Pricing - refers to the determination of the appropriate selling price for a product or service provided by a firm.

Pricing Policy

 For profit-oriented organizations, the selling price include all the costs incurred to produce and sell the
product, or all cost incurred in rendering a service, plus an acceptable mark—up or profit.
 For not-for-profit organizations, the price should likewise ensure recovery of cost, plus a satisfactory
margin to help the organization to survive or remain as going concern.
The Firms Pricing Policy will play a vital role in attaining the organizational goal which is: profit
maximization and/or survival as an entity.
5 Common Pricing Strategies
1. Cost-plus Pricing- simply calculating your costs and adding a mark up
2. Competitive Pricing- setting a price based on what the competition charges
3. Value-based Pricing- setting a price based on how much the customer believes what you’re selling is
worth
4. Price Skimming- setting a high price and lowering it as the market evolves
5. Penetration Pricing- setting low price to enter a competitive market and raising it later
FACTORS INFLUENCING PRICING DECISION

Establishing a selling price for the firm's products and services is not as simple as using a formula to add costs
and desired profit.
A figure obtained with the use of some quantitative calculations may not necessarily be the final selling price, for
a pricing decisions are influenced not only by quantitative factors, but by qualitative consideration as well which
include internal and external factors.
In qualitative consideration in terms of internal factors, it includes; the type of product or services that the
company sells, the company's objective and the image that it wants to portray to the management style and
public.
In qualitative consideration in terms of external factors, it consists of; competitor’s actions, type of industry
which the company belongs, type of market where the product and services are sold, economic trends, political
situation and governmental influence.
MARKET MODELS AFECTING PRICE DECISIONS
The type of market structures a firm faces has some impact on its pricing, these type of market greatly influence
the formulation of the firm’s pricing policies. These market structures include the following:
1. Perfectly competitive market
2. Monopolistic competition
3. Monopoly
4. Oligopoly
Perfectly Competitive Market
Economists characterize a perfectly competitive market as market where the goods traded are
homogenous, i.e., purchasers look at the products of one seller as identical with those of other sellers. In a
perfectly competitive market, neither of the buyers nor the sellers can individually influence the market price by
their actions. Instead, the products’ selling prices are determined through the interaction of demand for and
supply. Business firm which sell their products in a perfectly competitive market do not necessarily have to
formulate pricing decisions since the market forces determine the selling price for their products. Examples of
these firms are those engaged in producing and selling products like onion, potato, garlic, cabbage, etc.; and
those engaged in fishing and aquaculture, selling products like prawns, milkfish, etc. These firms cannot
establish price decisions on their own, what they can do is merely to study the market forces and decide on the
quantity of products that they want to produce and sell.
Monopolistic Competition
 In a monopolistic competition, several sellers of similar, but not identical, products exist in the market. In
this case, no seller can directly influence the market price of similar products. In other words, each producer will
be considered as a monopoly thanks to differentiation, but the whole market is considered as competitive
because the degree of differentiation I not enough to undermine the possibility of substitution effects. Examples
of firms in this type of market ae manufactures of some food products like sandwich spread, vinegar, instant
noodles, instant coffee, etc. Selling prices in a monopolistic competition are set without giving much regard to
competitors’ prices. Instead, policies ae formulated considering the product’s market acceptability at the
established selling price.
Monopoly
Monopoly occurs when the market is composed of sole seller or supplier. In this case, no competing
products exist in the market, and the sole seller can dictate the selling price that it wants to charge for its products.
Example are electric utilities (MERALCO), telephone companies (PLDT), and domestic air transport (PAL). In
some cases, the government imposes some regulatory measure to control the sales prices when monopoly
exists to protect the consuming public from the ill of a monopolistic market.
Oligopoly
An oligopoly exists when several large sellers dominate the market and basically compete with one
another. In this case, a supplier is large enough such that any change in its pricing policy may directly affect the
market. This is why when business firms that sell their goods in an oligopolistic market formulate their pricing
policies, they give much consideration to their competitors’ actions or possible reaction. Examples of firms in an
oligopolistic market are shipping lines, laundry and toilet soap manufacturers and tourist bus operators. Observe
that their selling prices are basically the same, for if a firm decides to charge a relatively much higher price for
its product than its competitors’, a loss in sales volume will definitely result, since customers will shift to other
companies charging lower prices.
In some cases, price leaders and price followers exist in an oligopolistic market. Here, a large supplier
sets the selling price, and the price followers merely adopt the selling price established by the leader. Formulation
of pricing policies of price followers is therefore much simpler that of the price leader, for the latter has to see to
it that the selling price it establishes will ensure maximization of profit, for the former will definitely sell all it can
at the same price.
SALES PRICE DETERMINATION
The selling price must be set such that it will ensure recovery of cost and generation of a satisfactory or
acceptable amount of mark-up or profit. The basic formula to compute selling price is stated below.

