Pricing Strategy an important tool for your internet business

Buying a product from your mini mart, you will easily come across so many divest products with similarities from different brand, Yet each has a different price, and each product has a different price strategy. These are marketing decisions, pure and simple. The 4 Ps of Marketing are elements of the marketing mix that you can control. Price is one of the key elements in a winning marketing mix.
Doing business on the internet without having a pricing strategy is a doom, sometime, it may seem pretty simple on the surface; your company's pricing strategy can easily mean the difference between thriving and going bankrupt. A lot of factors are involved.
One of the first questions you need to answer are as follows: -
1.What are your site visitors like?
2.Are they bargain hunters?
3.Or do they look for excellence in customer service?
4.Or shop for products based on their prestige value?
5.Another important question is what does it cost you to purchase (or produce) and market this product or service?
Your price will have to be above your costs -- most of the time. Here are the various pricing objectives you'll want to consider.

Pricing Objectives
Two main pricing objectives stand out:

•To maximize short-term profits. Here you try to squeeze as much money out of sales of the product as possible, even though fewer customers may make a purchase. Your strategy may be to charge premium prices for website design services. You end up with less customers, but then dealing with a lot of customers multiplies your problems. And you can make more profit off each customer. Or you may need to maximize profits in order to satisfy an impatient boss or investor.
•To gain marketshare. The other main strategy is to price your service lower to gain marketshare. You may want to maximize the number of subscribers to your online Internet access business, even though you don't make as much on each customer. But you know that later you'll be able to sell these subscribers other services such as web hosting, e-commerce, website design, DSL, and a host of others once they get comfortable with you. You don't make as much early, but you plan to make money later with "back end" sales.

Most importantly are these two above listed objectives, although two others objectives may be considered which includes: -
•To survive. Survival is a worthy goal. Sometimes companies lower prices so they can generate enough revenue to survive short term. But this isn't a very good long-term strategy. There's an old joke about the businessman who said he was losing money on every sale, but he expected to make it up in volume. Good luck. Sometimes it's better to call it quits before you lose even more.
•To help society. You might keep the price lower than "what the market will bear" in order to make essential products available to the consumers who would otherwise be priced out of the market. Altruism has its place. You don't have to make as much money as possible, unless making money is your only goal. For example, I really want to keep my consulting services priced within reach of small businesses. I long to see small businesses thrive; that's part of what makes me tick. But I also want to charge better-funded companies a more appropriate fee for the more extensive services I render them. The way I do this is to offer a standard product or service, and an economy service at a lower price, but with clear limitations.

Customer Demand
Consumer Demand is a crucial factor. Demand is driven by consumer tastes, consumer income, and the availability of other products at a different price. For example, if a competitor begins to sell 10 packs of iris chocolates at a lower price than yours, the demand for yours will decrease. Professional pricing consultants construct demand curves to determine absolute demand. An Educational center recently reduced the fees for admitting a new student into the school, for a duration of the first week, it was discovered just how much lowering the fees by 20 dollars, increments would increase the total number of registration by plotting registration figures on a demand curve.
Of course, commodities, well known products that are pretty much the same as every other similar product, are strongly affected by demand as well as supply. Take crude oil, for example. If it's abundant, prices drop. If it's in short supply, though, and customer demand remains constant, the price goes up. You could always sell beans or corn or pork bellies on your website. But the price would be constantly changing. You need a great product that you have more control over. Producing your own product, or getting exclusive marketing rights, of course, is best if you can do it.

But having a great and exclusive product is only half the battle. Making the customer aware of its existence and its value is the other, and that's the role of marketing. You can increase demand by advertising and careful pricing.

Estimating Revenue
Once you've established consumer demand, you need to estimate revenue. It'll help to master a few technical terms:
Total Revenue is the unit price multiplied by the quantity sold.
Average revenue is the average price the product sold for. This is still pretty simple. Now buckle your seat belts.
Price elasticity of demand is another concept. Think how much stretch a rubber band has in it. "Elastic demand" is when a small decrease in the price of Styrofoam cups produces a big increase in sales. "Inelastic demand" is when a small decrease in the price of cups makes only a tiny difference in sales.
Fixed cost comprises the fairly stable overhead costs of running the company, such as lease on the building, management salaries, insurance, and a Picasso print on the wall of your office.
Variable cost is the direct cost of production and marketing. This will vary with the number of goods produced and sold, such as labor and materials used in manufacturing. It costs you more for widget makers and widget glue when you produce more widgets.
Total cost is the sum of the fixed cost and the variable cost.
Break-even analysis is pretty straightforward. You determine the level of sales needed to cover the total costs and break even. Any sales after that start to accrue profits.
Determining the maximum profit point is a vital goal in pricing. This takes some research and then some mathematical analysis and graphing.

Pricing Approaches
Of course, pricing isn't just scientific. It has a lot to do with your particular niche on the Internet, and how you've determined you can best succeed. Below are some demand-oriented approaches to pricing:
1.Skimming pricing: - When you are offering a new or innovative product you can initially charge a high price, since the "early adopters" aren't very price sensitive. Then you lower prices to "skim" off the next layer of buyers, etc. Eventually, the price will drop as the product matures and competitors offer lower prices.
2.Penetration pricing: - You set a low initial price in order to penetrate quickly into the mass market. A low initial price discourages competitors from entering the market, and is the best approach when many segments of the market are price sensitive. Amazon.com, for example, offers a discount price and may lose money on the first sale, but this way they gain more customers who will purchase products later at a lower marketing cost (since it costs much less to attract them back for the second or third sale if they are happy with their first purchase experience).
3.Prestige pricing: - Cheap products are not taken seriously by some buyers unless they are priced at a particular level. For example, you can sometimes find clothing of the same quality brand at Nordstrom as you do at the Men's Warehouse. But because it is priced higher, Nordstrom's clientele believes it to be of higher quality.
4.Odd-even pricing takes advantage of human psychology that feels like $499.95 is less than $500. Studies of price points by direct marketers have found that products sell best at certain price points, such as $197, $297, $397, compared to other prices slightly higher or lower. Strange, we humans!
5.Demand-backward pricing is sometimes used by manufacturers. First, they determine the price consumers are willing to pay for a product using an approach such as Make Your Price Sell! (http://sales.sitesell.com/myps) automates. Then they work backward through the standard markups taken by retailers and wholesalers to come up with the price they can charge wholesalers for the product.
6.Bundle pricing is offering two or more products together in a single package price. This can offer savings to both the buyer and to the seller, who saves the cost of marketing both products separately. And the customer is willing to pay more because he perceives that he is getting a lot more, even though the cost to the seller may not really be that much more.

There are other cost-oriented approaches to pricing, this includes;
•Standard mark-up pricing: - Typically a manufacturer marks his price up 15% over his costs, a wholesaler 20% over his costs, and a retailer 40% over his costs. The retailer gets a larger markup based on the idea that, since he is closest to the end user, he is required to spend more services and individual attention meeting the buyer's needs.
•Cost-plus pricing adds a small percentage to the retailer's costs -- and "cost plus 5%" sounds so modest in ads for new cars! Ah! If only it were that simple.
•Experience curve pricing assumes that it costs a company less to produce a product or provide a service over time, since learning will make them more efficient.

Then there are competition-oriented approaches to pricing that you'll recognize:
•Customary pricing is where the product "traditionally" sells for a certain price. Candy bars of a certain weight all cost a predictable amount -- unless you purchase them in an airport shop.
•Above-, at-, or below-market pricing. Certain stores advertise "low cost" or "discount" pricing. Others price at the market, while others deliberately price above-the-market at premium prices to attract prestige buyers.
•Loss-leader pricing works on the basis of losing money on certain very low priced advertised products to get customers in the door who will buy other products at the same time.
•Flexible-price policies offer the same product to customers at different negotiated prices. Cars, for example, are typically sold at negotiated prices. Many B2B sales depend on negotiated contracts.

Once you have determined the list or quoted price you can make some special adjustments which includes;
Quantity discounts; encourage customers to buy larger quantities, and thus cut marketing costs.
Seasonal discounts; encourage buyers to stock inventory earlier than their normal demand would require. This enables the manufacturer to smooth out manufacturing peaks and troughs for more efficient production.
Rebates, such as $40 off Microsoft FrontPage 2000, are usually offered by the manufacturer, but sometimes a retail store will offer its own rebate. Rebates make marketing sense, since they strongly motivate sales, but often less than 50% of the buyers will remember to collect the receipt, proof-of-purchase, and rebate form, fill it out, and mail it prior to the expiration date. And, of course, the rebate is often subtracted from the list price of the item, which still has considerable profit built in. Rebate marketing is less than half as expensive to the marketer as the price cut would seem to indicate.
Trade discounts are offered by manufacturers to distributors or resellers in their distribution chain. For example, a manufacturer may quote list price of $1000 less 30/10/5, meaning 30% off the list price to the retailer, an additional 10% off the $1000 to the wholesaler, and an additional 5% off the $1000 to the jobber. This pricing will be expected if you have an online B2B store.
Cash discounts are sometimes offered for the costs saved from not having to extend credit and bill the buyer on an open account. This mainly affects B2B sales rather than retail.
Allowances may be permitted for trade-ins (not too many trade-in cars shipped by modem though) or by a manufacturer for promotional advertising that a retailer undertakes.
Geographic adjustments involve FOB (freight on board) pricing at the point of shipping.

Regulations on pricing
We need to note that there are various governmental regulations on pricing. If you sell outside your own country (and having a global marketplace is the beauty of the Internet!), you'll need to familiarize yourself with laws in other countries in other to get going. In most countries for example, conspiring with other firms to set prices for a product is called price fixing and is illegal. Price discrimination -- different prices to different buyers of the same goods or services is tricky. For instant in the US deceptive pricing is outlawed by the Federal Trade Commission. Predatory pricing that is, charging a very low price with the purpose of driving competitors out of business, is also illegal in the US under the Sherman Act and the Federal Trade Commission Act, but is hard to prove.

Lastly, you need to think through and then adopt a very deliberate price strategy for your business; will you sell what are essentially commodities and be the low price leader? Or the service leader? Will you deliberately price low in order to penetrate the market quickly and establish first-mover advantage? Or will you price high to skim off the early adopters at a premium profit? Will you bundle several products in order to make a greater profit? Will you round off to the nearest dollar or use an odd price approach? Do you have a new or exclusive product that you can study scientifically for the best price?

Most online businesses only guess at prices -- and most will be out of business in a few years as a direct result. The best online businesses are very deliberate about pricing, do their homework, and make changes quickly when necessary. Do your very best with pricing, After all, pricing is the only one of the 4 Ps of Marketing that brings revenue in rather than sending it out.

See you next time!!!!

Pricing Strategy a tool to position your company ahead of others

Taken a glance back to the last issue of the of Marketing Canada journal, summer 2009, vol 5, issue 3, I deal on the topic, “How Effective and Efficient is your Pricing Strategies” Today we will be going forward to see what pricing strategy can do to your business; how much should you charge for your products and services.
Pricing as be said over time as one of the most difficult, yet important part of a company strategies , issues you must face as a company is how much to charge for your products and services. Basically there is no one single right way to determine your pricing strategy, but there are some reasonable guidelines one need to follow in arriving at a pricing decision.
Let take a look at the definition of pricing again to have a clearer view of the topic.
What is pricing? Pricing is a method adopted by a firm to set its selling price. It usually depends on the firm's average costs, and on the customer's perceived value of the product in comparison to his or her perceived value of the competing products.

What is pricing Strategies? Price planning that takes into view factors such as a firm's overall marketing objectives, consumer demand, product attributes, competitors’ pricing, and market and economic trends.
The pricing strategy of your business can ultimately determine your fate. As a business owner you can ensure profitability and longevity by paying close attention to your pricing strategy.

Before we go further, let quickly look at some factors the company need to consider:

Positioning - How are you positioning your product in the market? Is pricing going to be a key part of that positioning? If you're running a discount store, you're always going to be trying to keep your prices as low as possible (or at least lower than your competitors). On the other hand, if you're positioning your product as an exclusive luxury product, a price that's too low may actually hurt your image. The pricing has to be consistent with the positioning. People really do hold strongly to the idea that you get what you pay for.

Demand Curve - How will your pricing affect demand? You're going to have to do some basic market research to find this out, even if it's informal. Get 20 people to answer a simple questionnaire, asking them, "Would you buy this product/service at Price X? Price Y? Price Z?" For a larger venture, you'll want to do something more formal, of course -- perhaps hire a market research firm. But even a sole practitioner can chart a basic curve that says that at Price X, X' percentage will buy, at Price Y, Y' will buy, and at Price Z, Z' will buy.

Cost - Calculate the fixed and variable costs associated with your product or service. How much is the "cost of goods", i.e., a cost associated with each item sold or service delivered, and how much is "fixed overhead", i.e., it doesn't change unless your company changes dramatically in size? Remember that your gross margin (price minus cost of goods) has to amply cover your fixed overhead in order for you to turn a profit. Many entrepreneurs under-estimate this and it gets them into trouble.

Environmental factors - Are there any legal or other constraints on pricing? For example, in some cities, towing fees from auto accidents are set at a fixed price by law. Or for doctors, insurance companies and Medicare will only reimburse a certain price. Also, what possible actions might your competitors take? Will too low a price from you trigger a price war? Find out what external factors may affect your pricing.

What next the company needs to do is to determine the pricing objectives. That is the aim of your pricing?

Short-term profit maximization - While this sounds great, it may not actually be the optimal approach for long-term profits. This approach is common in companies that are bootstrapping, as cash flow is the overriding consideration. It's also common among smaller companies hoping to attract venture funding by demonstrating profitability as soon as possible.

Short-term revenue maximization - This approach seeks to maximize long-term profits by increasing market share and lowering costs through economy of scale. For a well-funded company, or a newly public company, revenues are considered more important than profits in building investor confidence. Higher revenues at a slim profit, or even a loss, show that the company is building market share and will likely reach profitability. Amazon.com, for example, posted record-breaking revenues for several years before ever showing a profit, and its market capitalization reflected the high investor confidence those revenues generated.

Maximize quantity - There are a couple of possible reasons to choose the strategy. It may be to focus on reducing long-term costs by achieving economies of scale. This approach might be used by a company well-funded by its founders and other "close" investors. Or it may be to maximize market penetration - particularly appropriate when you expect to have a lot repeat customers. The plan may be to increase profits by reducing costs, or to upsell existing customers on higher-profit products down the road.

Maximize profit margin - This strategy is most appropriate when the number of sales is either expected to be very low or sporadic and unpredictable. Examples include custom jewelry, art, hand-made automobiles and other luxury items.

Differentiation - At one extreme, being the low-cost leader is a form of differentiation from the competition. At the other end, a high price signals high quality and/or a high level of service. Some people really do order lobster just because it's the most expensive thing on the menu.

Survival - In certain situations, such as a price war, market decline or market saturation, you must temporarily set a price that will cover costs and allow you to continue operations.

Note: it is important after having the information so needed and clear what we are trying to achieve, then we take a look at the pricing methods to help us achieve our real numbers.
Below are the Pricing Methods to consider

As mention earlier, there is no "one right way" to calculate your pricing. Once you've considered the various factors involved and determined your objectives for your pricing strategy, now you need some way to crunch the actual numbers. Here are four ways to calculate prices:

Cost-plus pricing - Set the price at your production cost, including both cost of goods and fixed costs at your current volume, plus a certain profit margin. For example, your widgets cost $20 in raw materials and production costs, and at current sales volume (or anticipated initial sales volume), your fixed costs come to $30 per unit. Your total cost is $50 per unit. You decide that you want to operate at a 20% markup, so you add $10 (20% x $50) to the cost and come up with a price of $60 per unit. So long as you have your costs calculated correctly and have accurately predicted your sales volume, you will always be operating at a profit.

Target return pricing - Set your price to achieve a target return-on-investment (ROI). For example, let's use the same situation as above, and assume that you have $10,000 invested in the company. Your expected sales volume is 1,000 units in the first year. You want to recoup all your investment in the first year, so you need to make $10,000 profit on 1,000 units, or $10 profit per unit, giving you again a price of $60 per unit.

Value-based pricing - Price your product based on the value it creates for the customer. This is usually the most profitable form of pricing, if you can achieve it. The most extreme variation on this is "pay for performance" pricing for services, in which you charge on a variable scale according to the results you achieve. Let's say that your widget above saves the typical customer $1,000 a year in, say, energy costs. In that case, $60 seems like a bargain - maybe even too cheap. If your product reliably produced that kind of cost savings, you could easily charge $200, $300 or more for it, and customers would gladly pay it, since they would get their money back in a matter of months. However, there is one more major factor that must be considered.

Psychological pricing - Ultimately, you must take into consideration the consumer's perception of your price, figuring things like:

Positioning - If you want to be the "low-cost leader", you must be priced lower than your competition. If you want to signal high quality, you should probably be priced higher than most of your competition.
Popular price points - There are certain "price points" (specific prices) at which people become much more willing to buy a certain type of product. For example, "under $100" is a popular price point. "Enough under $20 to be under $20 with sales tax" is another popular price point, because it's "one bill" that people commonly carry. Meals under $5 are still a popular price point, as are entree or snack items under $1 (notice how many fast-food places have a $0.99 "value menu"). Dropping your price to a popular price point might mean a lower margin, but more than enough increase in sales to offset it.
Fair pricing - Sometimes it simply doesn't matter what the value of the product is, even if you don't have any direct competition. There is simply a limit to what consumers perceive as "fair". If it's obvious that your product only cost $20 to manufacture, even if it delivered $10,000 in value, you'd have a hard time charging two or three thousand dollars for it -- people would just feel like they were being gouged. A little market testing will help you determine the maximum price consumers will perceive as fair.


