244 CHAPTER 9 PRICINGTHEPRODUCT
decreased.Forexample,thecostofraw materialto makeLheproductwillvarywith
production.
A secondshortcomingofbreak-evenan aly sis is it assumesthatvariablecostsarecon-
stant.However, wageswillincrease withovertimeandshippingdiscounts williJeobtained.
Third,break-evenassumes thatallcosts canbeneatlycategorizedasfixedorvariable.Where
advertisingexpensesare entered, break-evenanalysis willhavea significantimpactonthe
resultingbreak-evenpriceand vol ume.
TargetRatesofReturn
Break-evenpricingisa reasonableapproachwhenthereisa limitonthequantitywhicha
finncanprovideand particularlywhen atargetreturnobjectiveissought.Assume, forexam-
ple, thatthefirmwiththecostsillustratedin the previousexampledetenninesthatitc8.;'l
providenomorethan10, 000 unitsoftheproductinthenextperiodofoperation.Further-
more, thefirmhas seta targetforprofitof 20 %above to talcosts.Referringagaintointer-
nalaccountingrecords and thechangingcostofproduc tionatnearcapacityle vels,a new
totalcostcurveis calculated. Fromthecost curveprofile,management setsthede sirable
levelofproduclionat80%ofcapacityor8,000units.Fromthetotal costcurve,itisdeter-
minedthatthecost forproducing8, 000 units is $ 1 8,000.Twentypercentof$18,000is $3,600.
Addingthistothetotalcost at8,000unitsyields thepointatthatquantity throughwhich
thetotalrevenuecurve mus t pass.Finally, $ 21 ,600dividedby8,000unitsyieldstheprice
of$2.70perunit;herethe $3,600inprofitwouldberealized.T heobviousshortcomingof
thetargetreturnapproachtopricingis the absenceof anyinfOlmationconcerningthedemand
fortheproductatthedesiredprice.Itis assumedthatalloftheunitswillbesoldatthe
pricewhichprovides thedesired return.
Itwouldbenecessary,therefore, to determine whetherl iedesiredpriceisinfactattrac-
tivetopotential customersinthemarketplace. I f bre ak-evenpricingistobeused,it should
besupplementedbyadditionalinformationconcerning customerperceptionsoftherele-
vantrangeofpri cesfortheproduct.Thesourceofthis informationwouldmostcommonly
besurveyresearch,aswellasa thoroughreviewofpricingpracticesbycompetitorsinthe
industry.In spiteoftheirshortcomings, break-even pricingandta:'getreturnpricingarevery
commonbusinesspractices.
Demand-OrientedPricing
Demand-orientedpricingfocuses onthenatureofthedemandcurvefor theproductorser-
vicebeingpriced.Thena tureofthedemandcurveisinfluencedlargelybythe structureof
theindustry:nwhicha finncompetes. Thatis, ifa firmoperatesinanindustrythatis
extremelycompetiti ve,pricemaybeusedtosomestrategic advantage inacquiringandmain-
tainingPlarketshare.Ontheotherhand,ifthefirmoperatesinanenvironment witha few
dominantplayers, therangeinwhichpricecanvarymaybeminimal.
Value-BasedPricing
Ifweconsiderthethreeapproaches tosettingprice, cost-basedisfocusedentirelyonthe
perspectiveofthecompanywithverylittleconcernforthe customer; demand-basedisfocused
onthecustomer,butonlyasapredictorofsales; andvalue-basedfocusesentirelyonthe
customerasa determinantof thetotalprice/valuepackage.M arketerswhoemployvalue-
basedpricingmightusethefollowingdefinition:"Itis what youthinkyourproductis worth
tothatcustomeratthattime." Moreover, it acknowledgesseve,'almarketing/price truths:
