks are
determined according to the competitors prices.

Other Pricing Methods:

In addition to the pricing methods, there are other

methods that are discussed as follows:

i. Value Pricing:
Implies a method in which an organization tries to win loyal
customers by charging low prices for their high- quality products.
The organization aims to become a low cost producer without
sacrificing the quality. It can deliver high- quality products at low
prices by improving its research and development process. Value
pricing is also called value-optimized pricing.

ii. Target Return Pricing:

Helps in achieving the required rate of return on investment done

for a product. In other words, the price of a product is fixed on the
basis of expected profit.

iii. Going Rate Pricing:

Implies a method in which an organization sets the price of a

product according to the prevailing price trends in the market.
Thus, the pricing strategy adopted by the organization can be same
or similar to other organizations. However, in this type of pricing,
the prices set by the market leaders are followed by all the
organizations in the industry.

iv. Transfer Pricing:

Involves selling of goods and services within the departments of the

organization. It is done to manage the profit and loss ratios of
different departments within the organization. One department of
an organization can sell its products to other departments at low
prices. Sometimes, transfer pricing is used to show higher profits in
the organization by showing fake sales of products within
departments.
Methods of Pricing: Cost-
Oriented Method and Market-
Oriented Method
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The two methods of pricing are as follows: A. Cost-oriented Method B.

Market-oriented Methods.

There are several methods of pricing products in the market. While

selecting the method of fixing prices, a marketer must consider the factors
affecting pricing. The pricing methods can be broadly divided into two
groupscost-oriented method and market-oriented method.

A. Cost-oriented Method:

Because cost provides the base for a possible price range, some firms may
consider cost-oriented methods to fix the price.

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Cost-oriented methods or pricing are as follows:

1. Cost plus pricing:

Cost plus pricing involves adding a certain percentage to cost in order to fix
the price. For instance, if the cost of a product is Rs. 200 per unit and the
marketer expects 10 per cent profit on costs, then the selling price will be
Rs. 220. The difference between the selling price and the cost is the profit.
This method is simpler as marketers can easily determine the costs and
add a certain percentage to arrive at the selling price.

2. Mark-up pricing:

Mark-up pricing is a variation of cost pricing. In this case, mark-ups are

calculated as a percentage of the selling price and not as a percentage of
the cost price. Firms that use cost-oriented methods use mark-up pricing.

Since only the cost and the desired percentage markup on the selling
price are known, the following formula is used to determine the
selling price:

Average unit cost/Selling price

3. Break-even pricing:

In this case, the firm determines the level of sales needed to cover all the
relevant fixed and variable costs. The break-even price is the price at which
the sales revenue is equal to the cost of goods sold. In other words, there
is neither profit nor loss.

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For instance, if the fixed cost is Rs. 2, 00,000, the variable cost per unit is
Rs. 10, and the selling price is Rs. 15, then the firm needs to sell 40,000
units to break even. Therefore, the firm will plan to sell more than 40,000
units to make a profit. If the firm is not in a position to sell 40,000 limits,
then it has to increase the selling price.

The following formula is used to calculate the break-even point:

Contribution = Selling price Variable cost per unit

4. Target return pricing:

In this case, the firm sets prices in order to achieve a particular level of
return on investment (ROI).

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The target return price can be calculated by the following formula:

Target return price = Total costs + (Desired % ROI investment)/ Total sales
in units

For instance, if the total investment is Rs. 10,000, the desired ROI is
20 per cent, the total cost is Rs.5000, and total sales expected are
1,000 units, then the target return price will be Rs. 7 per unit as shown
below:

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5000 + (20% X 10,000)/ 7000

Target return price = 7

The limitation of this method (like other cost-oriented methods) is that

prices are derived from costs without considering market factors such as
competition, demand and consumers perceived value. However, this
method helps to ensure that prices exceed all costs and therefore
contribute to profit.
5. Early cash recovery pricing:

Some firms may fix a price to realize early recovery of investment involved,
when market forecasts suggest that the life of the market is likely to be
short, such as in the case of fashion-related products or technology-
sensitive products.