HOW TO COMBINE ALL THESE CALCULATIONS TO COME UP WITH A PRICE.

Your price must be enough higher than costs to cover reasonable variations in sales volume. If your sales forecast is inaccurate, how far off can you be and still be profitable? Ideally, you want to be able to be off by a factor of two or more (your sales are half of your forecast) and still be profitable.

You have to make a living. Have you figured salary for yourself in your costs? If not, your profit has to be enough for you to live on and still have money to reinvest in the company.

Your price should almost never be lower than your costs or higher than what most consumers consider "fair". This may seem obvious, but many entrepreneurs seem to miss this simple concept, either by miscalculating costs or by inadequate market research to determine fair pricing. Simply put, if people won't readily pay enough more than your cost to make you a fair profit, you need to reconsider your business model entirely. How can you cut your costs substantially? Or change your product positioning to justify higher pricing?
Pricing is an important factor in determining the success of the company, you’re certainly going to make a profit on your products and services are taken the right step in pricing decision. Always remember something is ultimately worth only when someone is willing to pay for it.

Pricing Strategies in a Recession Period - Your Best Recession Strategy? Think Twice Before Price Cuts

Sales and profits are plummeting and customers are demanding better deals. What can you do to silence customer complaints, cover fixed costs, and buy time until the economy rebounds? Often, companies will cut prices. But is this knee-jerk reaction the best strategy for pricing your products in a downturn? Definitely no it may affect profitability when the economy rebounds, signal to your customers that you're easy prey for additional discounts, and cloud your brand's hard-earned image. Learn how to craft your pricing strategies to strengthen your business now and to help prime your business for later growth.

Before you think about adjusting prices, think again, a knee-jerk reaction to the recession is never good for business in the long run, and could even erode your brand image. Instead, make your pricing decisions based on clear strategic goals.
When times are good, pricing mistakes can be easily forgiven. But when the economy sours, a misguided pricing strategy can shrink profitability, warp customer relationships, and destroy a brand.

When sales and profits are plummeting and customers are demanding better deals, the instinctive response is to cut prices. This silences customer complaints, helps cover fixed costs, and buys time until the economy rebounds. A price cut can also boost sales quickly, especially when there is no money for advertising or other promotions.
But such a knee-jerk reaction may not be the best strategy; Price cuts now may affect your company's profitability when the upturn occurs. It may signal to customers that you're an easy prey for additional discounting. And it may cloud your brand's hard-won image.

Pricing decisions should not be viewed as Band-Aid solutions for bleeding income statements, they should be part of a long-term strategy for fiscal fitness. When economic storm clouds gather, trim your production levels, postpone expansion plans that aren't absolutely vital to your future growth, and slash nonessential costs wherever you can. This prepares you to pursue low-value business opportunities that help you maintain your cash flow without drastically reducing your production capacity.

Crafting the right pricing strategies will not only strengthen your business now, it will also prime it for growth later. To bolster sales while avoiding a price cut's dampening effect on long-term profitability, keep the following advice in mind:

Consider the impact
Profitability is not the only prism through which you should view pricing. Other important perspectives include:
•Volume. Too many firms fail to account for the effects of price on volume and of volume on costs. In a recession, trying to recover these costs through a price increase can be fatal.
•Impact on customer relationships. "Sucker pricing" This creates ill will and tarnishes your brand.
•Impact on the industry. Price cuts not backed by cost reductions often lead to competitive counterattacks, which erode profitability.

Adjust your sales goals
"Don't fight today's sales wars with yesterday's pricing strategies," says Mitchell. Sales goals set when checkbooks were open may no longer be suitable for a recession. Executives experience what Holden calls the "coffin corner of costing" when, for the purposes of making the numbers, they overemphasize capacity utilization and become willing to cut the price of high-value products. The wireless industry, for example, generated strong demand with its low pricing but then was unable to recover its costs of capital.

Instead of sales goals, set dollar contribution goals for products, market segments, and individual customers. To do this you may have to invest in financial systems that can track process costs as well as direct costs. Moreover, setting profitability goals may mean abandoning market-share goals. After all, a large market share doesn't necessarily mean increased profitability. But switching to profitability benchmarks can help you pursue other low-price business.

It may also make sense to change the basis for your pricing. Most expert believe that pricing based on value the economic or psychological benefits delivered by your product or service is much more effective than competitor, cost, or customer-driven pricing strategies. Remember, too, that the basis for customer value can shift when the economic climate changes. When times are good, customers often place a premium on your maintaining production capacity to ensure timely delivery of their orders; otherwise, their sales suffer. But in a recession, logistical services may be more valuable.

Understand your competitive advantage
In a recession, pricing should be shaped by industry position and long-term strategy. If your competitive advantage derives from a low-cost structure, cost cutting can pump up your market share, positioning your firm for a payoff when the economy improves. But a common mistake, says Holden, "is to use price as a competitive advantage for high-value products by giving away services or discounting to your best customers. You erode the base of profitable customers and reduce the potential for profitability when the recession ends."

Leverage your segmentation strategy
Especially if you have high fixed costs, use pricing to generate incremental revenue from your segmented customer base. Strive for "first-class," "business-class," and "economy" pricing, the way the airlines do. First-class customers receive extra value with minimal discounting; economy customers get minimum value. Such segmentation based on price sensitivity creates sales opportunities that can offset losses in other areas, especially since there is often little difference in production costs among the offerings.

Offerings can be segmented not only by value added but also by time (for example, peak-load purchasing), location, or purchase quantity. "The more you can slice and dice your prices and offerings without affecting your brand, the more you can sustain profitability," Dynamic pricing represents an extension of such a segmented pricing strategy; here, prices shift instantaneously in response to changes in supply and demand. Although the practice doesn't suit every company, early testers of dynamic pricing software have been pleasantly surprised to discover how much more they can charge without affecting sales volume. The consulting firm Accenture reports that a price increase of just 5% can improve operating profits by 55% if sales volume remains constant.

Pamper loyal customers
Losing a customer now represents a double whammy: It drains customer equity and raises the cost of acquiring a replacement. Keep your best customers happy by bolstering loyalty programs or providing additional services. Consider offering product training or other classes for your B2B customers—not only will it augment the value you offer customers, it will also make it more difficult for those customers to switch to another provider.

Plug revenue leaks
Companies can run aground on pricing gaffes once covered by the high tide of a good economy. A common oversight is not recovering all the costs involved in services, delivery, or other processes, says Mitchell. Set minimum order quantities so that processing costs won't eat all the profits. Strengthen your collection efforts to shrink the time between orders and receipt of payment. Without undermining customer value, establish a price menu for "free" services such as delivery or favorable payment terms. When sold separately, such offerings increase revenue opportunities. They also provide a benchmark value for customers who formerly discounted them because they were free.

In a recession, revenue leaks also occur because sales forces become less resistant to customer pressures. They knock down the price until the sale is won, despite the impact on profitability. Ideally, prices should be negotiated based on business rules volume, delivery, financing and not according to the negotiating skills of purchasing agents. They should also be based on the value to the customer. But sales forces often oppose value pricing because it usually means higher prices and a greater willingness to walk away from price-sensitive deals. To encourage the desired behavior, compensate your sales force based on its contribution to profitability and/or customer equity, not just on sales volume.

Shift the battleground
When you negotiate with customers, include other factors besides the payment amount—for example, payment terms or ongoing training in the conversation. Some additional suggestions:
•Change the volume requirement to raise revenue and lower unit costs.
•Bundle products that increase customer value.
•In exchange for a discount, ask for a multiyear contract to smooth out your revenue and production variability.

Protect your brands
Brands become more valuable during a recession period because they offer defensible margins. Sales of cosmetics often rise during a recession, The reason: They represent affordable luxuries or offer a psychological boost. So don't cut prices on your premium brands during a recession; they can be sold without discounts through word-of-mouth or channel promotions that increase visibility and appeal.

Getting The Most Out Of Your Price

When you are setting up a business for the first time, it can be quite difficult to know what price to set. You need to think about what your customers are willing to pay what the competition is charging and your costs.

As a rule of thumb, it is best to aim high as you can, as you should always lower your price rather than increase it. If your price is low, you may attract a lot of customers but you may lose them if you need to increase the price. You may also be losing money because your price does not cover your costs. Customers may think that if your product is cheap, it can't be good. Customers would be happy to pay for quality - value for money is often the best option.

When comparing your product to competitive products, you do not necessarily have to follow their pricing. Ask yourself if your product or service compares favourably and whether you can justify a higher price.
When considering your costs, it would be helpful if you did a forecast. This will allow you to be more informed and realistic about the price you charge. Bear in mind that you will need to charge a fair and competitive price with a reasonable profit. Your gross profit will need to cover all overheads and expenses. You take your money (your drawings) from what is left, that is your net profit.

Costing Formulae
There are three main costing formulae you can use to work out a cost for your service or cost for your product.

