Chapter 18: Price Setting in the Business World

Marginal Analysis

( Demand Oriented) Marginal analysis focuses on the changes in total revenue and total cost from selling one more unit to find the most profitable price and quantity. Marginal analysis shows how costs, revenue, and profit change at different prices. The price that maximizes profit is the one that results in the greatest difference between total revenue and total cost. The best pricing tool marketers have for looking at costs and revenue (demand) at the same time is marginal analysis. Marginal Analysis helps the find the right price. It focuses on the price that earns the highest profit. In all, Marginal analysis gets us close to a range of potential prices.

Three Kinds of Average Cost Pricing

1. Average Cost (Per Unit): is obtained by dividing total cost by the related quantity (that is, the total quantity that causes the total cost). 2. Average Fixed Cost (Per Unit): is obtained by dividing total fixed cost by the related quantity. 3. Average Variable Cost (Per Unit): is obtained by dividing total variable cost by the related quantity. In short, average-cost pricing is simple in theory but often fails in practice. In stable situations, prices set by this method may yield profits but not necessarily maximum profits. Another danger of average-cost pricing is that it ignores competitors' costs and prices. Just as the price of a firm's own product influences demand, the price of available substitutes may impact demand. By finding ways to cut costs, a firm may be able to offer prices lower than competitors' and still make an attractive profit

Demand-Oriented Price Sensitivity Factors

1. Customers tend to be more price sensitive the greater the total expenditure. 2. Customers are less price sensitive the greater the significance of the end benefit of the purchase. 3. Customers are sometimes less price sensitive if there are switching costs—costs that a customer faces when buying a product that is different from what has been purchased or used in the past. 4. Sometimes customers have low price sensitivity; perhaps they must have a product and few or no alternatives exist.

Factors Affecting Price

1. If prices are too low people question the quality, if prices are too high people simply won't buy. What is the lowest price that people won't question the quality. 2. What is the highest price that the product will be a bargain. 3. What is the price that the product is starting to get expensive? 4. At what price is the product too expensive to buy at all?

Demand Oriented Approaches

1. Marginal Analysis 2. Price Sensitivity 3. Value in use pricing 4. Reference Prices

Cost Oriented Approaches

1. Markups 2. Average cost pricing 3. Types of Costs 4. Break Even Analysis

Three Kinds of Total Cost

1. Total Fixed Cost: is the sum of those costs that are fixed in total—no matter how much is produced. Among these fixed costs are rent, depreciation, managers' salaries, property taxes, and insurance. Such costs stay the same even if production stops temporarily. 2. Total Variable Cost: is the sum of those changing expenses that are closely related to output—expenses for parts, wages, packaging materials, outgoing freight, and sales commissions. At zero output, total variable cost is zero. As output increases, so do variable costs. 3. Total Cost: is the sum of total fixed and total variable costs. Changes in total cost depend on variations in total variable cost, because total fixed cost stays the same.

BEP (units) formula

BEP (in units) = Total Fixed Cost / Fixed Cost Contribution per Unit The BEP can also be figured in dollars. The easiest way is to compute the BEP in units and then multiply by the assumed per-unit price. If you multiply the selling price ($1.20) by the BEP in units (75,000) you get $90,000—the BEP in dollars.

Cost Oriented Pricing

Cost-oriented pricing requires an estimate of the total number of units to be sold. That estimate determines the average fixed cost per unit and thus the average total cost. Then the firm adds the desired profit per unit to the average total cost to get the cost-oriented selling price. How customers react to that price determines the actual quantity the firm will be able to sell.

Subscription Pricing

Customers pay on a periodic basis for access to a product. Pioneered by newspapers and magazines, subscription pricing has become popular because it gives a seller a regular and predictable stream of revenue.

Average-Cost Pricing

Is common and can be dangerous: means adding a reasonable markup to the average cost of a product. To get the price, the producer decides how much profit per unit to add to the average cost per unit. If the company considers $0.45 a reasonable profit for each unit, it sets the new price up by that much.

Full Line Pricing

Method in which all items comprising a family of products are priced relative to one another, and are discounted as a package. Basically setting prices for a whole line of products.

Price Lining

Setting a few price levels for a product line and then marking all items at these prices. Assumes that customers have a certain reference price in mind that they expect to pay for a product. For example, many neckties are priced Page 494between $20 and $50. In price lining, there are only a few prices within this range. Ties will not be priced at $20, $21, $22, $23, and so on. They might be priced at four levels—$20, $30, $40, and $50. The main advantage is simplicity—for both salespeople and customers. It is less confusing than having many prices. Some customers may consider items in only one price class. For retailers, price lining has several advantages. Sales may increase because (1) they can offer a bigger variety in each price class and (2) it's easier to get customers to make decisions within one price class. Stock planning is simpler because demand is larger at the relatively few prices. Price lining can also reduce costs because inventory needs are lower.

