Strategic Cost Management and Performance Evaluation (SCMPE) is a vital module of the overall skills base of today’s Chartered Accountant. SCMPE examines the Chartered Accountant’s role in dynamic organizations operating in the global business environment where organizations are considered integrated parts of the global market supply chain. In this article, we’ll study bit about the different pricing methods which affect the Pricing Decision.
Cost-Based Pricing Method:
In many businesses, the common method of price determining is to estimate the cost of a product & fix a margin of profit. The term ‘cost’ here means Full Cost at the current output and wages level since these are regarded as most relevant in price determination.
Pricing based on total costs is subjected to two limitations. They are:
In order to avoid these complications, Variable Costs which are considered relevant costs are used for pricing, by adding a mark-up (to include fixed costs allocation also).
Sometimes, instead of arbitrarily adding a percentage on cost for profit, the firm determines an average markup on cost necessary to produce a desired Rate of Return on Investment. The rate of return to be earned by the firm or industry must depend on the risk involved.
Competition-Based Pricing Method:
When a company sets its price mainly on the consideration of what its competitors are charging, its pricing policy under such a situation is called competitive pricing or competition-oriented pricing. It is not necessary under competitive pricing to charge the same price as charged by the concern’s competitors. But under such pricing, the concern may keep its prices lower or higher than its competitors by a certain percentage.
Going Rate Pricing: It is a competitive pricing method under which a firm tries to keep its price at the average level charged by the industry. The use of such a practice of pricing is especially useful where it is difficult to measure costs.
Sealed Bid-Pricing: The objective of the firm in the bidding situation is to get the contract and this means that it hopes to set its price lower than that set by any of the other bidding firms.
Value-Based Pricing Method
There is an increasing trend to price the product on the basis of customers’ perception of its value. This method helps the firm in reducing the threat of price wars. Marketing research is important for this method. It is based on:
Objective Value or True Economic Value (TEV)
This is a measure of benefits that a product is intended to deliver to the consumers relative to the other products without giving any regard to whether the consumer can recognize these benefits or not.
True economic value for a consumer is calculated taking two differentials into consideration:
TEV = Cost of the Next Best Alternative + Value of Performance Differential
The cost of the next best alternative is the cost of a comparable product offered by some other company. The value of performance differential is the value of additional features provided by the seller of a product.
A firm’s product may be superior to the next best alternative in some dimensions but inferior in others.
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