1 Daily/Hourly Rate
If you are providing a service, for example consultancy, you may find it useful to cost your service based on time calculation. You do this by first adding the number of days you will not be providing a service in the year. This will include weekends off, holidays, bank holidays, administration (about a day a week) and contingency days for any emergencies. Subtract this figure from the number of days in the year and this will give you your potential earning days. Then work out how many hours each day you will work and this will give you your total potential hours for the year.
To calculate your daily/hourly rate the formula is:
Business Overheads (fixed costs pa) + PSB (Personal Survival Budget - money taken out business to live on) divided by Number of days/hours available to sell = Cost per day/hour.

2 Cost of Product
The formula below applies if you are making something that you are going to sell.
Business Overheads + PSB divided by Production (the total number of items you produce) plus the Variable Cost per item (the variable costs per item will be know when you start making them) = Total Cost per item.

3 Mark up and margin
You business can only exist if you make a profit. The profit can either be as a percentage of the cost price or the selling price. If the profit is based on the cost price, it is known as Mark Up and can be expressed as follows:
Selling Price - Cost Price
--------------------------------------- x 100
Cost Price
If based on the selling price it is known as Margin and can be expressed as follow:
Selling Price - Cost Price
--------------------------------------- x 100
Selling Price
When pricing your product, make sure that the selling price provides an adequate margin to produce a profit.
There is no definitive method of setting a price. Your aim should be to set your prices initially at the level, which gives you your highest profits possible. Easier said than done!

Tips To Know When Setting Your Prices

Determining prices must be based on a broad, thoughtful basis. It requires a basic understanding of both your financial and business goals. Below are few principles to consider when you decide what prices to put on your product or service.

Keep your prices realistic. A realistic price is the price you set after taking into consideration various factors: the direction of your business, your cost structure and expenses, your resources and financial goals. Avoid setting your prices based on “what everybody is charging.” What is right for your competitors may not be profitable for your business. After all, their goals, strategies and financials may be different from yours. Research your competition and see what they are charging, but do not copy their pricing structure just to charge what everybody else is charging. Set your prices based on your own situation.

Cover all your costs. The price of your item should cover the costs associated with it, its contribution to the overhead, and profit. A successful pricing strategy is one that results in the most dollars after all your costs are met. Be careful in setting your prices too low: while it may attract a large sales volume, you may not be making enough revenue to cover the costs of selling the merchandise. If you set your prices too high, your sales volume may be so low you can't cover operating expenses.

Check your prices against inflation. Your prices must keep up with inflation. Inflation increases your cost of doing business, with the prices of your materials, overhead and other costs increasing. If you maintain your prices despite rising inflation, you will erode your profit margin. Allow your business to increase your prices at least once a year, but give your customers sufficient warning about the price increase. Once you’ve established your policies, constantly monitor your prices and operating costs to insure profit.

Include in your pricing the value of your time. Avoid committing the mistake of not including a salary for yourself, particularly if you are operating a service business. Your time is valuable, and you need to compute it in your pricing structure.

Customers are not always looking for the lowest price. Price is not always the topmost concern of customers. There are many customers who do not mind paying higher prices, particularly if they know that they are purchasing exclusive merchandise, or your business is located in a convenient or high-end location. Many customers are willing to pay premium prices for quality service: speedy delivery; helpful and friendly customer relations; excellent product knowledge, or satisfaction in handling complaints.

Price low, but smart. A common pricing strategy for small business. particularly new entrants into the market is to price low just to get the work. By pricing low, the aim is to penetrate the market and get as much repeat business.

However, be aware that pricing low can have adverse repercussions on your business. First, a low price may signal a low quality product and service. Be careful in setting prices too low. Second, it may be difficult to raise prices later on once customers are accustomed to your low prices. Third, your start-up business is yet to develop economies of scale that makes it hard to compete on price.

Use discounts with care. Offering discounts is a good strategy for encouraging repeat/bulk orders, bundling sales, and early payment of customers. Discounts also allow you to more quickly sell products with vanishing opportunity -- e.g. products with sell-by dates, seasonal and quick obsolescence like fashion and technology. You can also stimulate demand for your products during the times when your product/service is less popular. Discounts are also used to clear out merchandise that has become outdated.

How Effective and Efficient is your Pricing Strategies

First will shall be taken a look at the meaning of Pricing and Pricing Strategies this will gives us a good and clearer meaning of the topic.
What is pricing? Pricing is a method adopted by a firm to set its selling price. It usually depends on the firm's average costs, and on thecustomer's perceived value of the product in comparison to his or her perceived value of the competing products.

What is pricing Strategies? Price planning that takes into view factors such as a firm's overall marketing objectives, consumer demand, product attributes, competitors’ pricing, and market and economic trends.
The pricing strategy of your business can ultimately determine your fate. As a business owner you can ensure profitability and longevity by paying close attention to your pricing strategy.
Commonly, for many businesses, the pricing strategy has been to be the lowest price provider in the market. This approach comes from taking a superficial view of competitors and assuming one can win business by having the lowest price.

Below are some pricing strategies to consider.
Competitive pricing: Use competitors' retail (or wholesale) prices as a benchmark for your own prices. Price slightly below, above or the same as your competitors, depending on your positioning strategies. Note you must collect competitor pricing information by observation rather than by asking them. Otherwise it could be seen as collusion
•Cost plus mark-up: This is the opposite of competitive pricing. Instead of looking at the market, look at your own cost structure. Decide the profit you want to make and add it to your costs to determine selling price. While using this method will assure a certain per-unit margin, it may also result in prices that are out-of-line with customer expectations, hurting total profit.
•Loss Leader: A loss leader is an item you sell at or below cost in order to attract more customers, who will also buy high-profit items. This is a good short-term promotion technique if you have customers that purchase several items at one time.
•Close out: Keep this pricing technique in mind when you have excess inventory. Sell the inventory at a steep discount to avoid storing or discarding it. Your goal should be to minimize loss, rather than making a profit.
•Membership or trade discounting: This is one method of segmenting customers. Attract business from profitable customer segments by giving them special prices. This could be in the form of lower price on certain items, a blanket discount, or free product rewards.
•Bundling and quantity discounts: Other ways to reward people for larger purchases are through quantity discounts or bundling. Set the per-unit price lower when the customer purchases a quantity of five instead of one, for example. Alternately, charge less when the customer purchases a bundle or several related items at one time. Bundle overstocks with popular items to avoid a closeout. Or, bundle established items with a new product to help build awareness.
•Versioning: Versioning is popular with services or technical products, where you sell the same general product in two or three configurations. A trial or very basic version may be offered at low or no cost.

Avoiding the Lowest Pricing Strategy
Having the lowest price isn't a strong position for business. Larger competitors with deep pockets and the ability to have lower operating costs will destroy any small business trying to compete on price alone. Avoiding the low pricing strategy starts with looking at the demand in the market by examining three factors:
1. Competitive Analysis: Don't just look at your competitor's pricing. Look at the whole package they offer. Are they serving price-conscious consumers or the affluent group? What are the value-added services if any?
2. Ceiling Price: The ceiling price is the highest price the market will bear. Survey experts and customers to determine pricing limits. The highest price in the market may not be the ceiling price.
3. Price Elasticity: If the demand for your product or service is less elastic, you can then have a higher ceiling on prices. Low elastic demand depends on limited competitors, buyer's perception of quality, and consumers not habituated to looking for the lowest price in your industry.

The low price strategy is best avoided by small business but there are conditions such as a price war that can drag a company into the lowest price battle.

Evading a Price War
A price war can wreck havoc in any industry and leave many businesses, out of business. Care should be taken to avoid a Price war.
Take these tips to evade a deadly price war:
•Enhance Exclusivity: Products or services that are exclusive to your business provide protection from falling prices.
•Drop High Maintenance Goods: There may be products or services in your business that have high customer service and maintenance costs. Drop the unprofitable lines and find out what customers don't want.

•Value-added: Find value your business can add to stand out in the marketplace. Be the most unique business in the category.
•Branding: Develop your brand name in the market. Brand name businesses can always stand strong in a price war.

Carefully, consider your price decisions. Your business depends on it.

