3.3.2 Price – Pricing Methods (Cambridge IGCSE Business Studies 0450)
Setting the selling price is a strategic decision that must help a business meet its commercial objectives. The syllabus requires you to:
- know the five pricing methods (cost‑plus, competitive/market‑oriented, penetration, skimming, and the concept of price elasticity of demand),
- explain the advantages and disadvantages of each method, and
- be able to recommend and justify the most suitable method in a given situation (AO4).
Price Elasticity of Demand (Key Concept)
Price elasticity of demand (PED) measures how the quantity demanded responds to a change in price.
- Elastic demand: a small change in price causes a proportionally larger change in quantity demanded (|%ΔQ| > |%ΔP|).
- Inelastic demand: quantity demanded changes little when price changes (|%ΔQ| < |%ΔP|).
Understanding PED helps you decide which pricing method is most appropriate – e.g. a highly elastic market often favours penetration pricing, whereas an inelastic market may allow skimming.
Note: calculations are not examined, but the concept must be understood for AO3/AO4.
1. Cost‑Plus Pricing
Price is set by adding a standard profit margin (markup) to the unit cost of production.
- Formula: \(P = C + (C \times m)\) where P = selling price, C = unit cost, m = markup rate (decimal).
Example: Unit cost = £50, markup = 20 % (0.20) → \(P = 50 + (50 \times 0.20) = £60\).
Advantages
- Ensures all costs are covered.
- Provides a predictable profit margin.
- Simple to calculate and explain to customers.
Disadvantages
- Ignores market demand and competitor prices – may be uncompetitive.
- Can lead to over‑pricing if costs rise unexpectedly.
When to use
Best for contract work, specialised products, or situations where costs are stable and a guaranteed profit margin is required.
AO4 Prompt
In a case study, justify whether cost‑plus pricing would help the firm achieve its profit target while remaining competitive.
2. Competitive (Market‑Oriented) Pricing
The price is set primarily on the basis of competitors’ prices rather than on internal cost calculations.
Advantages
- Helps maintain market position in a price‑sensitive market.
- Responsive to changes in rival pricing.
- Useful when products are undifferentiated.
Disadvantages
- Requires continuous market monitoring.
- May trigger price wars and erode profit margins.
- Does not guarantee coverage of all costs.
When to use
Suitable for commodities, generic grocery items, or retail sectors where products are largely similar.
AO4 Prompt
Explain why a retailer of generic grocery items would choose competitive pricing over cost‑plus pricing.
3. Penetration Pricing
A low introductory price is used to gain market share quickly.
Advantages
- Attracts price‑sensitive customers.
- Discourages new entrants.
- Can achieve economies of scale through higher volume.
Disadvantages
- Low early profits.
- May create a perception of low quality.
- Later price increases can be difficult and may alienate early adopters.
When to use
Ideal for new entrants or mass‑market products where rapid market‑share growth is a priority.
AO4 Prompt
Recommend penetration pricing for a new smartphone brand and justify the choice in terms of market share and brand image.
4. Skimming Pricing
A high initial price is set to “skim” maximum revenue from customers willing to pay a premium.
Advantages
- Allows quick recovery of research & development costs.
- Targets early adopters who value innovation.
- Creates an image of exclusivity or high quality.
Disadvantages
- Limits the size of the initial market.
- Attracts competitors who may undercut the price later.
- May be perceived as “price‑gouging” if the price is reduced sharply after launch.
When to use
Used for innovative, high‑technology or luxury products where demand is initially inelastic.
AO4 Prompt
Evaluate whether a tech company should adopt skimming pricing for its latest tablet, considering both profit recovery and competitive risk.
5. (Optional) Dynamic / Variable Pricing – Extension
Dynamic pricing adjusts prices in real time in response to demand, supply, or other external factors. It is **not** part of the Cambridge IGCSE syllabus but is useful for enrichment or A‑Level study.
Advantages
- Optimises revenue per transaction.
- Highly flexible – can respond instantly to demand spikes.
