Metrics & Analytics

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MCM 723 Metrics and Analytics December 2, 2012 Think 4

A. Describe cost-based pricing and value-based pricing, noting the differences in approach and results. Give examples of products or services priced each way, and justify your reasoning. How could cost-based pricing lead to a price lower than customers would have paid and how does this impact the profit of a business?

The Cost- based pricing concept is regulating the cost of production or fulfillment as the basis for pricing goods and or services. Using this method, the selling price of a product will be the cost to produce it, including both direct and indirect costs, plus an additional amount to generate a profit for the seller. The strategy to establishing this type of pricing has a financial objective of setting a high price to make high profits initially. Then following a recovery period of extensive research and development cost to maximize profits before any factors, such as competitors begin to enter the market. Forming a low price on products to make quick sales is a way business (large or small) strategize to increase cash flow. The formula used to map out this type of pricing is : Break-Even Unit Volume= (Fixed costs/ Unit Contribution Margin). Unit Contribution Margin= Selling Price per unit-Variable cost per unit. The only disadvantage with cost based pricing is that if the cost increase, the price of the product must increase as well. Cost based pricing is sub-classified into four other types of pricing 1.) Cost plus pricing- a fixed percentage of profit is added to the cost. The fixed percentage of profits could be the manufacturer's profit, wholesalers profit and retailer's profit. 2.) Full Cost Pricing- Total cost is computed by adding the variable and fixed cost in the product manufacturing, administration and selling. On the total cost, the required margin of

profit is added. 3.) Target Profit Pricing- (also known as rate of return pricing). This concept is similar to full cost pricing but is different in the respect that total cost is computed in the same manner and a required margin of profit is added. the required margin of profit is carried at on a rational approach by keeping in mind the return on an investment criteria rather than done arbitrarily as in full cost pricing method. 4.) Marginal Cost Pricing- This pricing aims a t maximizing the contribution towards fixed cost and includes all the variable cost of the product. In addition, portions of the fixed cost are totaled. Value-based pricing s a method of pricing products in which companies first try to determine how much the products are worth to their customers. The goal is to avoid setting prices that are either too high for customers or lower than they would be willing to pay if they knew what kind of benefits they could get by using a product. Data mining software can play an important role in the process by helping users segment their customers and define the value they receive. MOST products are still priced according to what they cost -to produce. But some manufacturers and IT vendors employ an alternative approach, using information technology to help estimate how much value a product would provide to the buyer, then basing its price on that value. For example, one pharmaceutical maker priced a new anti-ulcer drug, but not by adding up the costs of developing and manufacturing the medication and tacking on the amount of profit it wanted to make, says George Cressman, a product pricing consultant at Strategic

Pricing Group Inc. in Marlboro, Mass. Instead, the company used value-based pricing techniques to justify a higher price than it might otherwise have been able to get from medical insurers. Its weapon: studies that showed the new drug could help patients avoid expensive surgery, which in turn would lower costs for the insurance companies. The goal is to avoid setting prices above the ceiling of what someone will pay -- and also to make sure you don't give away the...
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