Linear and Non-linear Pricing

Linear Pricing

When a customer pays the same price for each unit the seller is using “linear pricing”. The linear pricing method is not only easier to manage for business owners, it maintains the marginal profit on each item.

In the case of simple components where the crucial cost driver is evident (e.g. weight) a straightforward “rule-of-three” calculation is sufficient to determine the target price. Simple steel parts, products sold by the yard/meter, etc. are good examples.

The method may appear straightforward at first sight; however, the devil is in the details. The crucial cost driver is not always so easy to identify. Then there are cases in which the cost effect is far from clear. In the case of a casting, for example, both the weight and also the cross-section area of the mold can be relevant cost drivers.

The challenge is to pick the crucial cost driver out of all the possible ones. An appropriate method for this is simple correlation analysis. The result indicates the strength of the correlation between the cost driver and the price. The cost driver with the highest correlation to the price is the relevant one. After identifying the relevant cost driver with the aid of correlation analysis, the target price can then be determined, again using a rule-of-three calculation.

To be able to use linear performance pricing, however, following precondition must be met. There must be only one relevant cost driver, which usually means that the item concerned must be relatively simple. Simple parts that contain a large proportion of raw material are highly suited to this method, e.g. simple castings, crude steel, copper wire, etc. More complex parts, e.g. those involving various process steps, are not suited for linear performance pricing.

Pros and Cons of Linear Pricing

Linear pricing is a type of pricing strategy where the price of a product or service is based on the quantity of units sold. This means that each unit sold has the same price, regardless of how many units are sold. linear pricing can be used to encourage customers to buy more products or services, as they know that they will get the same price per unit regardless of how many units they purchase.

However, linear pricing can also have some disadvantages. For example, if a customer only wants to buy one unit of a product, they may be discouraged by the linear pricing structure as they would have to pay the same price as someone who buys multiple units. This could lead to lost sales for businesses who use linear pricing. Additionally, linear pricing can be difficult to maintain if there are fluctuations in demand for a product or service, as businesses may find it hard to adjust prices on a per-unit basis.

Alternatives to Linear Pricing

Tiered Pricing: Tiered pricing is a type of flexible pricing in which businesses charge different prices for different levels of service. For example, a business might offer a basic level of service for a lower price, and additional services for higher prices.

Flexible Pricing: With flexible pricing, businesses can charge different prices for the same product or service, depending on the customer’s needs. For example, a business might charge a lower price for a bulk order than it would for a single item.

Pay-as-you-go Pricing: With pay-as-you-go pricing, businesses charge customers based on their use of the product or service. For example, a business might charge per hour of use, or per month of service.

Flat Rate Shipping: Flat rate shipping is similar to free shipping, but with this option, businesses charge a flat fee for shipping, regardless of the order size or weight. This can be a good option for businesses that have low shipping costs.

Free Shipping: Many businesses offer free shipping as an alternative to linear pricing. With free shipping, businesses absorb the cost of shipping into their overall price. This can be a good option for businesses that have high shipping costs.

Drawbacks of Linear Pricing

The primary disadvantage of the linear pricing method is that it does not provide adequate incentive for customers to order in larger quantities. When customers order only single items, the price per transaction stays the same. Linear pricing also denies the business owner the opportunity to take advantage of economies of scale. Larger quantities allow businesses to combine incidental per-unit costs, such as shipping and packaging, into one order.

Nonlinear pricing

Nonlinear pricing is a broad term that covers any kind of price structure in which there is a nonlinear relationship between price and the quantity of goods. An example is affine pricing. A nonlinear price schedule is a menu of different-sized bundles at different prices, from which the consumer makes his selection. In such schedules, the larger bundle generally sells for a higher total price but a lower per-unit price than a smaller bundle.

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