- Explain different methods of calculating price


[SLIDE 1]

Number crunching is not an exact science, but there are a few ways to calculate prices that will help you to decide which one is best for your business. The key to pricing is to ensure you make a profit as well as to create value for your customers. Let's take a look at some of the common pricing methods.


[SLIDE 2]

Cost-led pricing involves calculating all the costs involved in manufacturing or delivering the product or service, plus all other expenses, and adding an expected profit or margin by predicting your sales volume to get the approximate price. For example, if it costs $2 to make a cupcake, you could add a 50% markup to cover costs which would mean selling each cupcake at $3 -- a profit of $1 per cupcake. However, you will also need to make sure this price is competitive and that you will have enough people buying the cupcakes to generate enough profit. 


[SLIDE 3]

Target return pricing involves setting the price based on the amount of investment you have put into your business. For example, if you have invested $3000 in start-up costs, and expected sales are 10,000 cupcakes per year, this means you need to cover your $3000 investment from sales as well as generate a profit. If your cupcakes sell for $3 each, that means 10,000 cupcakes sold per year will generate $30,000 in gross profit.

However, if cupcakes cost $2 each to produce, a total of $20,000 in production costs leaves $10,000. Taking away the $3000 investment, there is a profit of $70,000, or 70 cents on each $3 cupcake.


[SLIDE 4]

Value-based pricing involves pricing your product on how it benefits the customer. Buyers have an important influence over the pricing strategy and it is important to think about what the product means to buyers. Will it save them money or make them money? This could help you to justify a higher price. But, what if there is no monetary benefit to buyers? A cupcake, for instance, will not help customers save or make money but there is still value in pleasure. What is it about these cupcakes that could appeal to customers? In other words, what makes them different enough for customers to pay more?

Value-based pricing reflects whatever added value the customers perceive in the good.