Pricing — Objectives, Demand & Elasticity, Cost-plus (Markup vs Margin) and Pricing Strategies
Why price matters, when a price must be set, the six-step pricing policy, pricing objectives, demand and price elasticity, markup vs margin, full-cost vs marginal-cost plus pricing, target return, value-based, psychological, geographical, skimming, penetration, status quo, discounts and discriminatory pricing.
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Pricing
The main lecture: pricing factors, markup vs margin and the cost-plus examples.
00:02Introduction and learning outcomes01:01Why price matters: the only revenue-earning P02:29When a firm must set a price03:39Factors in the pricing policy (the six steps)04:44Pricing objectives06:24Demand: the inverse relationship08:03Price elasticity (elastic vs inelastic)08:40When demand is less elastic: the rice example10:39Estimating costs: fixed vs variable11:35Pricing methods overview12:08Markup vs margin (100 → 125 vs 100 → 75)15:10Full-cost vs marginal-cost plus pricing16:02Worked example: product A18:11Target return pricing (ROI)18:40Value-based pricing: the ice-cream example19:20Psychological pricing (29.99)20:29Geographical pricingPricing strategies: Farmer Joe's "Choco Brocco"
An animated case comparing skimming, penetration and status quo pricing for a new product.
00:07The case: Choco Brocco, a new chocolate-tasting broccoli01:07Three strategies: skimming, penetration, status quo01:34Price skimming: recoup the $10,000 investment02:04Penetration pricing: low price, wide reach03:09The risk: diluting a luxury brand03:38Status quo pricing: match the competition04:13Decision: $5 a bunch vs $3 for ordinary broccoli1Why price matters
In the marketing mix (4 Ps: product, price, place, promotion), price is the only element that brings in revenue. All the others are costs. Price also communicates the value positioning of the product 01:01.
A firm must set a price for the first time when 02:29:
- it develops a new product
- it introduces its regular product into a new distribution channel or geographical area (e.g. a Sri Lankan company entering India)
2The pricing policy: six factors
- Select the pricing objective
- Determine demand
- Estimate costs
- Analyse competitors (costs, prices, offers)
- Select a pricing method
- Select the final price
1. Pricing objectives 04:44
| Objective | Typical price |
|---|---|
| Survival | Low, enough to cover costs and stay in the market |
| Maximise current profit | Price that gives the best profit now |
| Maximise market share | Low, to build volume |
| Maximise market skimming | High at launch, falling later |
| Product-quality leadership | High, to signal premium quality |
2. Demand & price elasticity
- Demand and price are inversely related: a higher price means lower demand, and vice versa (the chocolate example: buy 2, then 5 when the price falls) 06:57.
- Price elasticity measures how demand changes with a unit change in price 08:03.
| Change in demand when price changes | |
|---|---|
| Price inelastic | Little or no change |
| Price elastic | Significant change |
Demand is likely to be less elastic when:
- there are few or no substitutes (rice in Sri Lanka 08:40)
- buyers are slow to change their buying habits
- buyers think the higher prices are justified
3. Estimating costs 10:39
- Fixed costs don't change with output: the same whether you make 1 or 100.
- Variable costs change with output: zero output means zero variable cost.
- Target costing works backwards: market price − required profit = cost you must achieve.
3Markup vs margin
- Markup: profit as a % of cost
- Margin: profit as a % of selling price
| Cost markup 25% | Profit margin 25% | |
|---|---|---|
| Cost | 100 | 75 (target cost) |
| Profit | 25 (25% of cost) | 25 (25% of price) |
| Selling price | 125 | 100 |
| Best for | New, introductory products (cost known, set the price) | Established products (market price known, target the cost) |
e.g. 25% markup = 20% margin; 25% margin = 33.3% markup
4Pricing methods
Cost-plus pricing
Set the price at the production cost (goods plus fixed costs at the current volume) plus a profit margin or markup 15:10.
| Full-cost plus | Marginal-cost plus | |
|---|---|---|
| Cost base | Variable + fixed costs | Variable costs only |
| Markup | Smaller (covers profit only) | Larger (must also cover fixed costs) |
Direct material 60, direct labour 30, variable overhead 90, fixed overhead 20.
| Full cost | Marginal cost | |
|---|---|---|
| Direct material | 60 | 60 |
| Direct labour | 30 | 30 |
| Variable overhead | 90 | 90 |
| Fixed overhead | 20 | – |
| Cost per unit | 200 | 180 |
| Markup 20% | 40 | 36 |
| Price | 240 | 216 |
The video says the marginal-cost price is 260 17:28. That's a slip: 180 × 1.20 = 216.
