This method of pricing establishes the selling price based on a desired rate of return on investment. It requires calculating the total costs associated with production, including variable costs per unit and total fixed costs, and then factoring in the desired profit margin. For instance, if a company invests $1,000,000 in developing a new product, aims to sell 50,000 units, and desires a 20% return on investment, the desired profit is $200,000. Adding the total production costs to this desired profit and dividing by the number of units yields the target selling price per unit. This approach ensures that each unit sold contributes its share to achieving the overall profit objective.
Setting prices to achieve a specified return offers several advantages. It provides a clear financial objective and allows businesses to assess the viability of products or projects before launch. By linking price to investment and profit goals, this pricing model promotes financial stability and sustainable growth. Historically, this approach has been favored by industries with substantial capital investments, such as manufacturing and utilities, where a predictable and consistent return is crucial for long-term planning. However, its application extends to various business sectors seeking a structured approach to pricing.