OBJECTIVE 3 03 EMPLOY PRICING STRATEGIES TO DETERMINE

OBJECTIVE 3. 03 EMPLOY PRICING STRATEGIES TO DETERMINE PRICES Identify types of pricing objectives. Part I a. b. Explain reasons for setting pricing objectives. c. Describe ways in which pricing objectives are used. d. Demonstrate procedures for establishing pricingobjectives.

What is a pricing objective? � A goal that guides a business in setting the cost of a product or service to potential consumers. A pricing objective underlies the pricing process for a product, and it should reflect a company's marketing, financial, strategic and product goals, as well as consumer price expectations and the levels of available stock and production resources.

Pricing objectives Survival � Prices are flexible. A company can lower them in order to increase sales enough to keep the business going. The company uses a survival-based price objective when it's willing to accept short -term losses for the sake of long-term viability.

Profit � Price has both direct and indirect effects on profit. The direct effect relates to whether the price covers the cost of producing the product. Price affects profit indirectly by influencing how many units sell. The number of products sold also influences profit through economies of scale -- the relative benefit of selling more units. The primary profit-based objective of pricing is to maximize price for long-term profitability.

Sales � Sales-oriented pricing objectives seek to boost volume or market share. A volume increase is measured against a company's own sales across specific time periods. A company's market share measures its sales against the sales of other companies in the industry. Volume and market share independent of each other, as a change in one doesn't necessarily spur a change in the other.

Status Quo � A status quo price objective is a tactical goal that encourages competition on factors other than price. It focuses on maintaining market share, for example, but not increasing it, or matching a competitor's price rather than beating it. Status quo pricing can have a stabilizing effect on demand for a company's products.

6 Steps to Setting a Price Strategy for your Business 1. 2. 3. 4. 5. 6. Select the pricing objective to decide where you want to position your market offering. Determine the demand. Estimate the costs. Analyze competitor costs, prices, offers and possible reactions. Select a pricing method. Finally, select the price

Part II a. b. c. d. e. f. Identify examples of fixed expenses. List examples of variable expenses. Cite examples of mixed/semi-variable expenses. Explain the importance of break-even in setting prices. Calculate the break-even point for a product in units. Calculate the break-even point for a product in dollars.

What Is the Break-Even Point? � A business reaches its break-even point when its total sales income at a given selling price equals its total costs. In other words, the business breaks even when it makes as much as it has spent to produce and/or sell its product(s). The business must calculate its total costs and estimate its sales revenues to project the point at which it will break even.

Components of Break. Even � Costs �Fixed costs ○ Are fairly predictable business costs that don’t change when sales go up or down ○ Tend to stay the same, no matter how many products the business produces or sells ○ Examples: taxes, rent or mortgage payments, equipment payments or leases, wages and salaries, depreciation of physical assets, fees and licenses, interest on loans, insurance, etc.

�Variable costs ○ Are costs that change along with changes in sales volume ○ Examples: cost of goods, promotional costs, sales tax, raw materials, business travel, sales commissions, etc. ○ Can be predicted only if the business can make a fairly accurate estimate of what its sales volume will be

�Semi-variable costs ○ Vary to some extent in response to sales ○ Should be assigned as either fixed or variable for the purpose of calculating break-even (assigning semi-variable costs to the fixedcost category results in a higher, more conservative break-even point)

� Sales revenues �Most businesses receive the bulk of their income from sales revenues, money received from sales of goods and services. �There are two ways that sales revenues increase: ○ Sales revenues increase as the number of units sold increases. ○ Sales revenues increase as the selling price per unit increases.

� Profit and loss �A business does not make a profit until it has passed the break-even point—when total sales revenues are greater than total costs. �A business loses money if it does not reach its break-even point and sales revenues are less than total costs.

Why Calculate Break. Even? � Calculating the break-even point can serve a number of purposes for a business. The most important reason for calculating the break-even point is to determine at what point the business can expect to begin making a profit. Calculating break-even can also help the business to make important decisions, such as:

� Setting prices �Most marketers consider more than one possible selling price for a product before setting a final price. �Calculating break-even helps a business to estimate the number of products it would expect to sell at each price. �Calculating break-even for estimated sales at each selling price helps the business to select the most appropriate price. � Relocating the business �Calculating break-even can help businesses determine whether moving to a new location would benefit them.

� Determining capital needs �All businesses need capital, or money, with which to operate. �A business should not borrow too much money because the interest it must pay on the amount borrowed will increase its expenses. �A business also should not set aside too much of its capital for business operations because the money will not be available for other uses, such as buying goods for resale. �Calculating break-even helps a business to borrow or to set aside appropriate sums.

