Market-based pricing is a widely used approach to price setting. Whereas cost-plus pricing is a pricing method that resellers use to set prices for goods and services based on the costs incurred to obtain them, market-based pricing involves resellers setting prices based on what the market, or buyer, is willing to pay for particular goods and services.
Market-based pricing puts the market as a top priority in price setting. This means that a company may experience a significant markup if the market is willing to pay much more than the products cost. It also means a company might have to sell products at a loss at times, if the market is not willing to pay prices higher than the costs to obtain products for resale.
Supply and Demand
Market-based pricing has a strong correlation with an economic principle known as the law of demand. This law indicates that without the influence of other economic factors, demand is generally inversely related to price. Thus, when price goes up, demand typically goes down. When price goes down, demand usually increases. Market-based pricing generally makes sense when the law of demand strongly influences your ability to sell products at certain prices in the marketplace.
A primary benefit of market-based pricing is that it is timely compared to cost-plus pricing. Companies that use this approach are more equipped to adjust prices up or down as the market dictates. The airline industry uses market-based pricing to try to get as much value for each ticket as possible. Typically, airlines will sell higher-priced tickets well in advance of flight dates and lower tickets closer to the flight to fill remaining seats. Market-based pricing is generally a plus when products are in high demand.
Market-based pricing is generally less beneficial when demand is low as companies have a hard time getting appropriate return on their investment. It is also less predictable. With cost-plus pricing, companies can better predict markups and returns. Market-based pricing also limits a company's ability to justify a hike in prices by suggesting it is due to increased costs of doing business.