Managerial Economics

1. Cost based pricing
Managerial Economics

2. GROUP MEMBERS
o Mohan Xavier
o Muhammad Asif
o Nikita Anne Jacob
o Saichandra
o Sachin Bose
o Shamlu Shaji

3. price
 Price is the amount of money charged for a good or
service
 It is the sum of all the values that consumers give up for
the product.

4. pricing
Process of determining what a company will receive in
exchange of its product.

5. Pricing objectives
 Survival
 Profit Maximization
 Target Return on Investment (ROI)
 Market Share Goals
 Status Quo Pricing

6. Factors to Consider
when Setting Prices

7. General Pricing Approaches
 Cost-Based Pricing
 Break-Even Analysis and Target Profit Pricing
 Value-Based Pricing
 Competition-Based Pricing

8. Cost based pricing
• Using the cost of production as the basis for pricing a product.
• Here the selling price of product a will be the cost to produce it.
• It includes :-
Direct and indirect costs
Additional amount to generate profit.

9. Cost based pricing
Product
Cost
Price
Value
Customers

10. Advantages
 Super easy.
 Flexible.
 If costs go up, it is easy to adjust prices.
 Super simple to calculate.
 Is easy for a marketer to defend pricing.
 May suit a manufacturer with scalable production based on demand.

11. Disadvantages
 Ignores product demand or the influence price may have on demand.
 Ignores what competitors are doing with their pricing.
 If costs increase, so must the price.
 Ignores brand positioning so may forfeit additional profit.
 It provides no incentive to improve cost efficiency.

12. Classifications of cost based
pricing
1. Cost plus pricing
2. Full cost pricing
3. Target profit pricing
4. Marginal cost pricing

13. Cost plus pricing
 A fixed percentage of profit will be added to the cost.
 The fixed percentage of profit will be taken by
manufacturer, wholesaler and the retailer.

15. Egg:-
 Fixed cost for making 10,000 shirts is Rs.1,50,000.
 Variable cost (P.U) = 30
 Cost (P.U) = 45
 Firm expects 30 % return on sales.
 The mark up Price will be
= 45/(1-0.3)
= Rs. 64.28 p

16. Full cost pricing
 Also called absorption cost pricing.
 Attempting to set price to cover both fixed and variable costs
 Total cost will be computed by adding variable and fixed cost
incurred in the product.
 The price of each product is dependant on how many costs it
creates.

18. Egg:-
• MM co. plan to produce 5000 widgets.
• Manufacturing labor = Rs. 50,000
• Material cost = Rs. 1,00,000
• Overhead cost= Rs. 20,000
• Direct labor (P.U)= 50,000/5000 = Rs.10
• Material cost (P.U)= 1,00,000/5000= Rs. 20
• Overhead cost (P.U)= 20,000/5000= Rs. 4
• Desired profit (P.U)= Rs. 8

19. Cont.
• Add all cost per units
• = 10+20+4+8
• Full cost price = 42 (P.U)
• This means using full cost pricing, MM company would sell
its widgets at Rs.42 (P.U)

20. Target profit pricing
 Also called rate of return pricing
 Mark-up = Profit/Cost x 100
 Setting price to ‘target’ a specified profit level
 Estimates of the cost and potential revenue at different prices, and
thus the break-even have to be made, to determine the mark-up
 This method is possible when there is no competition in the market.

22. Egg :-
• Sales price per unit = Rs. 250
• Variable cost per unit = Rs. 150
• Total fixed expenses = Rs. 35,000
• Target Profit = Rs. 40,000
• Q = Number (Quantity) of units sold
• How many units will have to be sold to earn a profit of Rs. 40,000?

23. Cont.
• Sales = Variable expenses + Fixed expenses + Profit
• Rs. 250Q = Rs. 150 + Rs. 35,000 + Rs. 40,000
• Rs. 100Q = Rs. 75,000
• Q = Rs. 75,000 / Rs. 100 per unit
• Q = 750 Units
• Thus the target profit can be achieved by selling 750 units per month, which represents
$187,500 in total sales ($250 × 750 units). This equation is also extensively used to calculate
break even point. When break even point is calculated the value of profit in the equation is taken
equal to ZERO.

24. Marginal cost pricing
 This aims at maximizing the contribution towards fixed cost.
 In addition portion of the fixed cost will also realized.
 Marginal cost – the cost of producing ONE extra or ONE fewer
item of production.
 Particularly relevant in transport where fixed costs may be
relatively high

26. EGG:-
 Aircraft flying from Bristol to Edinburgh – Total Cost
(including normal profit) = £15,000 of which £13,000 is
fixed cost*
 Number of seats = 160, average price = £93.75
 MC of each passenger = 2000/160 = £12.50
 If flight not full, better to offer passengers chance of flying
at £12.50 and fill the seat than not fill it at all!

27. Demand-Based pricing
• Pricing that is determined by how much customers are
willing to pay for a product or service
• This method results in a high price when demand is strong
and a low price when demand is weak
• May be differentiated based on considerations such as time
of purchase, type of customer or distribution channel

28. Price Elasticity of Demand

29. Competition-Based pricing
• Pricing that is determined by considering what competitors
charge for the same good. Once you find out what your
competition is charging, you must determine whether to
charge the same, slightly more, or slightly less.

30. Competition-Based Pricing
Product
Cost
Price
Value
Customer

31. Pricing Strategies
• New-Product Pricing Strategies
• Existing-Product Pricing Strategies
• Psychological Pricing
• Promotional Pricing

32. New-Product
Pricing Strategies
• Prestige Pricing
• Market-Skimming Pricing
• Market-Penetration Pricing

33. Setting Initial Product Prices
Market Skimming Market Penetration
> Setting a high price
for a new product to > Setting a low price for a
skim maximum new product in order to
revenues from the attract a large number
target market. of guests.
> Results in fewer, more > Results in a larger
profitable sales. market share.
> Popular night club > New Marriott
charges a high cover
charge

34. Existing-Product
Pricing Strategies
• Product-Bundle Pricing
• Price-Adjustment Strategies
– Volume Discounts
– Discounts Based on Time of Purchase
– Discriminatory Pricing
– Yield Management
• Non-Use of Yield Management
• Last-Minute Pricing

35. Product-Bundling Pricing
• Transfer surplus reservation price (the maximum price a customer will
pay for a product)
– Customer A will pay $60 for a Disney pass and $120 for a hotel room.
Customer B will pay $95 for the Disney pass and $80 for the hotel room – A
hotel selling a two night package with pass for $350 will get both customer
• Price-bundling also reduces price competition – by making it hard to
figure price of components
– In an airline and hotel package it is difficult to determine the price of the
room

36. Psychological Pricing
• Price-quality relationship
• Reference prices
• Rounding
• Length of the field

37. Promotional Pricing
• Temporary pricing of products below list price and
sometimes below cost
– Value Pricing
– Price Sensitivity Measurement