 Pricing Strategies The number of pricing strategies that are talked about today is confusing and consequently many people adopt their own method. As a result, we have split the strategies into three main areas. Read the full article or click on the area (below) that you feel is most appropriate for your business. Cost Based Pricing For Cost Based Pricing only, we talk about Direct Costs and Indirect Costs. Below are basic definitions that you can refer back to by clicking on the appropriate link within the text. Direct Costs Costs that are incurred directly by producing/selling the product. For example, materials, packaging, direct labour (production/sales staff), etc. Indirect Costs Sometimes referred to as 'overheads', direct costs are created by running the business in general.
For example, rent, insurance, wages (for all staff other than production/sales), electricity, etc. Indirect costs cannot be accurately linked to the production/sale of products or services. a) Basic Cost Covering aka Cost Plus Pricing This is one of the most simplest and popular ways of pricing a product/service. Say you manufacture (or buy in) 1000 products at a cost of £100, the average cost per product would be £10. This would form the basis of how much you sell each product for. You then decide to make a profit of, say, 20%, which is £2. So, the price that you would sell the product for will be £12. This method allows you to cover all direct costs and generate a profit. The down side is that people will argue that you have not taken into account the needs of the market and further, any indirect costs are not compensated for. b) Contribution Pricing Contribution pricing allows you to cover all direct costs (per product), but also allows a contribution (hence the name) towards indirect costs and profit. Say that Product A has a direct cost of £80 and you want to make a contribution of, say, £20 towards indirect costs and profit: this makes a total selling price of £100. If you had total indirect costs of, say, £800 and you aim to make a profit of £200 (being a total of £1000) then you would have to sell: Product A: £20 (contribution) x 50 units = £1,000 i.e. 50 of Product A. You can spread the contribution to indirect costs and profit over a range of products. Those products that are more successful can include a larger contribution in the selling price, and those products that are new or less successful can contribute less. For example, to cover indirect costs of, say, £7000 and you further expect a profit of £3,000 (totalling £10,000) assuming that 100 of each product A, B and C are to be sold, the following contributions can be included in the selling price: | Product | Contribution | | Units Sold | | Total Contribution | | A | £20 | x | 100 | = | £2000 | | B | £50 | x | 100 | = | £5000 | | C | £30 | x | 100 | = | £3000 | Total Contribution to Profit and Indirect Costs " | £10,000 |
This contribution would then be added to the direct costs to give you a total selling price for each product as in the example in the first paragraph of this section. c) Working Back Method (Expected Return) This method is a strategy that is most useful for the smaller small businesses. Say a business sells 100 products each month and the total costs (fixed, direct, indirect, etc) for the month are £1000. The business owner expects to cover all his costs and also make a return (or profit) of 50% (being a total of £1500). Therefore the business owner sells his products at: £1500 / 100 units = £15 per product Should this price seem too expensive compared to prices of other similar products, or is a price that will effectively reduce demand, the most feasible solution would be to generally try and sell more. This is so that the costs and expected return can be spread over a larger number of products consequently lowering the price. Another scenario would see a competitor charging £100 for, say, a car service, and your business, as a result of using this pricing method, charges £120. To stop the effect of losing customers to the cheaper business, you could upgrade your service to cleaning the car so that customers are returned with a fully serviced, clean car. It may require slightly longer hours, but the extra quality in the service will compensate for the extra in price.
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