Transcript Chapter 12 - Austin Community College

C H A P T E R
12
Price
Determination
and Pricing
Strategies
McGraw-Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives
After studying this chapter, you should be able to:


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Discuss the interrelationships among price, demand,
demand elasticity, and revenue.
Understand methods for determining price.
Recognize the different pricing strategies and the
conditions that best suit the choice of a strategy.
Recognize the importance of adapting prices under shifting
economic and competitive situations.
Understand the ethical considerations involved in setting
and communicating prices.
Bearden Marketing 5th Ed
12-2
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eBay
Founded in 1995, eBay continues
to be among the most consistently
profitable Internet companies; it is
used by millions of consumers
worldwide. The site offers online
trading opportunities in which
consumers can bid on products
and sellers can auction items for
sale. Of particular importance, and
unlike traditional exchange
relationships in the marketplace,
buyers have significant input into
the determination of prices.
Bearden Marketing 5th Ed
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Price Determination: An Overview
Exhibit 12-1
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12-4
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Price Determination: An Overview
The relationship between price and demand is
expressed in the traditional market demand curve
labeled D below. Under normal conditions, customers
buy more as prices drop; they buy less when prices rise.
Exhibit 12-2
Bearden Marketing 5th Ed
12-5
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Price Elasticity of Demand
Price elasticity of demand is a basic business concept.
The relationship between price and quantity demanded
varies; as one increases, the other decreases. Price
elasticity of demand is computed as follows:
% Change in quantity demanded
Price Elasticity of Demand =
% Change in Price
Elastic demand exists when small price changes result
in large changes in demand. When demand is elastic, a
small decrease in price increases total revenues. Elastic
demand prevails in the motor vehicles, engineering
products, furniture, and professional services industries.
Bearden Marketing 5th Ed
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Demand
Exhibit 12-3
Inelastic demand exists
when price changes do not
result in significant
changes in demand.
Cross elasticity of
demand relates the
percentage change in
quantity demanded for one
product to percentage
price changes for other
products.
Bearden Marketing 5th Ed
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Total Costs
Fixed costs (FC) such as plant and large equipment
investments, interest paid on loans, and the costs of
production facilities, cannot be changed in the short run and do
not vary with the quantity produced.
Variable costs (VC) such as wages and raw materials change
with the level of output.
Total costs (TC) are the sum of variable costs (VC) and fixed
costs (FC). Variable costs are made up of the variable cost per
unit times the number or quantity of units manufactured (Q):
TC = (VC X Q) + FC
Bearden Marketing 5th Ed
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Total Revenue
Marginal costs (MC) are incurred in producing one
additional unit of output.
Marginal revenue (MR) is the additional revenue the firm
will receive if one more unit of product is sold. This
amount typically represents the price of the product.
Total revenue (TR) is total sales, or price times the
quantity sold:
Total Revenue (TR) = Price X Quantity
Bearden Marketing 5th Ed
12-9
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Profits
To determine the price that maximizes profits, the firm
combines cost information with demand or revenue
information:
Profits = Total Revenue (TR) – Total Costs
This difference is greatest at the point where profits are
maximized, where the firm’s marginal revenue (MR)
equals marginal cost (MC). When marginal revenue
exceeds marginal cost, additional profits can be made by
producing and selling more product.
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12-10
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Markup Pricing
Retailers typically use some form of markup pricing,
where markup is the difference between the cost of an
item and the retail price, expressed as a percentage. A
product’s price is determined by adding a set percentage
to the cost of the product.
Markup
Markup as a % of selling price =
Selling Price
Markup
Markup as a % of cost =
Bearden Marketing 5th Ed
12-11
Cost
© 2007 The McGraw-Hill Companies, Inc. All rights reserved.
Break-Even Analysis
Exhibit 12-4
Break-even analysis is a useful
guide for pricing decisions. It
involves calculating the number of
units that must be sold at a certain
price for the firm to cover costs and,
hence, break even.
The break-even point (BEP) is
determined by the intersection of
the total revenue line (TR = P X Q)
and the total cost line (TC = FC +
VC X Q). The area between the two
lines and to the right of the
intersection represents profits. To
make a profit, the quantity sold
must exceed the BEP.
Bearden Marketing 5th Ed
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Target-Return Pricing
Target-return pricing is a cost-oriented approach that
sets prices to achieve some desired rate of return. Cost
and profit estimates are based on some expected
