MarketingManagement.pdf

222 CHAPTER12 DESIGNINGPRICINGSTRATEGIES ANDPROGRAMS

The manufacturer’s unit cost is given by:

Unit cost 
variable cost fixed costs 
$10$300,000
$16

unit sales 50,000

If the manufacturer wants to earn a 20 percent markup on sales, its markup price is

given by:

Markup price 
 unit cost 
 $16 
$20

(1desired return on sales) 1 0.2

Here, the manufacturer charges dealers $20 per toaster and makes a profit of $4 per

unit. If the dealers want to earn 50 percent on their selling price, they will mark up the

toaster to $40. This is equivalent to a cost markup of 100 percent.

Does the use of standard markups make logical sense? Generally, no. Any pricing

method that ignores current demand, perceived value, and competition is not likely to

lead to the optimal price. Markup pricing works only if the marked-up price actually

brings in the expected level of sales.

Companies that introduce a new product often price it high, hoping to recover

their costs as rapidly as possible. But a high-markup strategy could be fatal if a com-

petitor is pricing low. This happened to Philips, the Dutch electronics manufacturer,

in pricing its videodisc players. Philips wanted to make a profit on each videodisc

player. Meanwhile, Japanese competitors priced low and succeeded in building their

market share rapidly, which in turn pushed down their costs substantially.

Markup pricing remains popular for a number of reasons. First, sellers can deter-

mine costs much more easily than they can estimate demand. By tying the price to

cost, sellers simplify the pricing task. Second, when all firms in the industry use this

pricing method, prices tend to be similar, which minimizes price competition. Third,

many people feel that cost-plus pricing is fairer to both buyers and sellers: Sellers do

not take advantage of buyers when demand becomes acute, and sellers earn a fair

return on investment.

Target-Return Pricing

Intarget-return pricing,the firm determines the price that would yield its target rate of

return on investment (ROI). Target pricing is used by many firms, including General

Motors, which prices its automobiles to achieve a 15–20 percent ROI.

Suppose the toaster manufacturer in the previous example has invested $1 mil-

lion and wants to earn a 20 percent return on its invested capital. The target-return

price is given by the following formula:

Target-return price
unit cost desired return invested capital

unit sales

$16.20$1,000,000
$20

50,000

The manufacturer will realize this 20 percent ROI provided its costs and estimated sales

turn out to be accurate. But what if sales do not reach 50,000 units? The manufacturer

can prepare a break-even chartto learn what would happen at other sales levels (Figure

4-12). Note that fixed costs remain the same regardless of sales volume, while variable

costs, which are not shown in the figure, rise with volume. Total costs equal the sum of

fixed costs and variable costs; the total revenue curve rises with each unit sold.