THE FIRST CULTURE 

Chapter 9

PRICING
1. Pricing can be defined as a measure of the value exchanged by the buyer for the value
offered by the seller.

2. Unlike the other marketing mix elements, pricing decisions affect profits though their
impact on revenues rather than costs.

3. Pricing must also be consistent with other elements of the marketing mix since it
contributes to the overall image created for the product.

4. Pricing must be systematic and at the same time take into account the internal needs and
the external constraints of the organization.

5. Two broad categories of objectives may be specified for pricing decisions.

(a) Maximising profits is concerned with maximizing the return on assets or investments.
This may be realised event with a comparatively small market share depending on the
patterns of cost and demand

(b) Maintaining or increasing market share involves increasing maintaining the customer
base which may require a different, more competitive approach to pricing.

6. Cost is the amount of resources, usually quantified in monetary terms, which is allocated to
preparing a product for offer to market. In other words, everything we spend on making an
offering before we add the element of profit.

7. Profit is the excess over costs in revenue. In other words, when we receive a sum of money
from a sale whatever is left over when we have paid all our costs, it profit.

8. Cost accounting involves the calculation of costs of products (or services).

9. Direct cost: expenditure that can be economically identified with a specific saleable cost
unit.

10. Materials, labour costs and other expense can be classified as direct costs or as indirect
cost.

11. A direct cost is a cost that can be traced in full to the product, service, or department that is
being costed.

12. Direct costs are usually one of the three types.

(a) Direct material costs are the costs of materials that are known to have been used in
making and selling a product (or event providing a service).
(b) Direct labour costs are the specific costs of the workforce used to make a product or
provide a service. Direct labour costs are established by measuring the time taken for
a job, or the time taken in direct production work’.

1 
 
    THE FIRST CULTURE 

(c) Other direct expenses are those expenses that have been incurred in full as a direct
consequence of making a product, or providing a service, or running a department such
as the quality control laboratory.

13. Indirect cost: Expenditure on labour, materials or services which cannot be economically
identified with a specific saleable cost unit. Examples might include supervisor’s wages,
cleaning materials and buildings insurance.

14. An indirect cost or overhead is a cost that is incurred in the course of making a product,
providing service or running a department, but which cannot be traced directly and in full to
the product, service or department. Examples might include supervisor’s wages, cleaning
materials and building security cost.

15. Functional Costs

In a “tradional” costing system for a manufacturing organization, costs are classified as
follows.
 Production or manufacturing costs
 Administration costs
 Marketing, or selling and distribution costs
 General overheads

16. Manufacturing costs are associated with the factory, selling and distribution costs with
the sales, marketing, and warehousing and transport departments.

17. An administration costs are associated with general office departments (such as
accounting and personnel).

18. A fixed cost is the cost which is incurred for a period, and which, within certain output and
turnover limits, tends to be unaffected by fluctuations in the levels of activity (output or
turnover) whereas a variable cost is a cost which tends to vary with the level of activity.

19. The distinction between fixed and variable costs therefore lies in whether the amount of
costs incurred will rise as the volume of activity increases, or whether the costs will remain
the same, regardless of the volume of activity.

20. Direct material costs will rise as more units of a product are manufactured, and so they are
variable costs that vary with the volume of production.

21. Sales commission is often a fixed percentage of sales turnovers, and so is a variable cost
that varies with the level of sales (but not with the level of production).

22. The rental cost of business premises is a constant amount, at least within a stated time
period, and so it is a fixed cost that does not vary with the level of activity conducted on the
permises.

2 
 
    THE FIRST CULTURE 

23. Costs which a business is able to control in the short term are generally direct costs or
variable costs. Such costs may be avoided if output is lowered or particular activities not
undertaken. Controllable costs are sometimes called avoidable costs.

24. Costs which tend to be outside the short-run control of the business are uncontrollable
costs. Many fixed costs are often uncontrollable or unavoidable in the short run.

