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
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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
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The Consumers 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 doesnt mean dropping
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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
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Pricing Objectives
Management should decide on its pricing objective before determining the price itself.
Profit-oriented objectives: 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: Increase sales volume. Maintain or increase market share. Status quo goals: Copyright 2001 13 - 6 Stabilize prices. McGraw-Hill Ryerson Limited

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
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Estimating Demand
Determine if there is an expected market price. Estimate sales volume at different prices. Expected price: The price that shows price what customers 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).

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Inverse demand:
When an increase in price results in increase d sales.
Normal demand curve Price

Inverse demand
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Quantity sold
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More About Demand Estimation

Competitive Reactions: Directly similar products affect price Available substitutes and generic competition for consumers 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?
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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
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450 400 350 300

Price

250 200 150 100 50 0 0 1

Graphical Illustration of Key Terms in Product Cost

Total cost Variable cost Fixed cost
2 3 4 5
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Quantity

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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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 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 highturnover 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 marketinfluenced pricing.
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Pricing by Intermediaries

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Pricing Through the Channel

Markup = 20% = $18
Manufacturers Cost = 80% selling price = $72 = 100% = $72 Wholesalers selling price = 100% = $90

Markup = 40% = $60

Retailers Cost to selling consumer price = $150 = 100% = $150

Cost and profit = 100% = $72

Cost = 60% = $90

MANUFACTURER

WHOLESALER

RETAILER

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 firms 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
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Break-Even Analysis Illustration

$100,000 90,000 80,000 Cost, revenue, profit 70,000 60,000 50,000 40,000 30,000 20,000 LOSSES 10,000 0 100 200 300 400 500 600 700 800 900 1000 1100 1200 Quantity in units Copyright 2001 McGraw-Hill Ryerson Limited 13 - 18 Total fixed costs BREAK-EVEN POINT
To r al t ru e 0p i t) n 8 t$ a e( PROFITS nu e ev
To ts cos tal

Total variable costs

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
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