Chapter 13 Price Determination

Chapter 13 Price Determination Sommers



Barnes

Ninth Canadian Edition Presentation by

Karen A. Blotnicky Mount Saint Vincent University, Halifax, NS Copyright © 2001 by McGraw-Hill Ryerson Limited

Chapter Goals To gain an understanding of: • The meaning of price • The significance of price ot the firm, and the consumer • How value related to price • Pricing objectives • Factors influencing price • Nature of costs • Approaches to determining price • Break-even analysis Copyright © 2001 McGraw-Hill Ryerson Limited

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The Meaning of Price

• Starts with monetary terms • But value is important; what does consumer get? • Price often depends on circumstances: you pay more to fly when you want to fly • Importance of Price: • In the economy, price allocates production factors • Consumers can be price-sensitive • Often judge quality by price • Value part of consumer perceptions of price • Individual firms need to set price within 4Ps

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The Consumer’s View of Price • some consumers are very interested in getting a low price and pay close attention to price • but, many are interested in other elements of the purchase, including brand, quality, etc. • there is a tendency to link quality with price • consumers are often prepared to pay more if they expect to get excellent service • adding value doesn’t mean dropping price

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The Customer Wants Value • price is not always an important factor in influencing a sale; the customer wants more than a low price, may be willing to pay more • the customer considers what he or she gets for the price paid; the seller must offer value • price of a product or service communicates a message to the consumer about quality • many firms place considerable emphasis on adding value for their customers

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Pricing Objectives Management should decide on its pricing objective before determining the price itself. Profit-oriented objectives: •Profit-oriented •Achieve a target return — pricing product to achieve a specified percentage return on sales or investment. •Maximize profits — followed by the most companies. Sales oriented goals: •Sales •Increase sales volume. •Maintain or increase market share. Status quo goals: •Status •Stabilize prices. •Meet competition. Copyright © 2001 McGraw-Hill Ryerson Limited

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Factors Affecting Price pricing must take the customer into account how price elastic is demand? do customers have an expected price in mind? for some products, demand is inverse; if price is increased, sales will actually increase • how is the competition likely to respond? • price must be consistent with and support other elements of the marketing mix • • • •

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Estimating Demand Determine if there is an expected market price. • Estimate sales volume at different prices. price The price that shows what customers • Expected price: think the product is worth. • Pricing a product within the expected price range helps gain support from middlemen. • It is possible to set a price too low, thereby losing sales (prestige issues). • Pricing too high also loses potential sales •

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Inverse demand: Normal demand curve

Price

When an increase in price results in increase d sales.

Inverse demand Copyright © 2001 McGraw-Hill Ryerson Limited

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More About Demand Estimation

• Competitive Reactions: • Directly similar products affect price • Available substitutes and generic competition for consumer’s dollars • Unrelated products seeking same consumer dollar • Other Marketing Mix Issues: • Product issues, e.g. new vs. established • Distribution issues-- if using wholesaler, what is wholesaler doing for you? • Promotion issues-- who does it? Copyright © 2001 McGraw-Hill Ryerson Limited

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Product Costs • The total unit cost of a product is made up of two basic costs: fixed or variable • Fixed cost remains constant regardless of the number of units produced. • Variable cost can be controlled in the long run by changing the level of production. • Total cost is the sum of fixed and variable costs at a particular level of production.

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450 400

Graphical Illustration of Key Terms in Product Cost

350

Price

300 250 200 150

Total cost

100

Variable cost Fixed cost

50 0 0

1

Quantity

2

3

4

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Cost-Plus Pricing Set price based on total cost of the unit plus desired profit. • Easy to apply, but ignores market demand. • Retailers that offer many services require larger markups than those that offer few.

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Pricing by Intermediaries

• Different types of retailers require different percentage markups because of the nature of the products handled and the services offered: • Low-turnover products (jewellery) need much larger markups than high-turnover products (groceries). • Retailers that offer many services require larger markups than those that offer few. • What seems to be cost-plus pricing for middlemen is usually market-influenced pricing. Copyright © 2001 McGraw-Hill Ryerson Limited

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Pricing Through the Channel Markup = 40% = $60

Markup = 20% = $18

Cost and profit = 100% = $72

Manufacturer’s Cost = 80% selling price = $72 = 100% = $72

MANUFACTURER

Wholesaler’s selling price = 100% = $90

WHOLESALER

Cost = 60% = $90

RETAILER

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Retailer’s Cost to selling consumer price = $150 = 100% = $150

CONSUMER

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Assumptions Underlying Break-Even Analysis • Two assumptions underlie these calculations: • Total fixed costs are constant. • Variable costs remain constant per unit of output. • These assumptions are unrealistic in most real-world operations.

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Costs and Break-Even Analysis • cost is viewed as a floor under a firm’s price • many firms do not have particularly good cost data and may not know what it costs to produce a product or service • the break-even point is where total revenue equals total costs; will be different for each price -- lets a firm see what it will need to sell • break-even analysis is not a pricing strategy, but can offer useful information

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Break-Even Analysis Illustration $100,000 ) t i n ru

90,000

Cost, revenue, profit

80,000 70,000 60,000 50,000 40,000

BREAK-EVEN POINT

To

ta l

r

pe 0 $8 t (a PROFITS e nu e ev sts o c l Tota

Total variable costs

30,000 20,000 LOSSES

Total fixed costs

10,000 0 100 200 300 400 500 600 700 800 900 1000 1100 1200 Quantity in units Copyright © 2001 McGraw-Hill Ryerson Limited 13 - 18

Prices Set Based on Market Alone

• Pricing to meet the competition when there is: • Highly competitive market and undifferentiated products. • Kinked demand — a price raise above the prevailing market level results in a sharp drop in revenue. • An oligopoly (a few firms, similar products). • Pricing below competition, commonly used by discount retailers. • Pricing above competition, usually only when the product is distinctive or the seller has acquired prestige.

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