Such pricing can also be used when a firm anticipates that a large firm may
enter the market in the near future with its lower prices, forcing existing
firms to exit. In such situations, firms may fix a price level, which would
maximize short-term revenues and reduce the firms medium-term risk.

B. Market-oriented Methods:
1. Perceived value pricing:

A good number of firms fix the price of their goods and services on the
basis of customers perceived value. They consider customers perceived
value as the primary factor for fixing prices, and the firms costs as the
secondary.

The customers perception can be influenced by several factors, such as

advertising, sales on techniques, effective sales force and after-sale-
service staff. If customers perceive a higher value, then the price fixed will
be high and vice versa. Market research is needed to establish the
customers perceived value as a guide to effective pricing.

2. Going-rate pricing:

In this case, the benchmark for setting prices is the price set by major com-
petitors. If a major competitor changes its price, then the smaller firms may
also change their price, irrespective of their costs or demand.

The going-rate pricing can be further divided into three sub-methods:

a. Competitors parity method:

A firm may set the same price as that of the major competitor.

b. Premium pricing:

A firm may charge a little higher if its products have some additional special
features as compared to major competitors.

c. Discount pricing:

A firm may charge a little lower price if its products lack certain features as
compared to major competitors.

The going-rate method is very popular because it tends to reduce the

likelihood of price wars emerging in the market. It also reflects the
industrys coactive wisdom relating to the price that would generate a fair
return.

3. Sealed-bid pricing:

This pricing is adopted in the case of large orders or contracts, especially

those of industrial buyers or government departments. The firms submit
sealed bids for jobs in response to an advertisement.

In this case, the buyer expects the lowest possible price and the seller is
expected to provide the best possible quotation or tender. If a firm wants to
win a contract, then it has to submit a lower price bid. For this purpose, the
firm has to anticipate the pricing policy of the competitors and decide the
price offer.

4. Differentiated pricing:

Firms may charge different prices for the same product or service.
The following are some the types of differentiated pricing:

a. Customer segment pricing:

Here different customer groups are charged different prices for the same
product or service depending on the size of the order, payment terms, and
so on.

b. Time pricing:

Here different prices are charged for the same product or service at
different timings or season. It includes off-peak pricing, where low prices
are charged during low-demand tunings or season.

c. Area pricing:

Here different prices are charged for the same product in different market
areas. For instance, a firm may charge a lower price in a new market to
attract customers.

d. Product form pricing:

Here different versions of the product are priced differently but not
proportionately to their respective costs. For instance, soft drinks of
200,300, 500 ml, etc., are priced according to this strategy.

Factors Affecting Pricing Product:

Internal Factors and External
Factors
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The pricing decisions for a product are affected by internal and external
factors.

A. Internal Factors:
1. Cost:

While fixing the prices of a product, the firm should consider the cost
involved in producing the product. This cost includes both the variable and
fixed costs. Thus, while fixing the prices, the firm must be able to recover
both the variable and fixed costs.

2. The predetermined objectives:

While fixing the prices of the product, the marketer should consider the
objectives of the firm. For instance, if the objective of a firm is to increase
return on investment, then it may charge a higher price, and if the objective
is to capture a large market share, then it may charge a lower price.

3. Image of the firm:

The price of the product may also be determined on the basis of the image
of the firm in the market. For instance, HUL and Procter & Gamble can
demand a higher price for their brands, as they enjoy goodwill in the
market.

4. Product life cycle:

The stage at which the product is in its product life cycle also affects its
price. For instance, during the introductory stage the firm may charge lower
price to attract the customers, and during the growth stage, a firm may
increase the price.
5. Credit period offered:

The pricing of the product is also affected by the credit period offered by the
company. Longer the credit period, higher may be the price, and shorter the
credit period, lower may be the price of the product.

