What Is Target Pricing?
Updated June 24, 2022
Determining the price of a product or service you're going to sell can have a major impact on how your business progresses. Target pricing is a method used best in highly competitive markets where the level of demand affects the changes in price. By using target pricing, you can learn how to calculate the price of a prospective good and infer how likely it is to sell and make a profit. In this article, we discuss target pricing, the advantages and disadvantages of using this method and the other types of pricing styles.
What is target pricing?
Target pricing is a method that businesses use to calculate the selling price for a product based on market prices. First, a company decides on a competitive price for its product based on market research and what similar products are selling for. Once the business determines its product's price, the business sets how much of a profit it wants to make from it, which is also known as its profit margin.
After setting a profit margin, the company must figure out if the cost of producing or procuring the product is within the remaining budget. If the company can't complete the product within the cost constraint, then they cancel the project. By taking this approach, a firm can ensure that it will earn a reasonable profit because it can sell its product at a price that is consistent with market demand.
Companies like automobile manufacturers that have a high capital investment use target pricing most often because it is not directly tied to the demand of the product as long as they sell the entire volume of stock.
Example of target pricing
If a company seeks to sell desk chairs and the average market price for desk chairs is $200 a chair, then the company might set its selling price per chair to $250 and market their desk chairs as a high-end product. If they decide they want to make a 20% profit on each sale, then they will make $50 profit per every chair sold. Therefore, if the company wants to make $50 per chair and sell the chair at $200, then they must be able to manufacture the chair for $150 or less. If the manufacturing cost is over $150, then they will not make their desired profit and will probably choose to not move forward with selling desk chairs.
Related: What Is a Pricing Strategy?
What are the advantages of target pricing?
Here is a list of some of the advantages of using the target pricing method:
Target pricing is sensitive to the market, meaning that target pricing considers and responds to demand and supply.
Target costing results in higher profits for organizations by reducing the cost of manufacturing the product, since the selling price is fixed in advance.
It allows for a company to explore innovative and efficient utilization of resources.
It leads to creative and permanent ways to bring costs down and leads to technological and economic gains for the company.
Customers can enjoy better products at lower prices, as the company rather than the customer, takes on the responsibility of handling the costs, which means that there may be a greater volume of high value items available for purchase.
The business can better predict and respond to changes in the market since it fixes its price in the beginning of the process, and coordination among its various departments enables it to form a comprehensive strategy in the event of major shifts in market trends.
Related: Examples of Target Markets
What are the disadvantages of target pricing?
Here is a list of some disadvantages of target pricing:
The entire business strategy relies on the correct estimation of the product's final selling price. Any mistake on the price will negatively impact the rest of the marketing strategy.
If the company estimates a target price that is too low and gives the development and manufacturing departments constraints that are too rigid, then those departments will have to face the unrealistic burden of producing the product.
Occasionally, the business may use cheaper technology, materials or faulty designs in order to reduce production costs. This can result in a loss of reputation for the company and consumer distrust towards the products in the long run.
Since the business has to determine the amount of product it wants to sell at its target price, if the business doesn't sell the full stock amount of their product, it will experience losses.
Related: How To Calculate Selling Price
What are other methods of pricing?
Here are some other methods that businesses can use to price goods:
Cost-plus pricin**g:** This method first determines the cost of manufacturing the item and adds that to the company's desired profit margin to determine the selling price.
Value-based pricing: Value-based pricing uses the customer's perception of a product's value to set prices. Using this strategy involves measuring and analyzing your customer base's ideas about your product's worth. This strategy does not take into account the cost of production, therefore it does best in markets where prices generally exceed costs by a large margin.
Hourly pricing: Services, rather than goods or physical products, primarily use this model because it takes into account the labor that went into the service.
Fixed pricing: Also known as project-based pricing, fixed pricing involves one price for an entire contract or project. This method offers consistency for the customer and can maximize profits if the business can complete the project efficiently.
Equity pricing: In some cases, individuals will accept equity, or stock in a company, as compensation for their product or service. Choosing this pricing can depend on the size and success of the client and the anticipated performance of their stock.
Performance-based pricing: This option relies on the quality of a specific service provided to determine the price. Those who offer this model document their previous outcomes ahead of times and agree on a payment for the delivery of those outcomes.
Retainer pricing: Retainer pricing determines pricing for services and agreeing upon them with the customer before work is complete. Businesses set retainer prices using the value of the service provided. Some retainer pricing agreements allow the customer to keep leftover hours or billable units and use them during the next time period.
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