Where:
SP = selling price
SP = C + MU
C = Cost
MU = Mark-up

The above basic formula has two major components – cost and mark-up. How much cost should be
included in the computation and how much is ‘satisfactory’ or ‘acceptable’ amount or profit that must be added
to cost to come up with the selling price?

COST DATA
The selling price must include all the costs that it incurred in the production and sale of the product, these
are manufacturing costs, selling and administrative expenses. Once any of these items is unintentionally
excluded in the computation, the selling price will be understated and the company’s profitability will be negatively
affected. If the cost data are expected to remain stable during the period in which the selling price will be in
effect, the actual costs may be used in the calculation. However, if there are expected changes in the cost data,
the expected new figures should be used.
 For companies using the standard cost accounting system, it is advisable for them to use the standard
cost in computing the selling price. They should see to it, however, that the standard costs they are using are
realistic and reflective of the current costs and operating conditions.
The reason for the use of standard costs is to avoid inclusion of operational efficiencies or inefficiencies
(variances) in the selling price. For instance, assume that the standard unit cost to produce a product is P10, the
actual cost incurred during the previous period amounted to P12. Based on the variance analysis made, the
unfavorable variance of P2 was due to insufficient usage of materials and labor hours. Basing the selling price,
therefore, on the actual cost figure, the result will be unrealistic since it does not reflect cost data based on
normal operating conditions.

TARGET PROFIT
The amount of satisfactory profit mentioned earlier may refer to the maximum profit level that the firm
can possibly earn in a given business environment. This profit level may likewise be called target profit which
a price setter may use as a guide in computing selling price. It may be expressed as a total amount in pesos, a
per unit figure, or as a percentage based on some other data such as costs, sales or capital employed in the
business.

PRICE SETING METHODS

The following sections illustrate the various methods of establishing selling prices. These methods may serve as
a guide to price setters in computing the appropriate selling price or their product.

COST-BASED PRICING

Most formulas used in determining selling price use the cost data as the base for the desired mark-up. The cost
data may be full cost, materials cost, variable cost, conversion cost, and differential cost.

FULL COST PRICING

Where:
SP = TC + MU SP = Selling price
TC = Total cost consisting of materials, labor,
Or Factory overhead, selling and administrative
expenses
MU = mark-up or target profit which is usually
SP = TC + (MU% x TC) expressed as a percentage based on TC

Under this method, selling price is computed by adding the total production and operating costs to a mark-up
based on such total cost.
Illustration:
Manufacturing costs:

Materials P10
Labor 4
Factory Overhead 8 P22
Selling and administrative cost 8
Total cost or full cost per unit P30

Target profit: 30% of full cost

Using the above data, selling price may be computed as follows:

SP = TC + MU
= P30 + (30% x 30)
= P30 + P9
= P39

Materials Cost Pricing

 Also called Cost Plus Pricing

 Involves adding a markup to the cost of goods and services to arrive at a selling price. Under
this approach, you add together the direct material cost, direct labor cost, and overhead costs
for a product, and add to it a markup percentage in order to derive the price of the product.
Cost plus pricing can also be used within a customer contract, where the customer reimburses
the seller for all costs incurred and also pays a negotiated profit in addition to the costs
incurred.