6. Promotional activity:

The promotional activity undertaken by the firm also determines the price. If
the firm incurs heavy advertising and sales promotion costs, then the
pricing of the product shall be kept high in order to recover the cost.

B. External Factors:
1. Competition:

While fixing the price of the product, the firm needs to study the degree of
competition in the market. If there is high competition, the prices may be
kept low to effectively face the competition, and if competition is low, the
prices may be kept high.

2. Consumers:

The marketer should consider various consumer factors while fixing the
prices. The consumer factors that must be considered includes the price
sensitivity of the buyer, purchasing power, and so on.

3. Government control:

Government rules and regulation must be considered while fixing the

prices. In certain products, government may announce administered prices,
and therefore the marketer has to consider such regulation while fixing the
prices.
4. Economic conditions:

The marketer may also have to consider the economic condition prevailing
in the market while fixing the prices. At the time of recession, the consumer
may have less money to spend, so the marketer may reduce the prices in
order to influence the buying decision of the consumers.

5. Channel intermediaries:

The marketer must consider a number of channel intermediaries and their

expectations. The longer the chain of intermediaries, the higher would be
the prices of the goods.

What is a 'Transfer Price'

A transfer price is the price at which divisions of a company transact with each other,
such as the trade of supplies or labor between departments. Transfer prices are used
when individual entities of a larger multi-entity firm are treated and measured as
separately run entities. A transfer price can also be known as a transfer cost.

Definition of Cost Control

Cost Control is a process which focuses on controlling the total cost through
competitive analysis. It is a practice which works to maintain the actual cost in
accordance with the established norms. It ensures that the cost incurred on an
operation should not go beyond the pre-determined cost.

Cost Control involves a chain of functions, which starts from preparation of

the budget in relation to the operation, thereafter evaluating the actual
performance, next is to compute the variances between the actual cost & the
budgeted cost and further, to find out the reasons for the same, finally
to implement the necessary actions for correcting discrepancies.

The major techniques used in cost control are standard costing and budgetary
control. It is a continuous process as it helps in analyzing the causes for
variances which control wastage of material, any embezzlement and so on.
 Definition of Cost Reduction
Cost Reduction is a process, aims at lowering the unit cost of a product
manufactured or service rendered without affecting its quality by using
new and improved methods and techniques. It ascertains substitute ways to
reduce the cost of a unit. It ensures savings in per unit cost and maximization
of profits of the organization.

Cost Reduction aims at cutting off the unnecessary expenses which occur
during the production, storing, selling and distribution of the product. To
identify cost reduction, the following are the major elements:

Savings in per unit cost.

No compromise with the quality of the product.

Savings are non-volatile in nature.

Tools of cost reduction are Quality operation and research, Improvement in

product design, Job evaluation & merit rating, variety reduction etc.

Key Differences Between Cost Control and Cost Reduction

The following are the major differences between Cost Control and Cost
Reduction:

1. The activity of maintaining cost as per the established norms is known

as cost control. The activity of decreasing per unit cost by applying new
methods of production in such a way that it does not affect the quality of the
product is known as cost reduction.

2. Cost Control focuses on decreasing the total cost while cost reduction
focuses on decreasing per unit cost of a product.

3. Cost Control is temporary in nature. Unlike Cost Reduction which is

permanent.

4. The process of cost control is completed when the specified target is

achieved. Conversely, the process of cost reduction has no visible end as it is a
continuous process that targets for eliminating wasteful expenses.

5. Cost Control does not guarantee quality maintenance, however, 100%

quality maintenance is assured in case of cost reduction.

