Chapter 10

Pricing
Idil Yaveroglu
Lecture Notes
What is a Price?
 The amount of money charged for a product or
service, or the sum of the values that consumers
exchange for the benefits of having or using the
product or service.

To the seller... To the consumer...

Price is revenue What is Price? Price is the cost
and profit source of something
Factors to Consider When Setting Prices
 PRICE CEILING
Customer Perceptions of Value
(no demand above this price)

INTERNAL CONSIDERATIONS EXTERNAL CONSIDERATIONS

Marketing Goals Nature of Market
Marketing-Mix Strategy Consumer Demand
Costs Competition
Organizational Considerations Environmental Factors

PRICE FLOOR
Product Costs
(no profits below this price)
Pricing Approaches
 Cost Based Pricing
 Value Based Pricing
 Competition Based Pricing
Cost Based Pricing
1. Cost-Based Pricing: Cost-Plus Pricing
 Adding a standard markup to cost
 Popular pricing technique because:
 It simplifies the pricing process
 Price competition may be minimized

 It is perceived as more fair to both buyers and sellers

Two kinds of mark-up applied:

 Cost plus percentage of cost
 Cost plus fixed fee
Disadvantages of Cost Based Pricing

 Ignoresdemand (price sensitivity)

 Does not account for competition

 May result in underpricing or overpricing

Costs

 Fixed Costs: Costs that do not vary with sales or production levels.
– Overhead: Executive salaries, rent
– Direct Fixed Costs: Advertising, marketing manager’s salary

 Variable Costs: Costs that do vary directly with the level of

production.
– e.g. raw materials

 Total Costs (for a given level of production)

 Determining Costs

 TC = FC + TVC
 TC = FC + (UVC)xQ
 AC = TC/Q
FC
AverageCostPerUnit( UnitCost)   UVC
Q

FC
BreakEvenPr ice  UVC 
Q(unit.sales)




Mark up Pricing
Margin = selling price – acquisition price of a good
( also called unit contribution, or markup )
Percent margin = margin / selling price
Mark up Percentage on Selling Price= margin / selling price
Mark up Percentage on Cost = margin / cost

Ex: If a retailer paid $150 for a lawnmower and sells it for $200, what is the markup as a percentage of
selling price? what is the markup as a percentage of cost?
Mark up Pricing

$5 $8 $10
$11

manufacturer’s wholesaler’s retailer’s

Margin margin margin
=
%=
Cost-Based Pricing Example
- Variable costs: $20 - Fixed costs: $ 500,000
- Expected sales: 100,000 units - Desired Sales Markup: 20%
- What is the selling price?

Variable Cost + Fixed Costs/Unit Sales = Unit Cost

$20 + $500,000/100,000 = $25 per unit

Unit cost + Markup (% of SP) = SP

$25 + SPx.20=SP

Unit Cost/(1 – Desired Return on Sales) = Markup Price (Selling Price)

$25 / (1 - .20) = $31.25
Cost Based Pricing
2. Cost-Based Pricing: Break-Even Analysis and Target
Profit Pricing
 Break-even charts show total cost and total revenues at
different levels of unit volume.
 The intersection of the total revenue and total cost curves
is the break-even point.
 Companies wishing to make a profit must exceed the
break-even unit volume.
Break Even Pricing

 “At price X, how many units do we need to sell

in order to break even?” (zero profit point)
Profit = TR – TC
$ TR
TR =PxQ
TC
TC = FC + (UVCxQ) Profits

Profit = PxQ – (FC + UVCxQ)

0 = Q(P - UVC) – FC Breakeven Point

Loss
FC
Q=
P - UVC
Quantity Produced and Sold

At break even price, TR=TC, and profits are zero

Break-even analysis chart for a picture frame store

Page #15
Slide 13-46
Break Even for Profit Goals
 Break even + target profit level

 Unit volume = Fixed cost + Profit Goal

Price – Variable Cost
Profit Pricing
Unit Contribution = Price – Unit variable cost
= P – UVC
Unit contribution is the amount that each unit contributes to covering fixed costs.