25. Short-term avoidable costs are therefore controllable whereas long-term commitments
are unavoidable.

26. Price elasticity measures the responsiveness of demand to changes in price. It is calculated
as:

% change in sales demand

---------------------------------
%change in sales price

27. When elasticity is greater than 1 (elastic), a change in price will lead to a change in total
revenue so that.
(a) If the price is lowered, total sales revenue will rise, because of the large increase in
demand
(b) If the price raised, total sales revenues will fall, because of the large fall in demand.

28. When elasticity is less than 1 (inelastic),

(i) If the price is lowered, total sales revenue will fall, because the increase in sales volume
will be too small to compensate for the price reductions.
(ii) If the price is raised, total sales revenue will go up because the drop in sales quantities
will be very small.

29. Price is the unit of revenue combining costs and profit at which a satisfactory exchange
takes place in a transaction. When multiplied by volume it equals.

30. Policy is a principle of how and organization operates: how it does something consistently
in a certain way as lay down by the management.

31. Pricing policy, therefore, is the outcome of management decisions about price which
derive from internal operational considerations about costs and external, customer-focused
considerations about value.

32. Whatever is sold has a cost, even if it is an article which has been given to you. You can
only sell it at the cost of not having it! This is called an opportunity cost. The value you
receive from selling it may just be the money which is received for it- you value the money
more than the product.

33. A selling price is an amount of money which describes a point in a process of exchange in
which two or more parties achieve satisfaction.

3 
 
    THE FIRST CULTURE 

34. Figure : Information/price model

Information to the market
High Low

High
Rapid Slow
skimming skimming
Price

Rapid Slow
Low penetration penetration

35. Strategy is the way which organizations meet their medium to long-term objectives by
using their resources in certain ways.

36. Marketing strategy is the way in which organization meet their marketing objectives by
manipulating (fine-tuning) the interactions of the components of the marketing mix to
achieve optimum customer response.

37. Pricing strategy and the marketing mix

Outlet A  Outlet c 
Low prices  Low prices 
Top brands  Top brands 
Well‐advertised  Well‐advertised 
Low quality staff  Low quality staff 
Poor access  Good access 
No Parking  Parking Charge 

Outlet B  Outlet D
High prices  ? 
Top brands  The output we do not yet 
Poorly advertised  know about because it is In 
Well trained staff  a backstreet and does not 
Good access  advertise at all 
Free Parking   

4 
 
    THE FIRST CULTURE 

38. Competitive advantage

Lower cost Differentiation
 
Broad  
target  Cost Leader ship  Differentiation  
 
 
Competitive    
Focus 
  Cost Focus Differentiation 
Narrow   Focus   
target 

39. Cost plus is the simplest method of pricing which a standard or traditional percentage is
added to the cost.

40. Target pricing is where an organization pitches a price which will deliver a target profit or
return on investment over a period. The use of breakeven analysis is very important here.

41. In perceived value pricing, the components of the marketing mix are combined to build up
a perception of value in the mind of purchaser.

42. Price followers are those entrants to a market who simply follow the existing players, very
often pricing just below the market leader.

43. Price leaders are those entrants who establish the going rate in a market thus providing
a basis for others to follow.

44. Cost leadership refers to those advantages which have been brought about by serious
consideration of cost factors.

45. Economies of scale put simply, means that the larger operation terms of output, the smaller
the costs for each unit of output.

46. Learning (or experience) curve: the phenomenon, of which we all have experience, which
demonstrates that, the more we do anything, the more efficient and effective we become at
it. Practice not only make perfect but also makes life easier. This idea has been applied to
pricing by assuming that costs will fall as production of new product builds up.

47. The competitive focus elements refer to the scope of operation of the organization.

48. The sales line, which starts at the origin (zero sales volume = zero revenue) and ends at the
point which signifies the expected sales.

49. The fixed costs line which runs above and parallel to the horizontal axis, at a point on the
vertical axis denoting the total fixed costs.

5 
 
    THE FIRST CULTURE 

50. The total costs line, which starts at the point where the fixed costs line meets the vertical
axis (at zero output), and ends at the point which represents, on the horizontal axis,
the anticipated sales in units, and on the vertical axis the sum of the total variable cost
of those units plus the total fixed costs.