It ignores demand. It also ignores competitors and what customers are willing to pay.
Other methods
| Method | Idea | Example |
|---|---|---|
| Target return pricing | Set the price to achieve a target return on investment (ROI) 18:11 | "We need Rs 1 million profit. What price gets us there?" |
| Value-based pricing | Price on the value it creates for the customer 18:40 | Plain ice cream Rs 100; decorated sundae Rs 200 |
| Psychological pricing | Lessen the impact of the price in the customer's mind, or signal quality or esteem 19:20 | 29.99 feels "less than 30" |
| Geographical pricing | Different prices at different locations; may involve barter, countertrade, foreign currency 20:29 | |
| Skimming pricing | High introductory price with heavy promotion, slowly dropped later 01:34 | Unique products not easily copied; recovers development cost |
| Penetration pricing | Low initial price to reach the largest share of the target market 02:04 | Price-sensitive consumers; discourages new competitors |
| Status quo pricing | Match or stay close to competitors' prices 03:38 | Clothing companies, airlines |
Farmer Joe's daughters spent $10,000 developing a chocolate-tasting broccoli.
- Skimming fits: the product is unique, they want to recoup the investment, and there's no competitor.
- Penetration risks:
- shortages if demand outruns supply
- diluting the brand (the luxury-car starter-sedan example 03:09)
- Status quo is unnecessary: nobody else sells it.
Decision: $5 a bunch vs $3 for ordinary broccoli, a skimming price 04:47.
Discounts & allowances
- early payment and cash discounts
- off-season discounts
- bulk purchase (quantity) discounts
- retail discount
- trade allowance
Discriminatory pricing
The same product at different prices by:
- customer segment (student or senior rates)
- product form (versions or packaging)
- location (theatre seats)
- time (peak vs off-peak)
Tick what's true about your product and market.
Likely questions:
- Why price is important (the only revenue P)
- When a price must be set
- The six pricing-policy factors
- Pricing objectives
- Elasticity, and when demand is inelastic
- Markup vs margin calculations
- Full-cost vs marginal-cost plus prices (the 240 vs 216 example)
- The limitation of cost-plus
- Explaining skimming vs penetration with an example
5Practice questions (course paper)
Fixed costs: factory 750,000 + selling 550,000 + administration 325,000 = 1,625,000. Over 500,000 units, that's 3.25 per unit.
| Rs. per unit | |
|---|---|
| Variable cost | 8.00 |
| Fixed cost | 3.25 |
| Full cost | 11.25 |
| Mark-up 35% | 3.94 |
| Selling price | 15.19 |
1. Redistribute the service departments (simultaneous equations):
- A (packing) = 6,000 + 0.25B
- B (maintenance) = 5,000 + 0.2A
- So A = 7,631.58 and B = 6,526.32
Chair plant: 25,000 + 0.8 × 7,631.58 + 0.75 × 6,526.32 = 25,000 + 6,105.26 + 4,894.74 = 36,000
2. Absorption rate: 300 chairs × 5 hours = 1,500 direct labour hours, so 36,000 / 1,500 = Rs. 24 per hour
| Rs. per chair | |
|---|---|
| Direct material: 20 ft × 100 | 2,000 |
| Direct labour: 5 h × 60 | 300 |
| Overhead: 5 h × 24 | 120 |
| Full cost | 2,420 |
| Mark-up 25% | 605 |
| Selling price | 3,025 |
6Quick revision sheet
| Concept | Remember it as |
|---|---|
| Price | Only P that brings revenue; signals value positioning |
| Set a price when | New product · new channel or region |
| Policy steps | Objective → demand → costs → competitors → method → final price |
| Objectives | Survival · current profit · market share · skimming · quality leadership |
| Elasticity | Inelastic: small demand change; elastic: big change |
| Less elastic when | Few substitutes · slow habits · higher price seen as justified |
| Markup | % of cost: 100 → 125 |
| Margin | % of price: 100 → cost 75 |
| Full vs marginal cost plus | 200 × 1.2 = 240 vs 180 × 1.2 = 216 |
| Cost-plus weakness | Ignores demand |
| Target return | Price to hit an ROI |
| Value-based | Customer's perceived value |
| Psychological | 29.99 |
| Geographical | Different prices by location; barter, countertrade |
| Skimming | High then lower; unique product, recoup investment |
| Penetration | Low launch, maximum reach; price-sensitive buyers |
| Status quo | Match competitors |
| Discriminatory | Segment · product form · location · time |
?Self-check quiz
12 questions on this week. Answer them all, then press Check my answers. Your best and latest scores are saved and shown on the subject page.