Competitor profiling

Another common technique is to create detailed profiles on each of your major competitors. These profiles give an in-depth description of the competitor's background, finances, products, markets, facilities, personnel, and strategies. This involves:

•Background
1.location of offices, plants, and online presences
2.history - key personalities, dates, events, and trends
3.ownership, corporate governance, and organizational structure

•Financials
1.P-E ratios, dividend policy, and profitability
2.various financial ratios, liquidity, and cash flow

•Products
1.products offered, depth and breadth of product line, and product portfolio balance
2.new products developed, new product success rate, and R&D strengths
3.patents and licenses
4.quality control conformance
5.reverse engineering

•Marketing
1.segments served, market shares, customer base, growth rate, and customer loyalty
2.promotional mix, promotional budgets, advertising themes, ad agency used, and sales force success rate
3.distribution channels used, exclusivity agreements, alliances, and geographical coverage
4.pricing, discounts, and allowances

•Facilities
1.plant capacity, capacity utilization rate, age of plant, plant efficiency, capital investment
2.location, shipping logistics, and product mix by plant

•Personnel
1.number of employees, key employees, and skill sets
2.strength of management, and management style
3.compensation, benefits, and employee morale
•Corporate and marketing strategies
1.objectives, mission statement, growth plans, acquisitions, and divestitures
2.marketing strategies

Media Scanning

Scanning competitor's ads can reveal much about what that competitor believes about marketing and their target market. Changes in a competitor's advertising message can reveal new product offerings, new production processes, a new branding strategy, a new positioning strategy, a new segmentation strategy, line extensions and contractions, problems with previous positions, insights from recent marketing or product research, a new strategic direction, a new source of sustainable competitive advantage, or value migrations within the industry. It might also indicate a new pricing strategy such as penetration, price discrimination, price skimming, product bundling, joint product pricing, discounts, or loss leaders. It may also indicate a new promotion strategy such as push, pull, balanced, short term sales generation, long term image creation, informational, comparative, affective, reminder, new creative objectives, new unique selling proposition, new creative concepts, appeals, tone, and themes, or a new advertising agency. It might also indicate a new distribution strategy, new distribution partners, more extensive distribution, more intensive distribution, a change in geographical focus, or exclusive distribution. Little of this intelligence is definitive : additional information is needed before conclusions should be drawn.

A competitor's media strategy reveals budget allocation, segmentation and targeting strategy, and selectivity and focus. From a tactical perspective, it can also be used to help a manager implement his own media plan. By knowing the competitor's media buy, media selection, frequency, reach, continuity, schedules, and flights, the manager can arrange his own media plan so that they do not coincide.

Other sources of corporate intelligence include trade shows, patent filings, mutual customers, annual reports, and trade associations.

Some firms hire competitor intelligence professionals to obtain this information
New Competitors
In addition to analyzing current competitors, it is necessary to estimate future competitive threats. The most common sources of new competitors are:
•Companies competing in a related product/market
•Companies using related technologies
•Companies already targeting your prime market segment but with unrelated products
•Companies from other geographical areas and with similar products
•New start-up companies organized by former employees and/or managers of existing companies
The entrance of new competitors is likely when:
•There are high profit margins in the industry
•There is unmet demand (insufficient supply) in the industry
•There are no major barriers to entry
•There is future growth potential
•Competitive rivalry is not intense
•Gaining a competitive advantage over existing firms is feasible

Joint product pricing
Pricing for joint products is a little more complex that pricing for a single product. To begin with there are two demand curves. The characteristics of each demand curve could be different. Demand for one product could be greater than for the other product. Consumers of one product could be more price elastic than the consumers of the other product (and therefore more sensitive to changes in the product's price).
To complicate things further, both products, because they are produced jointly, share a common marginal cost curve. There are complexities in the production function also. Their production could be linked in the sense that they are bi-products (referred to as compliments in production), or they could be linked in the sense that they can be produced by the same inputs (referred to as substitutes in production). Also, production of the joint product could be in fixed proportions or in variable proportions.
When setting prices in a situation as complex as this, microeconomic marginal analysis is helpful. In a simple case of a single product, price is set at that quantity demanded where marginal cost exactly equals marginal revenue. This is exactly what is done when joint products are produced in variable proportions. Each product is treated separately. In fact, it might even be possible to construct separate cost functions. In the diagram below, to determine optimal pricing for joint products produced in variable proportions, you find the intersection point of marginal revenue (product A) with the joint marginal cost curve. You then extend that quantity, up to the demand curve for product A, and that gives you the profit maximizing price for product A (point Pa in the diagram). You do the same for product B, yielding price point Pb1.


Pricing of Joint Products
If the products are produced in fixed proportions (example: cow hides and cow steaks), then one of the products will very likely be produced in quantities different than the profit maximizing amount considered separately. In fact the profit maximizing quantity and price of the second half of the joint product, will be different than the profit maximizing amount considered separately. In the diagram, product B is produced in greater amounts than the profit maximizing amount considered separately, and sold at a lower price (point Pb2) than the profit maximizing price considered separately (point Pb1). Although price is lower and output is higher, marginal cost is also higher. Yet this is a profit maximizing solution to this situation. Quantity supplied of product B is increased to the point that marginal revenue becomes zero (i.e.: the point where the marginal revenue curve intersects the horizontal axis).

Transfer Pricing
Transfer pricing refers to the pricing of contributions (assets, tangible and intangible, services, and funds) transferred within an organization. For example, goods from the production division may be sold to the marketing division, or goods from a parent company may be sold to a foreign subsidiary. Since the prices are set within an organisation (i.e. controlled), the typical market mechanisms that establish prices for such transactions between third parties may not apply. The choice of the transfer price will affect the allocation of the total profit among the parts of the company. This is a major concern for fiscal authorities who worry that multi-national entities may set transfer prices on cross-border transactions to reduce taxable profits in their jurisdiction. This has led to the rise of transfer pricing regulations and enforcement, making transfer pricing a major tax compliance issue for multi-national companies.

Economic theory
The discussion in this section explains an economic theory behind optimal transfer pricing with optimal defined as transfer pricing that maximizes overall firm profits in a world with no taxes. In practice a great many factors influence the transfer prices that are used by multinationals, including performance measurement, capabilities of accounting systems, import quotas, customs duties, VAT, taxes on profits, and (in many cases) simple lack of attention to the pricing.
From marginal price determination theory, we know that generally the optimum level of output is that where marginal cost equals marginal revenue. That is to say, a firm should expand its output as long as the marginal revenue from additional sales is greater than their marginal costs. In the diagram that follows, this intersection is represented by point A, which will yield a price of P*, given the demand at point B.
When a firm is selling some of its product to itself, and only to itself (ie.: there is no external market for that particular transfer good), then the picture gets more complicated, but the outcome remains the same. The demand curve remains the same. The optimum price and quantity remain the same. But marginal cost of production can be separated from the firms total marginal costs. Likewise, the marginal revenue associated with the production division can be separated from the marginal revenue for the total firm. This is referred to as the Net Marginal Revenue in production (NMR), and is calculated as the marginal revenue from the firm minus the marginal costs of distribution.


Transfer Pricing with No External Market
It can be shown algebraically that the intersection of the firm's marginal cost curve and marginal revenue curve (point A) must occur at the same quantity as the intersection of the production division's marginal cost curve with the net marginal revenue from production (point C).
If the production division is able to sell the transfer good in a competitive market (as well as internally), then again both must operate where their marginal costs equal their marginal revenue, for profit maximization. Because the external market is competitive, the firm is a price taker and must accept the transfer price determined by market forces (their marginal revenue from transfer and demand for transfer products becomes the transfer price). If the market price is relatively high (as in Ptr1 in the next diagram), then the firm will experience an internal surplus (excess internal supply) equal to the amount Qt1 minus Qf1. The actual marginal cost curve is defined by points A,C,D.
If the firm is able to sell its transfer goods in an imperfect market, then it need not be a price taker. There are two markets each with its own price (Pf and Pt in the next diagram). The aggregate market is constructed from the first two. That is, point C is a horizontal summation of points A and B (and likewise for all other points on the Net Marginal Revenue curve (NMRa)). The total optimum quantity (Q) is the sum of Qf plus Qt.

Transfer Pricing with a Competitive External Market

Practical application
Role of Administrative Regulations and Guidelines
Although there is sound economic theory behind the selection of a transfer pricing method, the fact remains that it can be advantageous to arbitrarily select prices such that, in terms of bookkeeping, most of the profit is made in a country with low taxes, e.g. tax havens, thus shifting the profits to reduce overall taxes paid by a multinational group. However, most countries enforce tax laws based on the arm's length principle as defined in the OECD (Organisation for Economic Co-operation and Development) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, limiting how transfer prices can be set and ensuring that that country gets to tax its "fair" share. In the United States the pricing of transactions between related parties that are reported for tax purposes are governed by Section 482 of the Internal Revenue Code and the regulations there under.


Application of the Arm's Length Principle
Although there are discrepancies in the specifics of each country's laws concerning the application of the arm's length principle, the fact that they are primarily based in the OECD Guidelines means that, although such a strategy carries a greater taxation risk than solutions tailored to each country, global transfer pricing policies can be effectively used to determine an appropriate range representing the arm's length price for transactions carried out across a global enterprise.
However, different countries may accept different methods of calculating the transfer prices (i.e. Japan requires that the three "traditional" methods, outlined below, be systematically discounted before allowing the use of alternative methods, while the United States accepts the most appropriate method regardless), so care must be taken in such circumstances. In addition, some countries may have immature transfer pricing regimes or apply the arm's length principle in different ways—Brazil, for example, does not apply the arm's length principle despite the existence of transfer pricing legislation.
The following definitions are thus based on the OECD Guidelines.