Prestige Pricing

Setting a rather high price to suggest high quality or high status. Some target customers want the best, so they will buy at a high price. But if the price seems cheap, they worry about the quality and don't buy. Prestige pricing is most common for luxury products such as furs, jewelry, and perfume. It is also common in service industries, where the customer can't see the product in advance and relies on price to judge its quality.

Demand Backward Pricing

Setting an acceptable final consumer price and working backward to what a producer can charge. Commonly used by producers of consumer products, especially shopping products such as women's clothing and appliances. It is also used with gift items for which customers will spend a specific amount—because they are seeking a $10 or a $15 gift.

Complementary Product Pricing

Setting prices on several related products as a group. May lead to one product being priced very low in order to increase profits from another product, thus increasing the product group's total profits. EX: Pricing low for the razor (even maybe taking a loss) knowing people will pay hefty prices for the refillable blades. The cost of actual printers may be low, but the costs of ink cartridges is very high.

Value in Use Pricing

Setting prices that will capture some of what customers will save by substituting the firms product for the one currently being uses. which means setting prices that will capture some of what customers will save by substituting the firm's product for the one currently being used.

Leader Pricing

Setting some very lose prices- real bargains- to get customers into retail stores. The idea is not only to sell large quantities of the leader items but also to get customers into the store to buy other products. Certain products are picked for their promotion value and priced low but above cost. Leader pricing is normally used with products for which consumers do have a specific reference price.

Bait Pricing

Setting some very low prices to attract customers but trying to sell more expensive models or brands once the customer is in the store. Bait pricing is something like leader pricing. But here the seller doesn't plan to sell many at the low price. If bait pricing is successful, the demand for higher-quality products expands. Extremely aggressive and sometimes dishonest bait-pricing advertising has given this method a bad reputation. Some stores make it very difficult to buy the bait item. The Federal Trade Commission considers this type of bait pricing a deceptive act and has banned its use in interstate commerce. Even well-known chains like Sears have been criticized for bait pricing.

Break Even Point

The Sales quantity where the firm's total cost will just equal its total revenue. The BEP, in units, can be found by dividing total fixed costs (TFC) by the fixed-cost (FC) contribution per unit

Fixed Cost (FC) Contribution per Unit

The assumed selling price per unit minus the variable cost per unit. This can be stated as a simple formula:

Stockturn Rate

The number of times the average inventory is sold during a year.

Markup (Percent)

The percentage of selling price that is added to the cost to get the selling price. So the $1.20 markup on the $3.60 selling price is a markup of 33⅓ percent. Markups are related to selling price for convenience.

Predatory Pricing

The practice of charging a very low price for a product with the intent of driving competitors out of business or out of a market

Reference Price

The price the consumer expects to pay for a certain item; If a firm's price is lower than a customer's reference price, customers may view the product as a better value and demand may increase.

Markup Chain

The sequence of markups firms use at different levels in a channel—determines the price structure in the whole channel. The markup is figured on the selling price at each level of the channel. EX: Black & Decker's selling price for a cordless electric drill becomes the cost the Ace Hardware wholesaler pays. The wholesaler's selling price becomes the hardware retailer's cost. And this cost plus a retail markup becomes the retail selling price. Each markup should cover the costs of running the business and leave a profit.

Markup

a dollar amount added to the cost of products to get the selling price in order to make profits. Markups, however, usually are stated as percentages rather than dollar amounts.

Break Even Analysis

a method of determining what sales volume must be reached before total revenue equals total costs. Finds the Break Even Point

Odd-Even Pricing (psychological pricing)

a price tactic that uses odd-numbered prices to connote bargains and even-numbered prices to imply quality. is setting prices that end in certain numbers. For example, products selling below $50 often end in the number 5 or the number 9—such as 49 cents or $24.95. Prices for higher-priced products are often $1 or $2 below the next even dollar figure—such as $99 rather than $100.we

Product- Bundle Pricing

combining several products and offering the bundle at a reduced price. One price for several products. Firms that use product-bundle pricing usually set the overall price so that it's cheaper for the customer to buy the products at the same time than separately. A bank may offer a product-bundle price for a safe-deposit box, traveler's checks, and a savings account. Bundling encourages customers to spend more and buy products that they might not otherwise buy; because the added cost of the extras is not as high as it would normally be, the value is better.

Psychological Pricing

pricing goods and services at price points that make the product appear less expensive than it is. Setting prices that have special appeal to target customers. Some people think there are whole ranges of prices that potential customers see as the same.