Page 419 - Marketing Management

396 PART 5 SHAPING THE MARKET OFFERINGS

Companies select a pricing method that includes one or more of these three considerations. We
will examine six price-setting methods: markup pricing, target-return pricing, perceived-value
pricing, value pricing, going-rate pricing, and auction-type pricing.
MARKUP PRICING The most elementary pricing method is to add a standard markup to the
product’s cost. Construction companies submit job bids by estimating the total project cost and
adding a standard markup for profit. Lawyers and accountants typically price by adding a standard
markup on their time and costs.

Variable cost per unit $10

Fixed costs $300,000
Expected unit sales 50,000

Suppose a toaster manufacturer has the following costs and sales expectations:
The manufacturer’s unit cost is given by:
fixed cost $300,00
Unit cost = variable cost + = $10 + = $16
unit sales 50,000

Now assume the manufacturer wants to earn a 20 percent markup on sales. The manufac-
turer’s markup price is given by:

unit cost $16
Markup price = = = $20
(1 - desired return on sales) 1 - 0.2
The manufacturer will charge dealers $20 per toaster and make a profit of $4 per unit. If dealers
want to earn 50 percent on their selling price, they will mark up the toaster 100 percent to $40.
Markups are generally higher on seasonal items (to cover the risk of not selling), specialty items,
slower-moving items, items with high storage and handling costs, and demand-inelastic items, such
as prescription drugs.
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.
Consider what happened at Parker Hannifin.

Parker Hannifin When Donald Washkewicz took over as CEO of Parker
Hannifin, maker of 800,000 industrial parts for the aerospace, transportation, and manu-
facturing industries, pricing was done one way: Calculate how much it costs to make and
deliver a product and then add a flat percentage (usually 35 percent). Even though this
method was historically well received, Washkewicz set out to get the company to think more
like a retailer and charge what customers were willing to pay. Encountering initial resistance from some
of the company’s 115 different divisions, Washkewicz assembled a list of the 50 most commonly given
reasons why the new pricing scheme would fail and announced he would listen only to arguments that
were not on the list. The new pricing scheme put Parker Hannifin’s products into one of four categories
depending on how much competition existed. About one-third fell into niches where Parker offered
unique value, there was little competition, and higher prices were appropriate. Each division now has a
pricing guru or specialist who assists in strategic pricing. The division making industrial fittings re-
viewed 2,000 different items and concluded that 28 percent were priced too low, raising prices any-
where from 3 percent to 60 percent. 50

Still, markup pricing remains popular. First, sellers can determine costs much more easily than
they can estimate demand. By tying the price to cost, sellers simplify the pricing task. Second, where