To facilitate computation of selling price, mark-up may just be based on material cost.
FORMULA
WHERE:
M = materials cost
SP=M+ (MU% x M) + CC+ OE MU%=Mark-up percentage
CC = Conversion cost composed of labor and
overhead cost
OE = Operating expenses composed of selling and
administrative expenses

Let us use the following data to illustrate application of the formula:

Manufacturing Costs:
Materials P50
Labor 5
Overhead 10 65
Selling and administrative cost 5

Total Unit cost P70

Desired Mark-up = 40% of Materials Cost

Using the materials cost pricing method, the selling price may be determined as follows:

SP = M + (MU% x M) + CC + OE
= P50 + (40% x P50) + (5 +10) + 5
= P50 + P20 + P15 + P5
= P90
 Advantages of Cost Plus Pricing

 Simple. It is quite easy to derive a product price using this method, though you should define the overhead
allocation method in order to be consistent in calculating the prices of multiple products.
 Assured contract profits. Any contractor is willing to accept this method for a contractual agreement with
a customer, since it is assured of having its costs reimbursed and of making a profit. There is no risk of
loss on such a contract.
 Justifiable. In cases where the supplier must persuade its customers of the need for a price increase, the
supplier can point to an increase in its costs as the reason for the increase.
Disadvantages of Cost Plus Pricing

 Ignores competition. A company may set a product price based on the cost plus formula and then be
surprised when it finds that competitors are charging substantially different prices. This has a huge impact
on the market share and profits that a company can expect to achieve. The company either ends up pricing
too low and giving away potential profits, or pricing too high and achieving minor revenues.
 Product cost overruns. Under this method, the engineering department has no incentive to prudently
design a product that has the appropriate feature set and design characteristics for its target market.
Instead, the department simply designs what it wants and launches the product.
 Contract cost overruns. From the perspective of any government entity that hires a supplier under a cost
plus pricing arrangement, the supplier has no incentive to curtail its expenditures - on the contrary, it will
likely include as many costs as possible in the contract so that it can be reimbursed. Thus, a contractual
arrangement should include cost-reduction incentives for the supplier.
 Ignores replacement costs. The method is based on historical costs, which may have subsequently
changed. The most immediate replacement cost is more representative of the costs incurred by the entity.

Conversion Cost Pricing

 applies when multiple products are manufactured by a firm
 It is based on the idea that products requiring more conversion costs should be assigned a higher
selling price. The following formula may be used for this method.

SP= CC + (MU% x CC) + M + OE

Where:
CC= Conversion cost composed of labor and overhead
MU%= Mark-up Percentage
M= Materials cost
OE= Operating expenses composed of selling and
Administrative costs

Example: Product A is one of the product lies manufactured by a company, and this product’s cost data are as
follows:
Manufacturing Costs:
Materials P5
Labor 25
Overhead 20 P50
Selling and administrative cost 10

Total Unit cost P60

Mark-up= 40% of Conversion Cost
Computation:

SP= CC + (MU% x CC) + M + OE

= P45 + (40% x P45) + P5 + P10
= P45 + P18 + P5 +P10
= P78

Variable Cost Pricing

 Also called Contribution Approach Pricing. Under this method, all costs that vary with the product are
determined and used as the basis in computing the mark-up. Fixed Costs are not allocated to the
products or services.
 The amount of mark-up used in the calculation of selling price usually includes the target profit and an
allowance for the recovery of fixed cost.
FORMULA:
Where:
SP = VC + (MU% * VC) VC = Variable Cost
MU% = Mark-up Percentage

EXAMPLE:
Presyo Company produces three products, A, B and C. Cost data for the three product are as follows:

A B C
Materials P5 P6 P8
Labor 3 2 7
Variable Overhead 2 4 5
Variable Selling and Administrative Costs 2 2 2
Total Variable cost per unit 12 14 22
Mark-up Based on variable cost 50% 60% 40%

Fixed manufacturing cost P150,000

Fixed selling and administrative expenses P200,000

SOLUTION:
Selling prices for each product may be computed using the variable costing method as follows:
A B C
Variable cost per unit 12 14 22
x Mark-up % 50% 60% 40%
Mark up 6 8.40 8.80
Add: Variable cost per unit 12 14 22
Selling Price 18 22.40 30.80
Differential Cost Pricing

 is usually applied in cases involving special orders where a customer offers to buy a relatively high
volume of the company’s goods at a price much lower than the normal or original selling price.
The illustration highlights determination of the appropriate selling price for the special order. Let us consider
the following example:
Unsang Company manufactures a product called Tie-phun which it sells at a price of P50. Production and
selling costs for this product are as follows:
Manufacturing:
Materials P10
Labor 8
Overhead (1/3 fixed) 12 P30
Selling and administrative (1/3 fixed) 6
Total Cost Per unit P36

At present, the company utilizes 60% of the normal capacity of 20,000 units. To be able to utilize the idle
capacity, it is considering to accept a special order for 5,000 units of the product. However, the customer is
asking for a special price, which naturally should be much lower than the regular price of P50.
The company does not expect to incur additional selling and administrative cost for this special order.
What amount of selling price should be charged for this special order?

SOLUTION:
In this particular case, the amount of selling and administrative cost of P6 and the fixed overhead cost of P4
(1/3 of P12) are irrelevant because they are not expected to change whether the special order is accepted or
rejected.
The differential or relevant cost data that must be included in the computation of the variable manufacturing
costs as follows:

Materials P10
Labor 8
Variable Overhead (2/3 of 12) 8
Differential Cost per unit P26

The total differential cost per unit is P26 which means that if the special order is accepted, the additional cost
to be incurred for each additional unit to be produced is P26. Therefore, the company should not charge a
special price that is lower than P26 for the special order because this will definitely result into a loss. If it
charges a price of exactly P26, the company will just break-even from this order.
Therefore, the minimum selling price that must be charged for the special order is P26. Of course, the
company would be better off if it could set a price higher than this amount.
With the foregoing analysis, we were able to set a starting point, i.e., P26 for the company to set the
appropriate selling price the special order. The only problem left is to decide on the amount of mark-up that
must be added to the differential cost that will result into a selling price which is just appropriate to enable the
company to win the special order.
RETURN ON INVESTMENT PRICING
The amount of mark-up cost in this method is based not on cost, but on capital employed in the business or in
the production and sale of the product under consideration. the selling price computed using ROI pricing
method assures recovery of total cost as well as a desired return on investment.
where:
SP = Selling price
TC = Total or full cost
SP = TC + (DROR × CE) DROR = Desired rate of return on investment
CE = Total Capital employed or total investment or
US total asset
US = Sales in units

per unit cost can also be used in computing the tentative selling price using the ROI pricing method. the
formula is:

Where:
FC/u= Full or total cost per unit
SP = FC/u + (DROR × CE)

US

with the foregoing formulas, the resulting selling price is expected to yield profit that is equal to the desired
return on total investment or capital employed.
However, we should take cognizance of the fact that the total assets or capital employed is composed of fixed
and variable components. For instance, if the total capital employed is composed of current assets and fixed or
plant assets, the current portion is expected to vary with production and sales, whereas the fixed portion will
remain the same regardless of production and sales volume. The formula mays be modified as follows:
where:
SP = selling price
TC = Total or full cost
SP = TC + (DROR × F × Cap) / Us DROR = Desired rate of return on investment
FxCAP = Fixed capital or plant/fixed assets used
1- (DROR × VCapR) for the product
Us = Sales in units
VCapR = variable capital ratio or Current assets÷
Sales

