Chapter 17 Pricing Objectives and Policies Pricing Strategy

Chapter 17 Pricing Objectives and Policies

Pricing Strategy Determines • 1] How flexible prices will be • 2] At what level prices will be set over the Product Life Cycle • 3] To whom and when discounts and allowances will be given. • 4] How transportation costs will be handled

Review some Terms • • • Profit = Revenues - Costs Contribution = Revenues - Direct Variable Costs Unit Contribution = Selling Price – Unit Variable Costs Variable costs increase with every unit sold or produced • Most (but not all) marketing costs are variable costs

Price Cuts & Increases Have a Direct Profit Impact • You have a contribution margin of 20%, unit price = $100, 80 units were sold last month. You decide to cut your price 5%. • How many units will you have to sell to have the same contribution as last month?

Price Cuts & Increases • Last month’s unit contribution = $20 • $20 unit contribution x 80 units sold • = $1, 600 contribution last month • We would like to have a contribution of $1, 600 or better this month.

Price Cuts & Increases • New unit contribution = $20 - ($100 x. 05) = $15 • To make same contribution as last month • $1, 600 = $15 x • x = 106. 67 or 107 units (round up since you can’t sell partial units). • Your sales must increase (107 -80)/80 = 33. 75% to make the same contribution

Price Cuts & Increases • Note: Increasing or cutting prices usually does not effect the costs of a firm. • If you can make a price increase stick and demand does not fall (much), your profitability is sharply increased. • If you cut your price, you have to sell a LOT MORE UNITS to make the same profit level

Second Example • Unit contribution = $15. Unit price = $50 • Sold 300 units last year. You decide to cut prices 10%. How many units do you have to sell to have the same contribution as last year?

Example 2 continued • Old total contribution = $15 x 300 = $4, 500 • New unit contribution = $15 - ($50 x. 10) • = $10 • Units needed to be sold to make the same contribution as last year = • $4, 500 = 10 x = 450 units • Sales increase of (450 -300)/300 = 50% • Can you get this 50% sales increase?

Example 3 • Unit contribution = $9, unit price = $90, sold 900 units last year. You decide to raise prices $10. How many units do you have to sell to have the same contribution as last year?

Example 3 cont. • Total Contribution = $9 x 900 = $8, 100 • New unit contribution = $9 + $10 = $19 • $8, 100 = $19 x = 427 units

Pricing Objectives • 1] Target Return • 2] Profit Maximization • 3] Sales Oriented – Market share = Firms sales in units (dollars)/ – Industry sales in units ($s) • Status Quo (460)

Product Life Cycle & Pricing • Skimming (464) vs Penetration (466) • Skimming – Recoup Costs Quickly – Aim at members of the target that have strongest desire – Helps with production & distribution • Penetration - discourages competitive entry & builds market share quickly

Quantity Discounts • Discounts offered to encourage customers to buy in larger amounts • Can be price cuts or free goods • Often given due to economies of scale in production, distribution, & ordering • Two types – Cumulative Quantity Discounts (469) – Noncumulative Quantity Discounts (469)

Cumulative vs Noncumulative • Your firm sells plastic containers. Your price structure is: • Less than 1000 units - $0. 65 each • 1000 - 4999 units - $0. 60 each • 5000 - 9999 units - $0. 55 each • 10, 000 + units - $0. 50 each

Cumulative vs Noncumulative 2 • Zed buys 1200 units in January, 500 units in February and 3, 800 units in March. What was the total price paid if the discounts were: – Cumulative? – Noncumulative?

Cumulative vs Noncumulative • Cumulative: 1200 + 500 + 3800 = 5500 units. Total price = 5500 x $0. 55 = $3, 025 • Noncumulative • 1200 x $0. 60 = $720 • 500 x $0. 65 = $325 • 3800 x $0. 60 = $2, 280 • Total = $3, 325

Cash Discounts • Reduction in price to encourage buyers to pay in cash (470). • Ex: 2/10, net 30. Reads: • 2% discount if paid in 10 days of the invoice date; full amount due in 30 days. • What is the annual interest rate here?

Cash Discount • • Paying for 20 days use of the money (net 30 - 10 day discount period) How many annual periods? 365/20 = 18. 25 Annual interest rate = 36. 5% • You can change credit terms by altering the net date, the discount period, or the discount %

Distribution Pricing • F. O. B. - Free on Board some vehicle at some place. FOB delivered - seller pays freight and retains title until product is delivered • F. O. B. Shipper - buyer pays freight and takes title at the shippers loading dock.