In the modern day’s market, however, the number of factors being weighed into the consideration of a product’s price has risen significantly: Shipping costs and marketing alone provide a major contribution to the increase of the product’s final asking price. In order to adhere to the new way business works, many manufacturers looked for a way to ensure each product, however successful, will be able to remain economically viable.
Target profit pricing enables the manufacturer to estimate, even in the very early production stages, the final asking price he will have to set in order to maintain a profitable product. This lets a variety of products to be eliminated from the get-go, as they are deemed unfit to produce profits.
The process of target profit pricing usually involves four main stages:
Stage A – A thorough market research focused on understanding the competition: What are the products your product will be up against? What kind of companies stand behind them? Is the competing product the flagship of a rival company or a mere side effort that is not a key factor in the company’s revenue stream? These questions help the manufacturer to determine at which price the product remains competitive and will not seem too expensive.
Stage B – Designing the profit margins on the product: What is the profit the company needs to make in order to remain viable? Or in order to expand to other endeavours? This stage has as much to do with expectations as it has to do with concrete-solid business plans: A company might rely on an expected profit from a product sold on quarter B to build a new factory in quarter C or re-buy stocks in quarter D.
Stage C – Calculating the desired price, by subtracting the target price from the desired profit margin. This yields a new figure: The Target Cost. This number determines the highest available cost at which the product can be designed and manufactured, while still maintaining the desired profitability.
Stage D – Production planning, in which the engineers and product designers try to create a manufacturing process that will amount to or below the target cost. Then the executive rank of the company weighs in all the different variables: Diminishing quality in cheaper processes, rarely-available materials in more expensive processes and other factors that might affect the end product. They then decide what the preferred method is, and authorize production start.
These four stages are not set in stone. It’s possible that smaller companies might not have production engineers and designers, but rather an individual or a small group that’s in charge of the manufacturing line, and they might decide on their own without consulting the executive rank – often because there is no one. Whatever size the company is, however – it’s crucial for the people who run it to comprehend the concept of target profit pricing as a business strategy utilized by many other big companies.