Traditional Transaction Methods
The OECD Guidelines refer to the following methods as 'traditional transaction method':
Comparable Uncontrolled Price method (CUP);
Resale Price Method (RPM); and
Cost Plus Method (CP method or C+);
These are described below and are different from the transactional profit methods:
Profit split method; and
Transactional Net Margin Method (TNMM).
The OECD Guidelines prefer the use of the traditional transaction methods, whereby the other methods should be used as methods of last resort (for example when there is no data available or available data cannot be used reliably). However, the Guidelines stress there is no best-method rule: a taxpayer is only required to show that the method used delivers a reasonable (at arm's length) result and is not required to disprove the use of each other method than the method used. Regarding the 'reasonable outcome', the Guidelines note that transfer pricing is not an exact science

Comparable Uncontrolled Price method
The Comparable Uncontrolled Price (CUP) method compares the price at which a controlled transaction is conducted to the price at which a comparable uncontrolled transaction is conducted. Comparability between a controlled and uncontrolled transaction exists when there are no differences between these transactions or, if there are differences, when such differences do not have a material effect or for which reasonable adjustments can be made. Hence, an at arm's length transfer price can be determined through a comparison with the sales price between two unrelated corporations executing a (comparable) transaction. However, the fact that virtually any minor difference in the circumstances of trade (billing period, amount of trade, branding, etc.) may have a significant effect on the price makes it exceedingly difficult to find a transaction--much less transactions--that are sufficiently comparable.
Should they exist, such comparable transactions fall into two categories: external comparables and internal comparables. The former is a comparable uncontrolled transaction in the purest sense of the term--if Company A, in France, sells widgets to its subsidiary A(sub) in Turkey, then an external comparable transaction would be the sale of widgets from an unrelated French Company B to an unrelated Turkish Company C on comparable terms as the trade between Company A and its subsidiary A(sub). An internal comparable transaction, then, would be either the trade of widgets between Company A and an unrelated Company C, or the trade of widgets between an unrelated Company B and Company A's subsidiary, with the term "internal" referring to the fact that one of the parties involved in the tested transaction is also involved in the comparable uncontrolled transaction.

Cost Plus Method
The Cost Plus (CP) method, generally used for the trade of finished goods, is determined by adding an appropriate markup to the costs incurred by the selling party in manufacturing/purchasing the goods or services provided, with the appropriate markup being based on the profits of other companies comparable to the tested party. For example, the arm's length price for a transaction involving the sale of finished clothing to a related distributor would be determined by adding an appropriate markup to the cost of materials, labour, manufacturing, and so on. Cost-based method calculates transfer price on the cost of the goods or services available as per the cost accounting records of the company. The method is generally accepted by the tax customs authorities, since it provides some indication that the transfer price approximates the real cost of item. Cost-based approaches are, however, not as transparent as they appear. A company can easily manipulate its cost accounts to alter the magnitude of the transfer price. Companies that adopt the cost-based transfer pricing method have to choose between alternative approaches which are listed below :
Actual cost approach
Standard cost approach
Variable cost approach
Marginal cost approach

Apart from this, companies also have to decide on the treatment of fixed cost and research and development cost. These issues can prove problematic for the company that adopts a cost-based transfer pricing method. Cost-based method usually creates difficulties for the selling profit centre. As their incentives to be cost effective may fall, if they know that they can recover increased cost simply by raising the transfer price without an incentive. To produce efficiently the transfer price may erode the competitiveness of the final product in the market place.

Resale Price Method
The Resale Price (RP), while similar to the CP method, is found by working backwards from transactions taking place at the next stage in the supply chain, and is determined by subtracting an appropriate gross markup from the sale price to an unrelated third party, with the appropriate gross margin being determined by examining the conditions under which the goods or services are sold and comparing said transaction to other, third-party transactions. In our clothing example, then, the arm's length price would be determined by subtracting an appropriate gross margin from the price at which the distributor sold the products received from the manufacturer to third-party retailers--department stores, boutiques, etc.
In this example, both the CP and RP methods are being used to examine the same transaction--the one between the manufacturer and the distributor--meaning that the selection of one for use is ultimately dependent on the availability of data and comparable transactions. This flexibility is not available in other transactions, particularly those involving intangible goods (i.e. it is exceedingly difficult to determine the costs involved in developing technological know-how, and so the arm's length price for the payment of royalties from one company to another is best determined by working backwards from the profits gained based on the usage of the know-how--in other words, the RP method).

Transactional Profit Methods
The OECD Guidelines consider the following transactional profit methods: the Profit Split (PS) method and the Transactional Net Margin Method (TNMM). In principle, application of any other method which would deliver a reasonable at arm's length transfer price should not be disallowed.

Profit Split Method (PSM)
The PS method (and its derivatives, including the Comparative and Residual Profit Split methods) is applied when the businesses involved in the examined transaction are too integrated to allow for separate evaluation, and so the ultimate profit derived from the endeavor is split-based on the level of contribution--itself often determined by some measurable factor such as employee compensation, payment of administration expenses, etc.--of each of the participants in the project.
To present a highly simplified example, if Company A above sent three researchers to Company A(sub) to aid in the development of widgets tailored for the Turkish market while Company A(sub) allocated seven identically-compensated researchers to aid in the development, we would expect that Company A(sub) would pay Company A 30% of the royalty fee portion of the ultimate profits for the technical knowledge provided by Company A's researchers.

The residual profit split method initially focuses on the company in a controlled transaction which performs the most routine functions, for example toll-manufacturing or (limited risk) distributing services. Routine functions are functions which are low value-added compared to the overall profitability. Such company is generally referred to as 'least-complex entity'. The residual profit split method seeks to set the appropriate arm's length remuneration for such least-complex entity, whereby the remaining profit is allocated to the other company of the controlled transaction.
An example: Company A sells widgets through its subsidiary, a limited-risk distributor, in the Turkish market. Assume that an overall profit of 100 is made on the sale. The limited-risk distributor should receive an at arm's length return of 5. Then, the residual profit of 95 would be allocated to Company A, being the complex entity or entrepreneur. In case of an overall loss, the Turkish subsidiary should, in principle, continue to receive the arm's length return of 5.

Transactional Net Margin Method (TNMM)

TNMM, meanwhile, is a method that focuses on the arm's length operating profit (earnings after all operating expenses, including overhead, but before interest and taxes) earned by one of the entities (the tested party) in the transaction. It stipulates that relative operating profit (relative to sales, costs, or assets to allow comparisons between different companies or transactions) may be a more robust measure of an arm's length result when close comparables, as required for the traditional methods, are not available. For example, two distributors may sell different products that require different sales efforts per unit sold. This may lead to very different gross margins (and hence the resale price method may not be easily applicable). However, the operating margins would not be expected to be materially different since the margins reflects a competitive return only.
The margin is measured pre-interest since the level of interest expense is a function of how a company decides to finance its operations and unrelated to the transfer pricing.
Although not one of the traditional three methods, the TNMM and its counterpart under the U.S. transfer pricing regulations, the Comparable Profits Method or CPM is one of the most-widely used transfer pricing methods. See for example, the IRS' annual APA report which publishes details on the transfer pricing methods used in APAs.

Advance Pricing Agreement (APA)

An Advance Pricing Agreement/Arrangement (the specific terminology varies by country), or APA, is an agreement between the taxpayer and the competent taxation authorities that a future transaction will be conducted at the agreed-upon price, which is recognized as the arm's length price for the period designated. Although retroactive APAs can be used to reduce tax exposure in past years, APAs are primarily used to avoid the risk of future income assessment adjustments which, as in the case of GlaxoSmithKline, could lead to hefty payments in the future.

There are two types of APAs: unilateral and bilateral/multilateral APAs. A unilateral APA is, as its name suggests, an agreement between a corporation and the authority of the country where it is subject to taxation. Although simpler to implement than a bilateral/multilateral APA, a unilateral APA will not be recognized by a foreign tax authority, meaning that a U.S. company securing a unilateral APA for trade with its British subsidiary would still run the risk of being assessed should the foreign tax authorities not agree with the method of calculating the arm's length price, resulting in double taxation.

Bilateral/multilateral APAs, however, do provide such coverage, although their implementation requires a more lengthy application process, including consultation between and the agreement of all competent authorities involved.
Mutual agreement procedures
A mutual agreement procedure is an instrument used for relieving international tax grievances, including double taxation. Although the specifics vary based on the laws of each country, they are only carried out between authorities of countries or principalities with existing tax treaties--for example, it is impossible to relieve double taxation by holding mutual agreement procedures between the authorities of China and Taiwan.

Although most conventions require that each party to put forth all reasonable effort to resolve such disputes, they are generally not required to come to any sort of agreement. This means that although mutual agreement procedures can be an effective tool for the relief of taxation grievances, they are not fail-safes.
Some countries are beginning to insert into their tax treaties provisions for the mandatory arbitration of mutual agreement procedures that do not reach resolution after a period of time. Such arbitration provisions, for example Article 25 of the OECD model tax treaty as at 2008, are intended to ensure that double taxation disputes under tax treaties reach a final and relatively independent resolution within a fixed period of time.