6. Cost Control is a preventive function as it ascertains the cost before its

occurrence. Cost Reduction is a corrective action.
ASIS FOR COMPARISON COST CONTROL COST REDUCTION
Meaning A technique used for maintaining the costs as per the set
standards is known as Cost Control.
A technique used to economize the unit cost without lowering the quality of
the product is known as Cost Reduction.
Savings in Total Cost Cost Per Unit
Retention of Quality Not Guaranteed Guaranteed
Nature Temporary Permanent
Emphasis on Past and Present Cost Present and Future Cost
Ends when The pre-determined target is achieved. No end
Type of Function Preventive Corrective

Aspects of Cost Control:

Cost control involves the following steps and covers various aspects
of management. It has to be brought in the following manner:

(i) Planning:

Initially a plan or set of targets is established in the form of budgets,

standards or estimates.

(ii) Communication:

The next step is to communicate the plan to those whose responsibility is to

implement the plan.

(iii) Motivation:
After the plan is put into action, evaluation of the performance starts. Costs
are ascertained and information about achievements is collected and
reputed. The fact that the costs are being reported for evaluating
performance acts as a prompting force.

(iv) Appraisal:

Comparison has to be made with the predetermined targets and actual

performance. Deficiencies are noted and discussion is started to overcome
deficiencies.

(v) Decision-making:

Finally, the reported variances are received. Corrective actions and reme-
dial measures are taken or the set of targets is revised, depending upon
the administrations understanding of the problem.

The management and control of the resources used in most commercial

organisations leaves a great deal to be desired. Waste is growing at such
an enormous rate that it has spawned a new industry for recycling and
extracting useful materials.

Materials are wasted in a number of ways such as effluents, breakage,

contamination, inefficient storage, poor workmanship, low quality, pilfering
and obsolescence. All these contribute to significantly increased material
costs and all can be controlled by efficient working methods and effective
control.
Cost Audit: Meaning, Advantages
and Types
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Read this article to learn about the meaning, advantages and types of
cost audit!

Meaning and Definitions:

Cost Audit is a critical review undertaken to verify the correctness of Cost

Accounts and to check that cost accounting principles and planning have
been efficiently followed. It is noteworthy that India is the only country
which has introduced statutory cost audit to regulate about 45 vital
industries of the country. Cost Audit has been defined by the Chartered
Institute of Management Accountants (CIMA) of Landon as the verification
of cost accounts and a check on the adherence to the cost accounting
plan.

This definition implies the following:

(i) The objects of cost accounting with reference to which the cost
accounting plan must have been drawn up have to be kept in mind to see
whether or not the plan itself and the figures collected will lead to the
achievement of the goal or objective set. For instance, if the objective is to
achieve maximum efficiency, the plan and the analysis of data will be
different from the case where the only objective is to fix prices.

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(ii) It has to be examined whether the methods laid down for ascertaining
costs and other relevant decisions are being implemented. Treatment and
determination of abnormal losses of gains or treatment of certain expenses
as direct or indirect are cases in point.

(iii) The correctness of the figures has to be vouched.

Statutory Cost Audit is a system of audit introduced by the Government of

India for the review examination and appraisal of the cost accounting
record and added information required to be maintained by specified
industries (ICWA of India).

The concept of cost audit has been elaborated by ICWA as an audit of

efficiency of minute details of expenditure, while the work is in progress and
not a post mortem examination. Financial audit is a fait accompli, cost
audit is mainly a preventive measure, a guide for management policy and
decision in addition, to being a barometer of performance.

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Cost Audit can be called efficiency audit. It is evidenced by amendment in

section 209 which reads. The object of the amendment of the section is to
ensure specified company proper records relating to utilisation of material
labour are available which would make efficiency audit (cost- audit)
possible.

Management Auditing is the process of auditing the quality of managers

through appraising them as individual managers and appraising the quality
of the total system of managing in an enterprise. Thus management audit
aims at assessing how managers perform different functions of
management, e.g., planning, coordinating, motivating, etc.

Advantages of Cost Audit:

The chief advantage of a cost audit will be that management will be sure to
get reliable data for its objectives price fixing, decision-making, control,
etc. Existence of such a system of audit will also be of great use for
maintaining internal check and control and will be of great help to even
financial audit. But it must be understood that the aims of financial and cost
audit are different.

