BUS101: Introduction to Business

In their search for the best price level, Wow Wee's marketing managers could consider a variety of other approaches, such as cost-based pricing, demand-based pricing, target costing, odd-even pricing, and prestige pricing. Any of these methods could be used not only to set an initial price but also to establish long-term pricing levels.

Before we examine these strategies, let's pause for a moment to think about the pricing decisions that you have to make if you're selling goods for resale by retailers. Most of us think of price as the amount that we – consumers – pay for a product. But when a manufacturer (such as Wow Wee) sells goods to retailers, the price it gets is not what we the consumers will pay for the product. In fact, it's a lot less.

Here's an example. Say you buy a shirt at a store in the mall for $40. The shirt was probably sold to the retailer by the manufacturer for $20. The retailer then marks up the shirt by 100 percent, or $20, to cover its costs and to make a profit. The $20 paid to the manufacturer plus the $20 markup results in a $40 sales price to the consumer.

Cost-Based Pricing

Using cost-based pricing, Wow Wee's accountants would figure out how much it costs to make Robosapien and then set a price by adding a profit to the cost. If, for example, it cost $40 to make the robot, Wow Wee could add on $10 for profit and charge retailers $50.

Demand-Based Pricing

Let's say that Wow Wee learns through market research how much people are willing to pay for Robosapien. Following a demand-based pricing approach, it will use this information to set the price that it charges retailers. If consumers are willing to pay $120 retail, Wow Wee will charge retailers a price that will allow retailers to sell the product for $120. What would that price be? Here's how we would arrive at it: $120 consumer selling price minus a $60 markup by retailers means that Wow Wee can charge retailers $60.

Target Costing

With target costing, you work backward. You figure out (again using research findings) how much consumers are willing to pay for a product. You then subtract the retailer's profit. From this price – the selling price to the retailer – you subtract an amount to cover your profit. This process should tell you how much you can spend to make the product. For example, Wow Wee determines that it can sell Robosapien to retailers for $70. The company decides that it wants to make $15 profit on each robot. Thus, Wow Wee can spend $55 on the product ($70 selling price to the retailer minus $15 profit means that the company can spend $55 to make each robot).

Prestige Pricing

Some people associate a high price with high quality – and, in fact, there generally is a correlation. Thus, some companies adopt a prestige-pricing approach – setting prices artificially high to foster the impression that they're offering a high-quality product. Competitors are reluctant to lower their prices because it would suggest that they're lower-quality products. Let's say that Wow Wee finds some amazing production method that allows it to produce Robosapien at a fraction of its current cost. It could pass the savings on by cutting the price, but it might be reluctant to do so: What if consumers equate low cost with poor quality?

Odd-Even Pricing

Do you think $9.99 sounds cheaper than $10? If you do, you're part of the reason that companies sometimes use odd-even pricing – pricing products a few cents (or dollars) under an even number. Retailers, for example, might price Robosapien at $99 (or even $99.99) if they thought consumers would perceive it as less than $100.