Models of Calculating Product Pricing

There are several pricing models that a business can use to set their rates. Depending on which one the owner picks, and their ability to predict sales, will have a great impact on how profitable a business will be. Once a strategy has been decided, one of the below strategies can be used to calculate the actual price of an item or service.


Cost-plus pricing

This product pricing formula is relatively easy to calculate as well as all costs are well known. All the business owner needs to do is to take the cost of producing the item, add the overhead costs per item and multiply the total by the desired markup. For example, and Item might cost $30 to produce. Each item also incurs $22 in overhead costs. If the desired markup is 20 percent, the item should sell for $62.40. As long as total sales are calculated correctly, the business will earn a solid return.

Target return pricing

Assuming the same product costs, assume instead the goal was to reach a certain profit amount. If it is predicted 1,000 units will sell this year, and the desired profit is $10,000, then each item should be marked up $10, bringing the price to $62. This has the same weakness as cost-plus as it relies on an accurate prediction of sales volume to achieve the desired profit. If there is a change in the amount of profit desired later, the price can easily be recalculated to cover the difference.

Value-based pricing

The final pricing model is value-based pricing. This model looks at the value that the item gives the customer, and prices the item according to this. For example, in this product pricing formula the $55 item saves the average customer $200 per year in cost. Market research says that the average customer is willing to pay up to $100 for the item, since they will recoup the value in less than a year. This model is less sensitive to sales data, but it can still break down during unusually slow periods.

These three models form the basis for every item that sells in a store or service that is provided to customers. Good management ensures that each model will retain profitability year after year. By using cost as basis for price calculations, it become much easier that items will not be priced at a loss.

Another crucial factor to consider in product pricing is the market demand and customer expectations. Before make the right strategy for product pricing, it is important for business to know the customer demand and customer expectations. Meeting or exceeding customer expectations can give business competitive advantage over your competitors.