51. The breakeven point is the volume level at which the revenue from sales exactly covers
total fixed and variable costs at a specific price, that is, there is no profit or loss.

52. The breakeven point can be calculated by using the following formula:
Fixed cost
53. Breakeven point =
Price- variable costs

54. The breakeven point can also be determined graphically using a breakeven chart which
shows approximate levels of profit or loss at different sales volume levels within a limited
range.

55. The breakeven point is the intersection of the sales line and the total costs line. By
projecting the lines horizontally and vertically from this point to the appropriate axes, it is
possible to read off the breakeven point in sales units and sales value.

56. The breakeven point is where total costs are matched exactly by total revenue.

57. Contribution: sales value less variable cost of sales.

58. Economies of scale: reductions in the average cost of production a product in the long run
as the output of the product increases.

59. A ‘traditional’ approach to pricing products is full cost plus pricing, whereby the sales
price is determined by calculating the full cost of the product and then adding a percentage
mark-up for profit.

60. A major drawback of cost-based pricing models is the failure to take account of demand
factors.

61. Price differences can be achieved in a number of ways.

(a) Through product quality
(b) Through design differences
(c) Through geographical location
(d) Through brand loyalty

62. Further objections to full cost plus pricing can be listed as follows.
(a) Budget
(b) Allocate
(c) Competition
(d) Inflexible

6 
 
    THE FIRST CULTURE 

63. Price theory (or demand theory) is based on the idea a connection can be made between
price, quantity demanded and sold, and total revenue.

64. In practice, businesses might not make estimates of demand at different price levels, but
they might still make pricing decision on the basis of demand conditions and competition in
the market.

65. Pricing elasticity of demand: a measure of the responsiveness of demand to changes in

price: the percentage change in the quantity of a good demanded, divided by the percentage
change in its price.

66. There are several ways in practice by which price discrimination can be exercised.
(a) Negotiation with individual customers.
(b) On the basis of quantities purchased.
(c) By product type.
(d) By time
(e) By location

67. The price leader indicates to the other firms in the market what the price will be, and
competitors then set their prices with reference to the leader’s price.

68. An average price strategy and a lowest strategy are two forms of strategy based on what
competitors charge.

69. A lowest price strategy might be associated with market aggression or low quality.

70. When a firm sells a range of related products, or a product line, its theoretical pricing policy
should be to set prices for the products which maximize the profitability of the line as
a whole.

71. Inter-related demand occurs when two or more products in a line are either substitutes or
complements. Tea and sugar (or sweeteners) are examples of complementary products:
if the price of tea rises, the demand for sugar may well fall.

72. Cross elasticity of demand: a measure of the responsiveness of demand for one good to
changes in the price of another: the percentage change in the quantity demanded for one
good divided by the percentage change in the price of the other good.

73. Discounts are reductions in list, advertised or quoted prices offered by sellers to buyers.
74. Discounts can be categorized as follows.
(a) Quantity discounts
(b) Cumulative quantity discounts
(c) Cash discounts
(d) Sale prices
(e) Trade discounts

75. Monopolistic market structures price competitive may be avoided by tacit agreement
leading to concentration on non-price competition.

7 
 
    THE FIRST CULTURE 

76. Whether agreements exist at all is hard to prove, as the competitors are exposed to the
same market forces, so would expect to set similar price. This is a problem for
government when attempting to establish is unethical pricing agreements, such as price
fixing, exist.

77. Price skimming involves setting a high initial price for a new product (in order to take
advantage of those buyers prepared to pay a high price for innovation) and then gradually
reducing the price (to attract more price sensitive segments of the market).

78. Penetration pricing is pricing a new product low in order to maximize market
penetration before competitors can enter the market.

79. Sales maximizing objectives are favored when the following apply.

a. Unit costs will fall with increased output

(in other words, there are economies of sales)

b. The market is price sensitive and relatively low prices will attract more sales

c. Low prices will discourage any new competitors

8