Total Contribution = Total revenue – Total variable cost

= PxQ – UVCxQ = ( P – UVC ) Q

Profit = Total revenue – Total cost

= Total contribution – Fixed cost
= PxQ – FC – ( UVCxQ)
= ( P – UVC ) Q – FC
Break Even BE q = FC/(P – UVC)
Example
Vandelay Ind. sells frozen pizza. Sales figures:

Price ($) Sales (weekly)

7.50 600
6.00 700
5.00 1000

What is the price that maximizes total contribution if the unit variable
cost is $4?
If FC are $2275/week how many more units would Vandelay have to
sell to break even at a selling price of $7.5?
Value Based Pricing
 Value-Based Pricing:
 Uses buyers’ perceptions of value rather than seller’s costs
to set price.
 Measuring perceived value can be difficult.
 Consumer attitudes toward price and quality have shifted
during the last decade.

 Good-Value Pricing
 Everyday low pricing (EDLP) vs. high-low pricing
 Value-Added Pricing
 Addingvalue added features and services to be able to
charge high prices
Competition Based Pricing
 Competition-Based Pricing:
 Also called going-rate pricing
 May price at the same level, above, or below the
competition
 Bidding for jobs is another variation of competition-based
pricing
 Sealed bid pricing
Other Internal and External Considerations
Affecting Pricing Decisions
Overall Marketing Strategy, Objectives and Mix
 Company pricing objectives may include;
 Survival
 Low prices to cover variable costs and some of fixed costs

 Current profit maximization

 Choose the price that maximizes current profit, cash flow or ROI

 Market share leadership

 As low as possible to increase market share

 Product quality leadership

 High prices to cover higher performance quality
Price vs. Non Price Positioning
Other External Considerations Affecting Pricing
Decisions – Nature of the Market

• Pure competition
– Many buyers and sellers who have little effect on price
– Commodity markets such as wheat, copper, produce
• Monopolistic competition
– Many buyers and sellers trading over a range of prices
– Sellers can differentiate their offer to the market
– Most consumer goods
• Oligopolistic competition
– Few sellers, each sensitive to others’ pricing and marketing strategies
– Car companies
• Pure monopoly
– Single seller
– May not charge full price: prevent entry, faster penetration, fear of regulation
– Utilities
Other External Considerations Affecting
Pricing Decisions – Consumer Demand
• Consumers compare the Perceived Value of the alternatives
 In general, consumers buy if perceived value > price

• Price Elasticity of Demand: how responsive the demand will be to a change

in price.

 What does elasticity depend on?

• Higher elasticity (ease of not buying)
– Availability of substitutes
– Inventory capabilities
• Lower elasticity
– Price=quality assumptions
– Uniqueness
– Low price relative to budget
– Purchasing for someone else
 Price Elasticity
A. Inelastic Demand -
Demand Hardly Changes With
a Small Change in Price.
Price

P2
P1

Q2 Q1
Quantity Demanded per Period
B. Elastic Demand -
Demand Changes Greatly With
Price

a Small Change in Price.

P’2
P’1

Q2 Q1
Quantity Demanded per Period
Total Revenue and Price Elasticity

Percentage change in Q
Elasticity (E) =
Percentage change in P

Inelastic Demand  E < 1  when P increases, TR increases

Elastic Demand  E > 1  when P increases, TR decreases

Unitary Elasticity  E = 1  P increase is offset by increase in Q

 no change in TR
 Total Revenue and Price Elasticity
28
Price Elasticity
 Buyers are less sensitive to price changes when,
 Product they are buying is unique
 When it is high in quality, prestige, or exclusiveness

 Substitutes are hard to find

 When the total expenditure for a product is low

relative to their income or when cost is shared by
another party
Other External Considerations Affecting Pricing
Decisions

 Nature of Market and Demand

 Competitors’ Strategies
 Economic Conditions
 Government Actions