UNEC – International

School of Economics

Pricing on the World Market

Lecture 4:Mechanism of price
formation on the world market
Content
 Preface
 Levels of price management
 Methodology of pricing
 Methods of pricing
 Cost-based pricing
 Demand-based pricing
 Other methods of pricing
 Conclusion
Preface
 In the world market prevail various methods
of price setting.
 In this respect, one of the major issues is
becoming analyzing of pricing methods in
order to evaluate one’s decision and take
appropriate actions.
Levels of price management
 There are three levels of price management:
 Industry strategy;
 Product/market strategy;
 Transaction.
 Price level: Industry strategy
 Industry strategy is the first level in the price
management. It considers the influence of supply,
demand and cost dynamics to the overall industry
price level.
 Excellence in industry requires not only in-depth
knowledge of your own company and how your
actions will affect market prices, but also the feature
of competition.
 Capacities, cost structures, capital investments,
research and development expenditures and growth
aspirations of other companies are the key part of
this overall strategy.
Price level: Industry strategy
 Bringing all this knowledge together, companies
can anticipate industry price trends and become
proactive with regard to its operations rather than
just a pawn of the market “invisible hand”.
 They can adjust their tactics to take advantage of
this superior understanding.
 Price level: product/market
strategy
 At the second level of price management, a
primary issue is price positioning relative to
competitors. That is, within each market
segment that one serves, what price level
positions he or she occupies in customer’s
eyes.
 Price actions at this level tends to be quite
visible to the market, both to customers and
competitors.
Price level: product/market strategy
 At this level one is setting the following prices:
 “List prices” – is a basic published price or
advertised price;
 “Base prices” – is the initial price of something
(goods and services) without the additional
changes that may be added, such as handling
or transportation costs, sales tax and so on;
 “Target prices” – is a price that would result in
the best possible outcome for one’s investment.
It is the price at which a stockholder is willing to
sell his or her stock.
Price level: transaction
 Transaction – is the process based on which
goods, services, or money are passed from
one person, account to another one.
 At this level, the critical issue is how to
manage the exact price charged for each
transaction.
 The objective of transaction management is
to achieve the right and best realized price for
each transaction.
Transaction: off-invoice and
pocket price
 Invoice price - is the price that appears on
the invoice that a manufacturer sends to a
dealer when a dealer receives a car from the
factory.
 Pocket price – the revenues that are actually
left in a company’s pocket from a transaction
to cover costs and contribute to profit.
 Pocket price = invoice price-invoice off price.
Transaction: off-invoice prices
 Annual volume discount-an end year bonus paid to customers.
 Cash discount-a deduction from the price if payment is made quickly.
 Online order discount-a discount offered to customers ordering over
the internet.
 Consignment costs-the costs of funds when a supplier provides
consigned inventory to a retailer and wholesaler.
Consignment is a business arrangement in which a business, also
referred to as a consignee, agrees to pay a seller, or consignor, for
merchandise after the item sells.
 Market-development funds-a discount to promote sales to a specific
market segment.
 Stocking allowance-a discount paid to wholesalers or retailers to
make large purchases into inventory.
Methodology of pricing
 Methodology of pricing - is the sum of
common rules, principles and methods. It
involves elaboration of pricing concept,
definition and assessment of pricing,
formulating of a price system, management of
prices.
 Through the methodology is developed a
pricing strategy, whereas methods include
recommendations and instruments for the
realization on this strategy in the practice.
Methods of pricing
 Currently, there are
different kinds of
price methods used
by firms. Based on
these methods firms
compare their costs
and profits.
 Methods of pricing
 Pricing methods - are
the various tools of price
formation.
 Prices are based on three
dimensions that are costs,
demand and competition.
 The organization can use
any of the dimensions,
whereas combination of
dimensions in order to set
the price of product.
Pricing methods
 Cost-based pricing;
 Demand-based pricing;
 Value pricing;
 Target return pricing;
 Transfer pricing;
 Going-rate pricing;
 Competition-based pricing;
 Other pricing methods.
 Pricing methods
 In order to set relevant
price the seller should
analyze the prices of
competitors, internal and
external factors.
 Based on these factors
the seller should choose
the appropriate pricing
method.
Various pricing methods
Cost-based pricing
 Cost-based pricing refers to a pricing method
in which some percentage (total cost) of
desired profit margin is added to the cost of
a product in order to obtain the final price
(selling price).
 Cost-based pricing can be of three types:
 cost-plus pricing;
 mark-up pricing;
 marginal-cost pricing.
Cost-plus pricing
 Cost-plus pricing method refers to the
simplest method of determining the price of a
product. In cost-plus pricing method, a fixed
percentage, also which is called a mark-up
percentage, of the total cost is added to the
total cost.
 Cost-plus pricing method is also known as an
average cost pricing.
 This is the most commonly used method in
manufacturing organizations.
Cost-plus pricing
 The pricing method based on full expenses
includes all expenses during the production a
commodity.
 This method allows one to set a price limit.
 Cost-plus pricing
Advantages Disadvantages
 Requires minimum  Ignores price strategies of
information. competitors.
 Involves simplicity of  Ignores the role of
calculation. customers.
 Insure sellers against  Much more oriented to
the unexpected the production and less to
changes in costs. the market.
 Mark up pricing
 Mark up pricing is  Mark up as a
more common in the percentage of
retail industry in which cost=(markup/cost)*1
retailer sells a product 00
in order to earn profit.  Mark up as
percentage of
selling
price=(Markup/selling
price)*100
Mark up pricing calculation

Mark up Selling price=$500

Cost =$400

Mark up as a % of selling price (100/500)*100=20

Mark up as a % to cost (100/400)*100=25

 Marginal cost pricing
 Marginal cost pricing is the process of setting
an item's price at the same level as the extra
expense involved in producing another item.
 This method is useful in a specific situation
where a company can earn additional profits
from using up an excess production capacity. 
 Cost-based pricing: example 1
Company A Company B
Direct cost 370 340
Raw materials 55 45
Wage expenses 105 95
Other direct costs 210 200
Indirect costs 100 100
Total cost 470 440
Rentability (to expenses) 15% 12%
Profit 70 53
Price of product 540 493
 Cost-based pricing: example 2

For example, if the wholesaler purchases a product for 20 $ and sells

it to for 30 $ he or she will gain 10 $ of profit
(50% addition to the price).