The former aims at prevention of frauds and errors and with presentation of
Profit and Loss Account and Balance Sheet which exhibit a true and fair
view of the state of affairs (of profit earned during the year and of financial
position at the end of the year).

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It is concerned with totality of expenditure and revenue rather than its

functional analysis. Cost Audit will establish the accuracy of cost of each
product, job, activity, etc., and is concerned with proper analysis of
information and its estimation so that management gets the necessary
information promptly. Apart from reliability of data, cost audit should afford
certain incidental advantages. Rather, it should be said that cost audit will
help consolidate and realize advantages expected from a system of
costing. Following statement of the HR Gokhale Ex-minister of Law, Justice
and Company Affairs emphasizes the social advantage of cost audit.
The objective of this measure (cost audit) is to protect consumers from
unwarranted increase in prices. Reasonableness of the prices charged can
only be ensured by correct determination of costs and the margin charged
by producers and their retailers. Another object underlying this step is to
make the industries covered by such rules alert and efficient and also to
make them know their rational cost with a view to reducing it to the extent
possible. Thus by resorting to this method, the interest of consumer is
safeguarded and it is definite step towards removal of social injustice.

The advantages, briefly, are as follows:

(i) A close check will be maintained on all wastagesmaterials in store,

labour, etc.and they will be promptly located and reported.

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(ii) Inefficiencies in production (or efficiencies) will be located and converted

into monetary terms.

(iii) Through fixation of individual responsibility, management by exception

will be possible.

(iv) The system of budgetary control and standard costing will be greatly
facilitated with cost audit at the hands of a qualified cost accountant.

(v) Records will be up-to-date and information for various purposes will be
available.

(vi) Cost audit may unearth a number of errors and frauds which may not
be revealed otherwise. This is because a cost auditor examines
expenditure minutely and compares it with standards and ascertains exact
reasons for discrepancy.
Cost audit offers many advantages to management, cost accountant,
shareholders, statutory auditor, consumers and the government.

These advantages are summarized below:

Advantages to Management:

(i) Errors in following costing principles and techniques are detected.

Inconsistencies and frauds can also be detected. This keeps everyone alert
and promotes efficiency.

(ii) Cost audit can serve to measure performance of managers and better
performance can be rewarded.

(iii) It helps to prepare accurate cost reports and this business planning can
be more accurate.

(iv) Inter-firm comparisons can be made with ease and this might be a very
useful proposition if industrial intelligence is good.

(v) Cost audit can give an idea about the comparative operational efficiency
of each department of division; and may thus pin-point deficiencies and
also encourage to operate in a competitive spirit.

Advantages to Management/Cost Accountant:

Important advantages are:

(i) His task is facilitated since errors, deficiencies, etc., are pointed out.
Costing plans can be prepared to take care of these things.

(ii) Cost audit may help in easier reconciliation of cost and financial
accounts.
(iii) If the cost auditor is an outsider and is an expert, he can certainly give
some practical and sound advice to streamline costing systems and
organisation.

(iv) Cost audit helps to focus attention of management on the problems

faced by the cost accountant. This helps him to realize his goals and
objectives with ease.

Advantages to Statutory Auditor:

Important advantages are:

(i) Audited cost data helps him to determine the value of stocks,
remuneration of managerial personnel, etc., with ease and accuracy.

(ii) Data and statements of cost audit help him to prepare his audit
programme and plan so that he concentrates more on those aspects which
have not been adequately covered by cost audit.

Advantages to Consumers:

(i) The direct benefit accrues where a statutory cost audit has been done to
fix a reasonable price for the consumers.

(ii) Since cost audit aims at ensuring efficiency in the organisation, this may
also get reflected in reduced prices to the consumers.

Advantages to Labour:

(i) If cost audit is done thoroughly labour also stands to gain through
increased profitability in the shape of bonus and other benefits.

