Market-Based and Cost-Based Pricing in Cost Accounting
In cost accounting, market-based pricing sets the product price based on customer expectations and demand. You take a look at the customer’s perceived value of the product. Based on the customer view, you estimate how much he or she would be willing to pay.
Companies that face high levels of competition use market-based pricing. Customers may not see much difference between your product and that of your competitors. Say you sell lawn mowers. You compete with similar products that are all priced around $300. If you price your product at $350, a customer may not see any difference between you and the competition. The customer buys a lawn mower priced at $300 from somebody else.
With market-based pricing, you start at the top — with the price. After you nail down a price, you then look at costs. You compare price less costs to see if the profit is reasonable. There’s pressure not to raise your price; the only way to increase profit is to cut costs.
Cost-based pricing assumes that you can differentiate your product from your competitors. Think about the latest technology gadget. A certain number of people want to have a new device right after it’s launched, and they’re willing to pay quite a bit for that privilege.
Those customers perceive a high level of product value, even if the value is only in its being The Next New Thing. In high tech, the mantra is “Time to market is everything.” When the customer buys a hot product from a competitor, you won’t be selling to that customer.
Using cost-based pricing, you look at costs first. You then consider how high a price you can charge, based on your estimate of customer demand. This pricing method allows you to start at the bottom (costs) and work your way up to a price. You set that price as high as you reasonably can to maximize your profit.