If the operational cost of the store accounts for 8 $, the net profit of
the wholesaler will be 2 $.
Cost based pricing
 The price OP is made up of three elements: average
fixed cost, average variable cost and a profit margin.
Demand-based pricing
 Demand-based pricing refers to a pricing
method in which the price of 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.
 Success of demand-based pricing depends
on the ability of marketers to investigate the
demand.
Demand-based pricing
 The named method
of pricing can be
used in the travelling
industry.
 To take an example,
airlines during the
period of low
demand charge less
rates as compared
to the period of high
demand.
Competition-based pricing
 Competition-based pricing refers to a
method in which an organization considers
the price 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.
 An aviation industry is the best example of
competition-based pricing, where airlines
charge the same or fewer prices for the same
routes as charged by their competitors.
 Sealed bid pricing
 Sealed bid pricing is based on how the firm
considers competitors will price their products
rather than only on its own costs or demand.
 In this pricing method firms go for competitive
bidding through sealed tenders or
quotations.
 Firms look for the best (lowest possible) price
consistent with minimum quality specification.
Value pricing
 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.
Value pricing
 It can deliver high-
quality products at
low prices through
improving its rese-
arch and develop-
ment process.
 Value pricing is also
called value opti-
mized pricing.
Perceived-Value Pricing
 In perceived-value pricing a firm sets price
based on the customer’s perception of the
goods and services taking into account all the
elements such as advertising, promotional
tools, product quality and other that influence
the customer’s perception.
Perceived value vs Cost-based pricing
Target-return pricing
 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.
 The target return price can be calculated as:
 Target return price = unit cost + (desired
return * invested capital) / unit sale.
Return Investment
 Return on investment (ROI) is the benefit to
an investor resulting from an investment of
some resource.
Target-return pricing calculation
 Suppose a tv manufacturer has invested 1
million dollars in the business and wants to
set a price to earn a 30% ROI. The
manufacturing cost of per tv is 20. Assuming
that the sales can reach 50,000 units.
 Target return price will be = 20 + (0.3 *
1000000)/ 50,000 = 26
Transferring prices
 Transferring prices involves selling of good
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 a low
prices.
Going-rate pricing
 Going-rate price implies a method in which
an organization sets the price of a product
according to the prevailing price trends in the
market.
 In most cases the pricing decisions adopted
by an organization can be the same or similar
to other organizations.
 Breakeven pricing
 Breakeven pricing -associated with breakeven
analysis, which is a forecasting tool used by
marketers to determine how many products
must be sold before the company starts
realizing a profit.
Breakeven pricing
 For instance, assume a company operates a single-
product manufacturing plant that has a total fixed cost
(e.g., purchase of equipment, mortgage, etc.) per
year of $3,000,000 and the variable cost (e.g., raw
materials, labor, electricity, etc.) is $45.00 per unit. If
the company sells the product directly to customers
for $120, it will require the company to sell 40,000
units to breakeven.

B/E pricing=$3,000,000/$120-$45=40,000 units.

 Breakeven pricing
 The calculation presented above is a measure of units that need
to be sold. Clearly it is easy to turn this into a Revenue
Breakeven Analysis by multiplying the units needed by the
selling price. In our example, 40,000 units x $120 =
$4,800,000).
Price leadership method
 Price leadership prevail in the case when a
firm that is the leader in its sector determines
the price of goods or services and others
follow this price.
 These methods are practiced in the markets
where prevail several firms. The firm with high
market shares takes initiative.
Stackelberg price leadership
 Stackelberg price leadership assumes that
one firm has knowledge or foresight of its
competitor’s reaction to its price policies.
 As a result, the firm may credibly announce a
price in anticipation of competitor’s reaction.
 Stackelberg price leader benefits from this
foresight and is normally better off than in the
simultaneous game.
Tender price methods
 Tender usually refers to the process whereby
governments and financial institutions invite
bids for large projects that must be submitted
within a finite deadline. 
 Tender price methods-are used in the cases
when several firms have serious competition
for obtaining contract.
Auction type pricing
 Auction type pricing method is growing
popular with the more usage of the internet.
Several online sites such as eBay provides a
platform to customers where they buy or sell
the commodities.
Parametric methods of pricing
 Unit price method - price formation based on one of
the major quality characteristics of a commodity.
 Pricing method of bands - refers to the use of
expert valuations of the significance of products. It
involves using of bands in the process of basic
parameters of a product.
 Regressive analysis method - is based on the
technical-economic parameter of a product. One can
built here also correlation dependence.
 Aggregate methods - refers to the summing of
separate constructive parts of products.
Summary
 Pricing methods are common tools and
procedures used on the world market by
producers and manufacturers.
 Based on pricing methods entrepreneurs
formulate their tactics with regard to the
products and services.