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Marketing Basics - Kotler Philip

Price calculation using the method of "average cost plus profit"

The easiest pricing method is to charge a certain margin on the cost of goods. So, a retailer of household goods can pay a producer $ 20 for a toaster and, paying a margin of 50% of the original cost, sell this toaster for $ 30. In this case, the retailer’s gross profit is $ 10. If the costs of organizing the work of the store amount to $ 8 for each toaster sold, the seller’s net profit will be equal to two dollars. (The calculation of margins is described in Appendix A. Marketing Arithmetic.)









No profit at this price

Cost of production

Competitor prices and substitute product prices

Unique merits of goods

The formation of demand at this price is impossible

Fig. 63. Basic pricing considerations

The toaster manufacturer probably also used the “average cost plus profit” method of calculating the foam. If production costs per toaster are $ 16, it is possible that the entrepreneur made a 25% mark-up when setting the selling price for retailers at $ 20. Construction companies issue proposals for work on the basis of the full cost of the project plus an extra charge in the form of standard deductions for profit. Lawyers and other individuals in free professions usually infer the price, adding a standard mark-up to their costs. Some sellers tell customers that they will ask them for a price equal to the amount of costs plus a certain margin. That is how aerospace companies calculate the price when delivering their goods to the state.

The sizes of margins vary widely depending on the type of goods. Here are some of the most typical markups made by department stores (at the original price, not at the cost of goods): tobacco products - 20%, cameras - 28, books - 34, women's dresses - 41, jewelry for a dress - 46, women's hats - 50 % 3. In the retail grocery trade, small margins are placed on coffee, canned dairy products and sugar, and high ones on frozen foods, jellies and some canned goods. Markups vary widely. For example, in the frozen food category, retail price markups can range from 13 to 53% 4. The difference in the size of margins reflects differences in the value of commodity units, sales, inventory turnover and the ratios between brands of brands and private brands5.

Is it logical to use standard markups when setting prices? Generally not. Any calculation method that does not take into account the characteristics of current demand and competition is unlikely to allow reaching the optimal price. The retail business cemetery is crammed with the graves of merchants who held fast to their standard mark-ups, while competitors set discount prices.

Nevertheless, margin pricing techniques remain popular for a number of reasons. First, sellers know more about costs than about demand. By tying the price to costs, the seller simplifies the pricing problem for himself. He does not have to adjust prices too often depending on fluctuations in demand. Secondly, if all firms in the industry use this pricing method, their prices are likely to be similar. Therefore, price competition is minimized. Thirdly, many consider the calculation method “average costs plus profit” to be more fair in relation to both buyers and sellers. With high demand, sellers do not profit at the expense of buyers and at the same time have the opportunity to get a fair rate of return on invested capital.