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There are different types of pricing methods used by companies; one of these is the rate of return pricing. The Rate of Return pricing is a technique used to recoup the capital employed or achieve objectives by fixing the price of the product. This concept is congruent to return on investment with the exception being; the company can alter the cost of commodities to garner its goals like the desired profit (Shim, & Sudit, 2015).
The company starts by outlining its rate of return objectives for example 15% of sales revenue or 10% of invested capital. The price structure is then adapted to this objective to achieve the target rates of return.
Target return price= (invested capital*desired returns)/unit sales + unit cost
For instance, if company X has set the goal of achieving a 20% rate of return on products, then the rate of return pricing would be as follows.
The company produces tennis balls and has invested $1,000,000. The unit cost of a tennis ball is $16. Assuming that sales reach 50,000 units per annum, then;
Target return price= (1,000,000*20)/50,000) +16= $20
It is estimated that the company should price the tennis balls at $20 each.
The method is suited for markets where competition is low. However, its accuracy is adversely affected because it does not take into account the pricing of competition and price elasticity which are essential in the pricing of sets. As compared to break-even pricing methods, the accuracy of the rate of return pricing is also affected when production constraints emerge, and the company fails to make estimated units, losses can be experienced. As compared to the pricing method such as standard cost plus, the accuracy of the technique is limited because the company will be required to adapt its prices as demand changes.
Shim, E., & Sudit, E. F. (2015). How manufacturers price products. Strategic Finance, 76(8), 37.
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