This approach to setting prices begins with a desired profit margin. A company calculates the necessary price to achieve this specific return, considering both fixed and variable costs, along with projected sales volume. For example, if a company invests $1 million in developing a new product and aims for a 20% return, it needs to generate $200,000 in profit. The price of the product will be set to ensure this profit target is met, given anticipated sales figures and production expenses.
Focusing on a predetermined profitability level provides businesses with a clear financial objective and aids in resource allocation decisions. By anchoring prices to desired returns, companies can better assess project feasibility and align pricing strategies with overall financial goals. This method has become increasingly prevalent in modern business, particularly in capital-intensive industries where significant upfront investments are required. Its roots lie in traditional cost-plus pricing but evolve the concept by incorporating specific profitability targets into the pricing equation.
