important thing i.e set up of price of the product. The businessmen use the pricing device for the purpose of maximising profits. Many problems come in the way of determining a price of the product. In order to avoid different problems, managers or businessmen must resort to suitable pricing methods for set up of price of the product.
Pricing Methods There are five important methods of pricing (i) Cost-plus of full cost pricing (ii) Pricing for a rate of return (iii) Marginal Cost Pricing (iv) Administered Pricing (v) Going-rate Policy
(i) Full Cost Pricing Method or Cost Plus Pricing Cost-plus or full cost pricing is a method commonly adopted by the businessman to fix a price of the product. He calculates the cost of production per unit and adds a margin of profit to it. In other words, the producer adds a certain percentage of profit which he considers as fair to his cost in order to arrive at a price which is acceptable to the consumers.
Cost-plus pricing means the addition of certain % of profit to the cost of production to arrive at a price. Advantages : Easy and Convenient method In practice, firms are uncertain about the demand conditions facing them, so moving away from the cost-plus price may be too risky. Cost-plus pricing is more popular and suitable in industries where price leadership prevails. Limitations : Ignores the demand side of the problem. Fails to consider the importance of competition. Ignores the future cost in the pricing decision.
Rate of Return Pricing or Target Pricing Under the method of rate of return pricing, the price is determined based on the pre- determined target rate of return on capital invested by the manufacturer. Rate of Return Price is determined in five steps. It is evident from the final step that ROR p changes as the costs change.
Similarly, if the demand conditions or competition for the product undergoes a change the mark-up will change, thus leading to a price change. Since this method of pricing has the same underlying logic as cost-plus pricing, its advantages and limitations are similar to those of cost-plus pricing. However, it has two additional advantages over the cost-plus pricing : (i) In case of ROR pricing, full cost is based on normal output and cost, which is not so in case of cost-plus pricing. (ii) In ROR pricing mark-up is based on expected or planned rate of return on investment, whereas cost-plus pricing is based on arbitrary mark-up.