Disadvantages
- Requires sophisticated data‑analysis systems.
- May frustrate customers if perceived as unfair.
Typical Use
Airlines, hotels, and online platforms where capacity is perishable and demand fluctuates sharply.
Cross‑Topic Connections
- Break‑Even Analysis: Cost‑plus pricing directly links to the break‑even point because the markup must cover both fixed and variable costs before profit is realised.
- Profit Targets: All methods can be evaluated against a firm’s profit target – e.g., skimming may achieve the target quickly, while penetration may require higher volume.
- Marketing Mix (4 Ps): Pricing interacts with product (quality/value), promotion (price‑related advertising), and place (distribution costs). A change in price often necessitates adjustments in the other three elements.
- Market Research: Accurate knowledge of PED, competitor prices, and customer price sensitivity is essential before selecting a pricing method.
- Regulatory Constraints: Price‑fixing laws prohibit collusion on price; businesses must ensure their pricing strategy complies with competition legislation.
Template for AO4 – Recommending & Justifying a Pricing Method
- Identify the business objective: profit maximisation, market‑share growth, rapid cost recovery, etc.
- Analyse the market situation:
- Nature of the product (innovative, commodity, perishable).
- Degree of price elasticity (elastic vs. inelastic).
- Competitive environment (few rivals, price wars, dominant players).
- Cost structure (stable vs. variable, high fixed costs).
- Select the most appropriate method: match the objective and market analysis to one of the five methods.
- Justify the choice: explain how the method helps achieve the objective, reference PED, competitor behaviour, and any cross‑topic considerations (break‑even, marketing mix, legal constraints).
- Consider limitations: acknowledge any disadvantages and suggest how the business could mitigate them.
Comparison of Pricing Methods
| Method |
Basis for Setting Price |
Primary Objective |
Key Advantages |
Key Disadvantages |
Typical Use |
| Core Syllabus Methods |
| Cost‑plus |
Unit cost + markup |
Cover costs & guarantee profit margin |
Simple; predictable profit; ensures cost recovery |
Ignores market demand; can be uncompetitive |
Manufacturing, contract work, stable‑cost products |
| Competitive (market‑oriented) |
Competitors’ prices |
Maintain market position |
Responsive to market; useful for undifferentiated goods |
Requires constant monitoring; risk of price wars |
Commodities, generic retail, supermarkets |
| Penetration |
Low introductory price |
Rapid market‑share growth |
Attracts price‑sensitive buyers; builds volume quickly |
Low early profits; possible low‑quality perception |
New entrants, mass‑market consumer goods |
| Skimming |
High initial price |
Maximise early revenue from innovators |
Fast R&D cost recovery; high margins; premium image |
Limited market size; invites competition |
Tech gadgets, luxury items, patents |
| Extension (Not required for IGCSE) |
| Dynamic (variable) |
Real‑time demand & supply data |
Optimise revenue per transaction |
Highly flexible; can increase profitability |
Complex IT systems; possible customer dissatisfaction |
Airlines, hotels, online ticketing platforms |
Decision‑Making Flowchart (Suggested Diagram)
Use this flowchart to decide which pricing method to adopt:
- Is the product innovative/high‑tech/luxury and demand appears inelastic?
- Is the product a new entrant in a **price‑sensitive** market (elastic demand)?
- Yes → Consider Penetration.
- Are costs stable and a guaranteed profit margin required?
- Yes → Consider Cost‑plus.
- Is the market **highly competitive** with similar products and little differentiation?
- Yes → Consider Competitive (market‑oriented).
- (Extension) Do you have the technology to adjust prices in real time?
- Yes → Consider Dynamic pricing (A‑Level/extra‑curricular).
Summary Checklist for Exam Answers
- State the chosen pricing method.
- Link the method to the business objective (profit, market share, etc.).
- Show understanding of price elasticity and the competitive environment.
- Explain at least two advantages and two disadvantages relevant to the case.
- Use the AO4 template to structure your justification.
- Briefly mention any cross‑topic implications (break‑even point, marketing mix, legal constraints).