Target Return Pricing: How to Use it Efficiently?

28 October 2021 - 14:01, by , in Best practices in price monitoring, Comments off
Reading Time: 5 minutes

Target return pricing is a strategy that is used to set the product price based on the expected rate of return on the investment. Or in other words, it’s the profit that the firm can expect in the future from a certain investment. But wait, don’t get so easily scared away! We promise it’s not as complicated as it sounds. 

Let’s explain this strategy in more detail. 

How to set a product price that actually sells?

One of the first steps when it comes to developing a new product or service is deciding on the price. As you already know, the price can be a very fluctuating factor, and it will depend on many parameters. But, when a company says that they want to set the right pricing strategy, what they actually mean is that they are on the hunt for a price that sells. Logical question is – how to find it?

Target return pricing will help you, but let’s see how. One of the initial thoughts is of course how much will it cost you to produce something. Those are the initial costs that you’re able to foresee. For instance, if you spend $10 on making the products, and $4 to promote them, your outgoing is $14 which means that the product price can’t be lower than that if you want to sell effectively. Thus, the final price needs to be higher than the costs, but the million-dollar question is – how do you decide what is high enough?

It’s indisputable that every manufacturer thinks highly about its product, but let’s be real, the customers are the ones who have the final word. Numerous factors, especially nowadays, are affecting the customers’ willingness to pay, and all of them can be aggregated into psychological factors. So, besides the investor’s expectations and customers’ willingness to pay, what else is important? The time in which this return can be reached. If a company wants to get a high return over a short period, that means that they are aiming for high profitability in the short run. Moreover, the final price needs to be pretty high or the company won’t be able to meet such expectations. 

Target return price takes into account all these factors, and soon we’ll explain to you how to calculate it. But, our most careful readers are now reading this and thinking how is this any different from cost-plus pricing

Great question! Let’s get to it right away.

What is target return pricing?

As we said, target return pricing will help you aggregate all the costs and decide on the price that needs to be higher than that. So, you would be correct to say that in this case, the companies have a certain price as a target, and they are trying to reach it by using different methods. Truth be told, that sounds very like a cost-plus pricing strategy. So, where’s the catch?

Although these strategies seem similar, they are in fact, different and used in different business models. In the cost-plus pricing strategy, you start with the price, and then, as the name suggests, you add your margin and come to the final price. So, things such as time or sales volume are not playing an important role as they do in target pricing. 

To give an even more precise answer to this question, let’s see how to calculate the target rate of return. It’ll help us put things into perspective. 

How to calculate the target rate of return?

The rate of return (RoR) is the net profit during a specific time. It can be calculated by using the following formula:

Our initial value can be $4,000, and after a year, let’s say that our current rate is $10,000. Additionally, our RoR is 150%. This is also called the return of investment (RoI) or basic growth rate since it represents the amount of money that the investor (company) gained (or lost) from the given project. 

Let’s see one example. Hypothetically, we can be a manufacturer that produces premium phone cases that we want to sell for $25. If we want to make 30% of every sold product, our margin would have to be $7.5 per phone case. Further on, that means that our production costs per unit can not be higher than $17.5. 

As much as you would like to be the only one on the market, that’s probably not the case. So, it’s time to include the competitors into our equation. All these calculations are based on something that you can more or less control, but competitors are a completely unpredictable factor. Or maybe they are not? 🙂

If you’re trying to guess their actions and pricing strategies, then they will probably remain an unpredictable variable. But, if you spear some time to find an accurate price monitoring tool, the end result can be completely different. Price monitoring tool will help you understand the price changes, detect the patterns behind them, and analyze what steps your competitors are making and you don’t. You can monitor one competitor, (or as many as you want) and analyze their actions through various reports. This will be the final piece in your pricing strategy puzzle.

How others are doing it: examples of target return 

One of the first markets in which the target return pricing strategy emerged was the US. Transportation and the heavy equipment industry were the first industries to adopt this pricing model. Given the factors that characterize target return pricing, this information is not surprising. These are industries that have strong competition, complex supply chains, and long production cycles. What these companies have in common is that they all listen to the “customers’ voice”, strive to reduce production costs, and are very efficient in the process of shifting costs within supply chains. This strategy is still very present in these industries, especially in transport and logistics. Many studies on this topic speak in favor of this, such as Pricing in railway transport in Poland.

But, over the years, target return pricing has found its place in the price strategies of many other industries as well. 

Conclusion

We hope that you were able to learn a couple of more new things about target return pricing after this post. Maybe this strategy will be a game-changer for your business! Make sure to let us know your impressions! Even better – if you’re already using this strategy, please share your experiences with us and our readers. We’re always eager to hear and learn new things!

 

About Price2Spy

 

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This blog is a place for eCommerce professionals to discuss ideas, methodologies and strategies to compete more effectively in the ever more tightening world of online retail. We explore things like competitive price monitoring, competitor business intelligence, competitive pricing, and counter-intelligence in general.

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