(ii) Also it brings into focus the role of labour in improving efficiency in term
of increased productivity.
Advantages to Shareholders:

(i) There is correct valuation of all kinds of inventories. This may project a
true picture of the organisation before shareholders and other investors and
help them to assess its performance.

(ii) External cost audit highlights efficiency or inefficiency, utilisation of

manpower and other resources, adequacy of return, etc.

Advantages to Government and Economy:

(i) It helps the government to settle accounts where cost-plus contracts

have been made.

(ii) The government can intervene to protect the interests of the consumers,
labour, shareholders and investors from exploit-age or inefficient
managements.

(iii) At the national level, cost audit promotes cost consciousness and
overall efficiency. This means that every rupee invested produces the
maximum quantity of goods and services.

Types of Cost Audit:

The main types of Cost audit are the following:

(i) Cost Audit as an Aid to Management:

The aim is to see that all information placed before management is

relevant, reliable and prompt so that management can discharge its duties
well. It must also be seen that no relevant or pertinent information is
suppressed.
(ii) Cost Audit on Behalf of a Customer:

Often contracts are placed on Cost Plus basis. In other words, the
customer will determine the final price to be paid on the basis of exact cost
plus an agreed margin of profit. The customer, in such a case, usually gets
cost accounts of the product concerned audited to establish correct cost
and, therefore, price.

(iii) Cost Audit on Behalf of Government:

Sometimes the Government is approached with request for financial help or

protection. Before taking a decision on the request, the Government may
choose to get cost accounts of the applicant audited to establish whether
the need for help is genuine or is a result of mere inefficiency.

(iv) Cost Audit under Statute:

The Amendment Act of 1965 has inserted a new section, 233B, in the
Companies Act, 1956 whereby the Central Government may order that
certain classes of companies will get their cost accounts audited by a
member of the Institute of Cost and Works Accounts of India. Only such
companies as are required to maintain proper records regarding materials
consumed, labour and other expenses under Section 209 (as amended to
date) and may be required to get their cost accounts audited.

The powers and duties and manner of appointment of the cost auditor are
the same as that of external financial auditor and the same disqualifications
will apply. The cost auditor will submit his report to the Company Law Board
with a copy to the company. The right to investigate all aspects of cost
accounts is presumably granted to the cost auditor.
The aim of cost audit under statute seems to be that the Government
wishes to know, as an instrument of control, the costs of various goods.
Government has the power to prescribe the forms in which cost audit
reports are to be made out. These are designed not only to verify
information, but also to convey good deal of information to Government.

(v) Cost Audit on Behalf of the Trade Association:

Sometimes trade associations seek to maintain prices at a certain level.

For this purpose, the accuracy of costing information submitted by various
concerns has to be checked. The trade associations may seek to have full
information about production capacity and the relative efficiency of
productive processes.

here are two important aspects which come within the purview of cost audit. They are:

(a) Propriety audit

It is an audit concerned with such action and plans of management which have a
bearing on the finance and expenditure of the company. The cost auditor has not only to
see that an item of expenditure is properly sanctioned and supported by vouchers but
also is justifiable ob grounds of propriety. He has therefore to report:

(i) Whether or not the planned expenditure could give optimum results.

(ii) Whether or not the size or channels of investment was/were designed to produce the
best results.

(iii) Whether the return from investment in certain channels could be bettered by some
alternative plan of action.

(b) Efficiency audit

It is an audit concerned with appraisal of performance to determine not only that the
expenditure has been incurred according to plan but also to see that the results have
been obtained as planned. It starts with examination of plan (such as financial or other
functional budgets) and extends to the comparison of actual performance with the
budgeted performance and finding out reasons for variances. It thus ensures that:

(i) Every $ invested in capital or in other fields gives the optimum return; and

(ii) Investment in different spheres of the business has been so balanced that it gives
maximum results.

The cost auditor thus combines in himself the role of the Consultant and Financial
Adviser. He helps the Chief Executive of the organisation in working out a sound overall
judgement on the financial plans and performances of the company by coordinating the
results of actions of the various departments.