Example - Total capital employed is given:

Total Manufacturing cost 200,000 Solution:
Total selling and admin expenses 100,000
Full cost or total cost 300,000 SP = TC+(DROR×CE)/Us
= 300,000+(20%×1,000,000)/50,000
= 10.00

The total capital employed is 1,000,000 and the desired ROR on this investment is 20%. the company expects
to sell 50,000 units of this product.
MARK-UP BASED ON SALES
some firms prefer to base their mark-up on sales rather than on cost or amount of investment. In this case,the
formula is:
Where:
Basic formula: SP= C+MU SP = Selling price
If mark-up is based on sales: C = full or total cost
SP= C + (MU% × SP) MU% = Mark-up percentage

Transpose (MU% x SP) to the other side:

SP - (MU% × SP) = C
or
SP (1 - MU%) = C
Therefore: SP = C
1-MU%

Illustration:
Assume that Gana Co. marks up its merchandise at 40% of selling price. Cost per unit of merchandise is 60.
The selling price, therefore is equal to 100, computed as follows:

SP = C/ 1-MU%
= 60/1-.40
= 60/.60
= 100

Other factors considered in Price Setting

Trade Discount
When a firm wants to allow for a certain trade discount on sales, and SP is computed with the use of any of the
methods discussed and illustrated in the previous sections is still exclusive of the discount, the adjusted or
gross SP may computed as follows:
Where:
GSP = NSP
GSP = Gross selling price
1 - Disc.% NSP= Net selling price
Disc% = Rate of discount
Illustration
Assume that bargain co. has computed a selling price of 29.10 using full cost pricing method. If bargain co.
wants to allow for a 3% discount on sales and he wants to include this on the sales price determined, the GSP
is computed as follows:

GSP = 29.10/1-.03

= 29.10/.97

= 30
Sales Tax
some firms are required to pay sales tax on goods and services sold. gross and net sales price computations
in this are as follows:
Sales Price Does Not Include Sales Tax
The procedure involves simply adding the applicable sales tax to the net selling price to arrive at the gross
sales price figure:

Net Selling Price (NSP) PXXX

ADD: SALES TAX (NSP × T × R) XXX

GROSS SELLING PRICE PXXX

Where TxR = Sales Tax Rate

Illustration
Assume that the selling price established by a company for its product is 200, exclusive of tax sales of 10%.
the gross selling price will be 220 computed as:

NSP P200

ADD SALES TAX (200 × 10%) 20

GROSS SELLING PRICE P220

Gross Sales Price Includes Tax

where:
GSP
NSP = NSP = Net selling price
1+ T×R GSP = Gross selling price
TxR = Sales tax rate

Illustration
Francisco Co. is Vat-registered firm which sells its products at 330 each, inclusive of VAT of 10%. The NSP for
products may be computed as:

NSP = GSP/(1+T×R)

= 330 / (1+.10)

= 330/1.10

= 300
OTHER PRICING TECHNIQUES

There are two unusual pricing techniques applied for some firms and those are:

Loss Leader Pricing

The fact that firms naturally always think of a selling price that will ensure recovery of all costs and generation
of satisfactory amount of profit. They do not usually attempt to sell their goods at a price lower than its cost.
However, some do sell one of some of their products at a price lower than the cost, hoping that as the
customers go their place of business to take advantage of the low-priced offer, they will buy the company's other
regular-priced products.
Inferior Goods

When we increase our selling price, it is but natural for the sales volume to decrease, since our customers
will tend to shift to other supplier selling the same items at a lower price. Some have tried this and their sales
volume dramatically increased to an unexpected level. Customers, which is some, relate the quality of a product
to its price.
This technique should not be used in the general analysis of pricing decisions perhaps they should be used
only on a case to case basis, considering strong possibility of success.