Break-Even Point

What is Break-Even Point?
The Break-Even Point for a product is the point where total revenue received equals the total costs associated with the sale of the product (TR=TC). A break-even point is typically calculated in order for businesses to determine if it would be profitable to sell a proposed product, as opposed to attempting to modify an existing product instead so it can be made lucrative. Break even analysis can also be used to analyse the potential profitability of an expenditure in a sales-based business

Introduction

Break-even analysis is a technique widely used by production management and management accountants. It is based on categorizing production costs between those which are "variable" (costs that change when the production output changes) and those that are "fixed" (costs not directly related to the volume of production).
Total variable and fixed costs are compared with sales revenue in order to determine the level of sales volume, sales value or production at which the business makes neither a profit nor a loss (the "break-even point").

Graphing the Break-Even Point
Break-even point can also be indicated by graphing. Figure 1 below is a sample graph for a business. To draw the graph, we should follow these steps:
1.Number of units produced is marked along the horizontal axis and the total revenue expressed in dollars is set on the vertical axis.
2.The sales line is drawn to indicate the sales at each level of production.
3.A horizontal line is drawn at the $12,000 level of sales to represent the fixed costs for our sample business.
4.A total cost line is drawn from the point of intersection of the fixed cost line and the vertical axis to the point of total costs as full capacity --$28,000.
5.The intersection of the total cost line with the sales line represents the break-even point, in this case $20,000. The dotted lines represent the level of production and the total costs at this level of operation.
6.Areas of net loss and of net profit are marked.

The break-even point graph helps the business owner determine the levels of production that will create profits for every level of sales. The business owner then works to increase profits without investing extra funds. To do this, he/she should study the following important points:
1.A possible increase in utilization of existing capacity through reduction of idle time.
2.Better repair and maintenance of equipment to reduce down time --time elapsed from the moment the machine breaks down to the time it gets back in service.
3.Improved working schedules and inventory levels.
4.Longer business hours.
5.Improved production control.
6.Markup policy.

Let us take a closer look at two of these points.

Markup Policy
Another item to study when considering ways to improve profit without increasing investment is the company's markup policy. Markup is the amount above cost that the business charges for an item. Too many business owners believe that the only way to larger profits is through higher markups. As a result, they tend to use either a fixed percentage of cost markup or some vague and arbitrary "rule of thumb" which multiples costs by some mystical figure in the manager's head to arrive at the selling price.

Actually, markup should be flexible. Break-even analysis allows studies to be made of volumes of sales at various price levels. It is often discovered that a lover markup will produce a higher volume of sales and increased profits.
If a customer feels costs are too high he/she will take their business elsewhere. Reduced turnover means slow sales. It also means that the business owner may have to raise prices to cover its inventory investment. This will drive more customers away.
An appreciation of the meanings of break-even analysis can prevent such a vicious cycle from even starting.

Margin of Safety
Margin of safety represents the strength of the business. It enables a business to know that what is the exact amount he/ she has gained or lost over or below the breakeven point).
Margin of safety = (sales - break-even sales) / sales) x 100% If P/V ratio is given then sales/pv ratio

Fixed Costs
Fixed costs are those business costs that are not directly related to the level of production or output. In other words, even if the business has a zero output or high output, the level of fixed costs will remain broadly the same. In the long term fixed costs can alter - perhaps as a result of investment in production capacity (e.g. adding a new factory unit) or through the growth in overheads required to support a larger, more complex business.
Examples of fixed costs:
- Rent and rates
- Depreciation
- Research and development
- Marketing costs (non- revenue related)
- Administration costs

Variable Costs
Variable costs are those costs which vary directly with the level of output. They represent payment output-related inputs such as raw materials, direct labour, fuel and revenue-related costs such as commission.
A distinction is often made between "Direct" variable costs and "Indirect" variable costs.
Direct variable costs are those which can be directly attributable to the production of a particular product or service and allocated to a particular cost centre. Raw materials and the wages those working on the production line are good examples.
Indirect variable costs cannot be directly attributable to production but they do vary with output. These include depreciation (where it is calculated related to output - e.g. machine hours), maintenance and certain labour costs.

Semi-Variable Costs
Whilst the distinction between fixed and variable costs is a convenient way of categorizing business costs, in reality there are some costs which are fixed in nature but which increase when output reaches certain levels. These are largely related to the overall "scale" and/or complexity of the business. For example, when a business has relatively low levels of output or sales, it may not require costs associated with functions such as human resource management or a fully-resourced finance department. However, as the scale of the business grows (e.g. output, number people employed, number and complexity of transactions) then more resources are required. If production rises suddenly then some short-term increase in warehousing and/or transport may be required. In these circumstances, we say that part of the cost is variable and part fixed.

In Capital Budgeting
Break even analysis is a special application of sensitivity analysis. It aims at finding the value of individual variables which the project’s NPV is zero. In common with sensitivity analysis, variables selected for the break even analysis can be tested only one at a time.
The break even analysis results can be used to decide abandon of the project if forecasts show that below break even values are likely to occur.
In using break even analysis, it is important to remember the problem associated with sensitivity analysis as well as some extension specific to the method:
Variables are often interdependent, which makes examining them each individually unrealistic.
Often the assumptions upon which the analysis is based are made by using past experience / data which may not hold in the future.
Variables have been adjusted one by one; however it is unlikely that in the life of the project only one variable will change until reaching the breakeven point. Management decisions made by observing the behaviour of only one variable are most likely to be invalid.
Break even analysis is a pessimistic approach by essence. The figures shall be used only as a line of defence in the project analysis

Break-Even Point Calculation( BEP)
Calculation of the BEP can be done using the following formula:

BEP = TFC / (SUP - VCUP)

Where:
BEP = break-even point (units of production)
TFC = total fixed costs,
VCUP = variable costs per unit of production,
SUP = selling price per unit of production.

Benefits of Break-Even Analysis

The main advantage of break-even analysis is that it explains the relationship between cost, production volume and returns. It can be extended to show how changes in fixed cost-variable cost relationships, in commodity prices, or in revenues, will affect profit levels and break-even points. Break-even analysis is most useful when used with partial budgeting or capital budgeting techniques. The major benefit to using break-even analysis is that it indicates the lowest amount of business activity necessary to prevent losses.

Limitation of Break-Even Analysis

It is best suited to the analysis of one product at a time;
It may be difficult to classify a cost as all variable or all fixed; and
There may be a tendency to continue to use a break-even analysis after the cost and income functions have changed.

Summary
Break-even analysis and techniques are the tools that finally tell the business owner or manager when he/she is making a profit. Break-even charts and analysis will be part of every budget the business owner put out. They enable he/she to gauge the business' production rate accurately. They will tell whether an increase or a slowdown in production is called for. They are a vital part of the business owner's life

Markup (business)

What is Markup?

•Markup is the determination of a retail selling price, based on some percentage increase in the wholesale cost; also called margin. For example, a 20% markup on an item wholesaling at $100 would be $20, resulting in a retail selling price of $120. Typical markups are 28% for cameras, 41% for dresses, 46% for costume jewelry, and so forth. The size of retail markups tends to vary inversely with the wholesale cost and with turnover (the rate at which a quantity is sold).
•Markup is the amount by which the price of a product exceeds the cost of producing and distributing the product.

Initial Markup
The initial markup is the average markup required on all products to cover the cost of all items, incidental expenses, and to obtain a reasonable profit. The initial dollar markup is expressed as a percentage. Initial Dollar Markup = (Operating Expenses + Price Reductions + Profit) / (Forecasted Net Sales + Price Reductions)
Example:
Forecasted Sales = $380
Operating Expenses = $140
Anticipated Price Reductions = $24
Expected Profit = $38
($140 + $24 + $38) / ($380 + $24) = 50%
Thus the initial dollar markup on the product should be 50%. Price reductions, or markdowns, are reductions in the retail selling price when the item cannot be sold at its intended price and erode into profit. Operating expenses are costs incurred in addition to the total product cost and can vary depending on the product and service being sold. In reviewing operating expenses, annualized figures should be used since any individual month may not properly reflect the expenses incurred over a full year.
Initial pricing of a product is an important step in merchandising. The Keystone Method doubles cost of an individual product to arrive at its selling price (2 x total product cost ). The Dollar Markup Method takes into account the total amount of operating expenses and desired profit. These are then broke down on a per product unit basis, which is then added on to the total product cost. This addition onto the total cost is the dollar markup. This dollar markup is either expressed as a percentage of the total cost per unit or the selling price.