volume or sales level. The price is determined using this
equation:
(Desired return X Invested capital)
Price = Unit Cost +
Expected unit sales
Target-return pricing forecasts a fair or needed rate of
return.
Bearden Marketing 5th Ed
12-13
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Role of Cost in Pricing
Exhibit 12-5
Some Japanese firms use
an approach to pricing that
recognizes the effects of
price on demand and the
role of costs in determining
demand.
The Japanese specify a
target cost based on the
price they believe the
market is most likely to
accept. Designers and
engineers then meet target
costs.
Bearden Marketing 5th Ed
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Prices and Customer Value
Exhibit 12-6
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Pricing Strategies
Differential Prices
Product Line Pricing
Second-market discounting
Periodic discounting
Bundling
Premium pricing
Partitional pricing
Competitive Pricing
Psychological Pricing
Penetration pricing
Price signaling
Going-rate pricing
Odd-even pricing
Customary pricing
One-sided claims
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Industrial Pricing Strategies
Bearden Marketing 5th Ed
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Price Decreases
Price reductions are risky. Competitive
retaliation to price decreases is particularly
important. Firms may encounter three traps in
reducing prices:
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Low-quality trap—Buyers may question the quality of lowpriced products.
Fragile market share trap—Price-sensitive buyers may
switch to the next lower-priced product that comes along.
Shallow pockets trap—Higher-priced competitors that
reduce prices also may have longer staying power due to
higher margins.
Bearden Marketing 5th Ed
12-18
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Price Changes
Considerable research has been conducted regarding
the effects of price changes. These studies have
involved experiments in which price levels were
systematically varied and analyses of scanner data were
collected in-store. A review of these studies yielded the
following conclusions:
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Temporary retail price reductions substantially increase
store traffic and sales.
Large-market-share brands are hurt less by price
changes from smaller competitors.
Frequent price dealing lowers consumers’ reference
prices, which may hurt brand equity.
Price changes for high-quality brands affect weaker
brands and private-label brands disproportionately.
Bearden Marketing 5th Ed
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Price Discounts and Allowances
Cash
Discounts
Marketers offer cash discounts for
prompt payment by retailers. Terms of
payment may be “3/10, net 30”
Trade Sales
Promotion
Allowances
Trade sales promotion allowances
are concessions a manufacturer
pays or allocates to wholesalers or
retailers to promote its products.
Quantity
Discounts
Marketers give quantity discounts
when the customer buys large
quantities of a product.
Bearden Marketing 5th Ed
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Geographic Pricing
FOB Origin
Pricing
FOB stands for “free on board,” meaning
the goods are placed on a carrier and
shipped to the customer.
Uniform
Delivered Price
Using a uniform delivered price, the
company charges each customer an
average freight amount.
Zone Pricing
Zone pricing is an approach between
the previous two. Customers within an
area are charged a common price.
Freight
Absorption
Pricing
Bearden Marketing 5th Ed
Freight absorption pricing is a form of
geographical pricing. The seller absorbs
freight costs to attract more business.
12-21
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Competitive Pricing
In the United States, retail prices for most consumer goods
normally are not negotiable. However, outside the United
States, price negotiations for consumer goods occur regularly.
Likewise, almost all business-to-business purchases are
negotiated to some extent.
Sealed-bid
Pricing
Sealed-bid pricing is unique in that the
buyer determines the pricing approach
and the eventual price.
Reverse
Auctions
Reverse auctions, in which sellers bid
instead of buyers and prices fall instead
of rise, enable buyers to negotiate lower
prices from multiple suppliers.
Bearden Marketing 5th Ed
12-22
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Ethical Issues
Bait and
Switch
A bait and switch occurs when the retailer
advertises but does not actually offer a
reasonable amount of the promoted
product.
Predatory
Pricing
In some instances, companies charge very
low prices to drive competition from the
market. This practice is called predatory
pricing.
Unit Pricing
Unit pricing presents price information on
a per-unit weight or volume basis to
facilitate price comparisons across brands
and across package sizes within brands.
Bearden Marketing 5th Ed
12-23
© 2007 The McGraw-Hill Companies, Inc. All rights reserved.
Summary
After studying this chapter, you should be able to:





Discuss the interrelationships among price, demand,
demand elasticity, and revenue.
Understand methods for determining price.
Recognize the different pricing strategies and the conditions
that best suit the choice of a strategy.
Recognize the importance of adapting prices under shifting
economic and competitive situations.
Understand the ethical considerations involved in setting
and communicating prices.
Bearden Marketing 5th Ed
12-24
© 2007 The McGraw-Hill Companies, Inc. All rights reserved.