The Price is Right - Fundamentals of Optimal Pricing

Although the Classical price theory assumes that price is the primary Quantity demanded certainly, this is only a conditional aid for pricing within the company. In Theory and Practice Different approaches have therefore emerged. The price for a product or service can generally be set based on costs, profit, demand, competition/industry, or value.

As the name suggests, it is based on Cost-oriented pricing on the Cost accounting. The price regularly consists of the Cost price (e.g. per item) and a Profit margin together. However, it can also be structured such that a certain profitability is achieved at an estimated sales volume. The advantage of this approach is that the costs are typically better known to the company than, for example, the prevailing market Market demand. Key performance indicators in this context are the The long-term and the short-term price floor. The long-term price floor refers to that price which covers all costs (Unit costs, which are comprised of variable costs and fixed costs). On the other hand, in the case of short-term price floor the price that variable unit costs correspond. If the actual price is above the short-term price floor, the excess amount contributes to covering fixed costs. Conversely, at the short-term price floor, the Fixed costs not covered, as fixed costs cannot be changed in the short term per se. Cost-oriented pricing is – perhaps also because it is a simple and schematic procedure – particularly popular with trading companies and is considered Trade margin calculation known.

Circle referencing makes profit-oriented pricing difficult

At the profit-oriented pricing a different approach will be taken. The price should derived from the profit target werden, a goal which is beset by several problems. One is that the company has sufficient knowledge of the course of Total cost curve have to have and also about the corresponding Production capacities must have. Furthermore, there is a fundamental difficulty in that the price is determined based on the estimated sales volume and the Paragraph quantity nevertheless again depends on the price. Here, the company sometimes runs the risk of pricing itself out of the market.

The demand-oriented pricing is also Value principle called. The price will be considered in light of the current or expected demand situation set and therefore also increased with expected higher demand. An important parameter for determining the price is the Assessment of the product or service by the customer - this can depend on the company's reputation, what margins are typically charged, or whether a "broken" or "round" price is to be chosen. This price determination is regularly implemented computationally by a Reverse calculation. The starting point for this is a price that can be achieved to maintain sales opportunities, from which, after consideration of revenue reductions and variable costs, a Contribution margin should result, which is sufficient High is, in order to Fixed costs and the expected Profit margin to cover. The so-called " also goes in a similar direction"Value-based pricing"Crucial for entrepreneurial success is, a better value for money to offer more than the competition and thus maximise the benefit for the customer.

If the company completely relies on its own pricing and active pricing policy (i.e. taking demand or costs into consideration) forgoes, so it often follows the competition- or industry-oriented pricing. The market leader's price is then decisive for pricing (Guide price) or the average price for comparable products and services (Industry award).

Long-term pricing strategies

To set the price with the overarching Company goals to harmonise, can various pricing strategies be taken into account. Compliance with the other paragraph policy instruments, as well as with the Product life cycle. In the long term, it must also be considered that the price of one period shapes price expectations in later periods (e.g., through speculation). Furthermore, "Carry-over effects"brand loyalty in repurchase, the need for Variety or "word-of-mouth" to consider, as well as the aspect of cost dynamics (keywords: experience curve, learning curve, wear-and-tear effects, etc.).

fundamentally, price policy strategies can manifest as Premium pricing strategy, Low-price strategy, Penetration policy and Skimming pricing strategy can be distinguished. High-price policy (premium pricing strategy) and low-price policy (promotional pricing policy) pursue diametrically opposed goals, with the focus on the respective Quality of the product or service. Within the scope of Premium pricing strategy will the Target audience regularly small and exclusive held, while a low-price product typically appeals to a larger target audience.

The Penetration policy or a penetration pricing strategy is fundamentally characterised by the fact that at product launch firstly a low price is required, which is then successively increased. By ideally rapidly opening up new mass markets, Market entry barriers and potential competitors can be kept at bay. A common problem with this can often be longer payback period The Investments as well as the fact that the already low entry price limits the scope for price reductions. On the other hand, due to the low entry price, price increases are difficult to enforce with customers.

By contrast, the procedure when applying the Skimming pricing strategy. In doing so, with a rather high introductory price begun, which with increasing market penetration along with growing competitive pressure gradually lowered This strategy is particularly successful when sufficient customers are willing to pay a relatively high price for the new product or service. Typically, the suitable product only has Short product lifecycle and is unique in the market – meaning there is no benchmark against which its benefit could be meaningfully measured. Ultimately, it is advantageous where production or distribution capacities are limited and can only be expanded relatively slowly.

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