Price determination
1 As a fixed Amount
Assume:
retail list price = $1.99 and the product cost is $1.40
MARKUP = price − cost
1.99 − 1.40 = 0.59

assume the actual selling price was $1.60
MARKDOWN = List price − selling price
1.99 − 1.60 = 0.39

INITIAL MARKUP = list price − cost
1.99 − 1.40 = 0.59

MAINTAINED MARKUP = sale price - cost
1.60 − 1.40 = 0.20
2 As a percentage
INITIAL MARKUP % = initial markup / sale price
0.59 / 1.99 = 29%

MAINTAINED MARKUP % = maintained markup / sale price
0.20 / 1.60 = 13%

MARKUP % ON COST = markup / cost
0.59 / 1.40 = 42%

MARKUP % ON PRICE = markup / price
0.59 / 1.99 = 29%

To convert from markup on price to markup on cost:
MARKUP ON COST = markup % on price / (1 − markup % on price)
0.29 / (1 − 0.29) = 42%

To convert from markup on cost to markup on price:
MARKUP ON PRICE = markup % on cost / (1 + markup % on cost)
0.42 / (1 + 0.42 ) = 0.29

PRICE = cost / (1 − markup % on price)
1.40 / (1 − 0.29) = 1.99

COST = price / (1 + markup % on cost)
1.99 / (1 + 0.42) = 1.40

PRICE = markup / markup % on price
0.59 / 0.29 = 1.99
Cost-Plus Pricing with Elasticity Considerations
One of the most common pricing methods used by firms is cost-plus pricing. In spite of its ubiquity, economists rightly point out that it has serious methodological flaws. It takes no account of demand. There is no way of determining if potential customers will purchase the product at the calculated price. To compensate for this, some economists have tried to apply the principles of price elasticity to cost-plus pricing.
We know that:
MR = P + ((dP / dQ) * Q)
where:
MR = marginal revenue
P = price
(dP / dQ) = the derivative of price with respect to quantity
Q = quantity
Since we know that a profit maximizer, sets quantity at the point that marginal revenue is equal to marginal cost (MR = MC), the formula can be written as:
MC = P + ((dP / dQ) * Q)
Dividing by P and rearranging yields:
MC / P = 1 +((dP / dQ) * (Q / P))
And since (P / MC) is a form of markup, we can calculate the appropriate markup for any given market elasticity by:
(P / MC) = (1 / (1 - (1/E)))
where:
(P / MC) = markup on marginal costs
E = price elasticity of demand
In the extreme case where elasticity is infinite:
(P / MC) = (1 / (1 - (1/999999999999999))
(P / MC) = (1 / 1)
Price is equal to marginal cost. There is no markup. At the other extreme, where elasticity is equal to unity:
(P /MC) = (1 / (1 - (1/1)))
(P / MC) = (1 / 0)
The markup is infinite. Most business people do not do marginal cost calculations, but one can arrive at the same conclusion using average variable costs (AVC):
(P / AVC) = (1 / (1 - (1/E)))
Technically, AVC is a valid substitute for MC only in situations of constant returns to scale (LVC = LAC = LMC).
When business people choose the markup that they apply to costs when doing cost-plus pricing, they should be, and often are, considering the price elasticity of demand, whether consciously or not.

Geographical Pricing

Geographical Pricing is the practice of modifying a basic list price based on the geographical location of the buyer. It is intended to reflect the costs of shipping to different locations.

There are several types of geographic pricing:
•FOB origin (Free on Board origin) - The shipping cost from the factory or warehouse is paid by the purchaser. Ownership of the goods is transferred to the buyer as soon as it leaves the point of origin. It can be either the buyer or seller that arranges for the transportation.
•Uniform delivery pricing - (also called postage stamp pricing) - The same price is charged to all.
•Zone pricing - Prices increase as shipping distances increase. This is sometimes done by drawing concentric circles on a map with the plant or warehouse at the center and each circle defining the boundary of a price zone. Instead of using circles, irregularly shaped price boundaries can be drawn that reflect geography, population density, transportation infrastructure, and shipping cost. (The term "zone pricing" can also refer to the practice of setting prices that reflect local competitive conditions, i.e., the market forces of supply and demand, rather than actual cost of transportation.)
Zone pricing, as practiced in the gasoline industry in the United States, is the pricing of gasoline based on a complex and secret weighting of factors, such as the number of competing stations, number of vehicles, average traffic flow, population density, and geographic characteristics. This can result in two branded gas stations only a few miles apart selling gasoline at a price differential of as much as $0.50 per gallon.

Many businesspeople and economists state that gasoline zone pricing merely reflects the costs of doing business in a complex and volatile marketplace. Critics contend that industry monopoly and the ability to control not only industry-owned "corporate" stations, but locally owned or franchise stations, make zone pricing into an excuse to raise gasoline prices virtually at will. Oil industry representatives contend that while they set wholesale and dealer tank wagon prices, individual dealers are free to see whatever prices they wish and that this practice in itself causes widespread price variations outside industry control.

•Basing point pricing - Certain cities are designated as basing points. All goods shipped from a given basis point are charged the same amount.
•Freight-absorption pricing - The seller absorbs all or part of the cost of transportation. This amounts to a price discount, and is used as a promotional tactic

Cost-Plus Pricing
Cost-plus pricing is a strategy that is used to determine the retail and/or wholesale price of goods and services offered for consumption. Businesses of all sizes tend to use this simplistic pricing model as a guideline for arriving at sale prices that will allow the company to cover all costs associated with the production and sale of the products, and still make a reasonable profit from the effort. The basic formula for cost-plus pricing works as well for calculating pricing goods such as the cost of a meal in a café as it does for pricing services such as utilities or courier services.
The ultimate goal of cost-plus pricing is to allow the originator of a good or service to price goods and services in a manner that helps to ensure all costs associated with the effort are covered. At the same time, cost-plus pricing helps to promote the creation of a situation where the originator makes a profit and remains competitive with companies that offer similar goods and services. Fortunately, only a few simple pieces of information are required to establish a solid cost-plus pricing model for any business.

The first key component to calculating cost-plus pricing is to establish what it costs to actually produce the end product or service. This involves considering all expenses that go into the production process, such as raw materials, labor and production costs, packaging, transport, and sales and marketing expenses. By dividing the cumulative expenses associated with producing the products by the number of units produced, it is possible to arrive at what is sometimes referred to as the unit cost. The unit cost represents the minimum price that must be charged in order for the producer to recoup his or her investment into the creation of the unit.

Calculating price using the cost-plus method
There are several ways of determining cost, and the profit can be added as either a percentage markup or an absolute amount. One example is:
P = (AVC + FC%) * (1 + MK%)
Where:
P = price
AVC = average variable cost
FC% = percentage apportionment of fixed costs
MK% = percentage markup
For example: If variable costs are 30 dollars, the allocation to cover fixed costs is 10 dollars, and you feel you need a 50% markup then you would charge a price of 60 dollars:
P = (30 + 10) * (1 + 0.50)
P = 40 * 1.5
P = 60
**This equation states that 50% of the Total costs will be added on top of the total costs to get the selling price

An alternative way of doing a similar calculation is:
P = (AVC + FC%) / (1 − MK%)
** This equation states the total costs are 50% of the selling price**
These two mark up equations are slightly different, and yield different results. The first equation (40*1.5=60) The second equation (40/(1-.5)=80
If you are in the USA, it should be noted carefully that any pricing on a cost-plus contract can be audited by the government. How to do this pricing, what items can be included, and how the calculations are to be made is governed by the FAR (or Federal Acquisition Regulations). Failure to follow the precepts of FAR can lead to decreased contractor revenue or, in extreme cases, claims of penalties against the contractor under the False Claims Act and Contract Disputes Act.
To make things simpler, some firms, particularly retailers, ignore fixed costs and just use the purchase price paid to their suppliers as the cost term. They indirectly incorporate the fixed cost allocation into the markup percentage. To simplify things even further, sometimes a fixed amount is applied rather than a percentage. This fixed amount is usually determined by head-office to make it easy for franchisees and store managers. This is sometimes referred to as turnkey pricing.
Another variant of cost plus pricing is activity based pricing. This involves being more careful in determining costs. Instead of using arbitrary expense categories when allocating overhead, every activity is linked to the resources it uses.
Cost will need to be recalculated and the percentage markup wills likely need to be adjusted as the product goes through its life cycle. This is sometimes referred to as product life cycle pricing, although it is seldom done deliberately or in a planned and organized manner. Price skimming and penetration pricing are also types of product life cycle pricing but they are demand based pricing methods rather than cost based.


Advantages of Cost-Plus Pricing
1.Easy to calculate
2.Minimal information requirements
3.Easy to administer
4.Tends to stabilize markets - insulated from demand variations and competitive factors
5.Insures seller against unpredictable, or unexpected later costs
6.Ethical advantages

Disadvantages of Cost-Plus Pricing
1.Provides no incentive for efficiency
2.Tends to ignore the role of consumers
3.Tends to ignore the role of competitors
4.Use of historical accounting costs rather than replacement value
5.Use of “normal” or “standard” output level to allocate fixed costs
6.Inclusion of sunk costs rather than just using incremental costs
7.Ignores opportunity costs
8.Contractors may not focus on performance because the cost is always covered by the client