� Offering incentives �Some businesses offer incentives such as bonuses or sales commissions to their employees to motivate them to do a good job. �These businesses need to know what they can afford to spend before they offer these incentives.

Calculating Break-Even � A basic formula for calculating break- even for a product is: � BP = FC ÷ VCM � BP—break-even point FC—total fixed costs VCM—variable-cost margin

� Putting the formula into words, break- even point equals total fixed costs divided by the variable-cost margin. � The variable-cost margin is the amount that each sale contributes to fixed costs. It is also called the fixed-cost contribution. Variable-cost margin is calculated by subtracting variable costs per unit from the selling price per unit.

Break-Even in Units � Calculating break-even in units determines how many products a business must sell to break even. Let’s see how this might work for a hot dog vendor at the baseball park:

� The vendor’s fixed costs include a $25 license and $100 for equipment rental. � Variable costs are estimated to be $50 for twelve dozen (144) hot dogs and buns, as well as condiments. � The hot dogs will sell for $1. 50 each. � How many hot dogs will the vendor need to sell to break even?

�Determine total fixed costs by adding the two fixed costs together: � $25 + $100 = $125

�Determine variable costs per unit by dividing the variable costs by the number of units: � $50 ÷ 144 = $0. 35

�Calculate variable-cost margin by subtracting the variable cost per unit from the selling price: � $1. 50 - $0. 35 = $1. 15

�Therefore, using the break-even formula, BP = FC ÷ VCM, we find: � BP = $125 ÷ $1. 15 = 108. 7 � The vendor must sell 109 hot dogs to break even and begin making a profit.

Break-Even in Dollars � � � Break-even can also be expressed in dollars: After you calculate the number of units you need to sell to break even (109 for the hot dog vendor), multiply that number by the selling price per unit ($1. 50 for each hot dog). This figure is the total dollar sales you need to make to break even. In the case of the hot dog vendor, s/he needs to make $163. 50 in sales to break even: 109 × $1. 50 = $163. 50

Steps for Calculating Break. Even � The steps to calculating break-even include: � Identify costs and revenues. � Classify costs as fixed or variable. � Total the costs in each classification. � Calculate the variable cost per unit. � Subtract the variable cost per unit from the selling price per unit to obtain the variablecost margin. � Divide the total fixed costs by the variablecost margin to determine break-even point.

Part III a. Identify strategies for pricing new products. � b. Select product-mix pricing strategies. � c. Determine discounts and allowances that can be used to adjust base prices. � d. Adjust base prices using psychological pricing techniques. � e. Select promotional pricing strategies. � f. Select geographic pricing strategies to adjust base prices. � g. Identify segmented pricing strategies. � h. Demonstrate procedures for selecting appropriate pricing strategies for products. �

New product Pricing Strategies � Penetration pricing in the introductory stage of a new product's life cycle involves accepting a lower profit margin and pricing relatively low. � Price skimming involves setting the price relatively high to generate a high profit margin. � A premium product generally supports a skimming strategy. �

Product Mix Pricing Strategies � The product mix is the collection of products and services that a company chooses to offer its market. Pricing strategies range from being the cost leader to being a high-value, luxury option for consumers.

� � Cost Plus Cost-plus pricing is the most basic type of pricing and simply represents setting the cost of a product at some level above the cost of producing and distributing that product. So, for instance, a jeweler might decide to price products at a 100 percent mark-up based on the costs that go into creating the product. � � Competition Based Competition-based pricing is pricing that is established specifically to address and respond to the prices of competitors' products. Businesses may decide to price either higher or lower or at about the same levels of the competition, but their decisions are based on an evaluation of what competitors are doing and how they want to position their product mix.

Discounts and Allowances � Clearance Markdowns to get rid of slow- moving, obsolete merchandise � Promotional Markdowns �To increase sales and promote merchandise �To Increase traffic flow and sale of complementary products generate excitement through a sale � To generate cash to buy additional merchandise

There are five basic types of psychological pricing strategies. � Odd-even pricing is a strategy of setting prices in odd numbers just below an even price, for example pricing an item at the odd $19. 95 rather than the even price of $20. 00. The intention of oddeven pricing is to make the price appear considerably lower than it is.

� Prestige pricing works on the opposite premise; rather than making prices seem low, prices are inflated in order to create a sense of greater value. For example, a wine might be priced at $20 per bottle rather than $12 merely to give the impression that it is a better product.

� Multiple pricing is a psychological pricing strategy in which items are bundled together, such as two for $5 rather than $2. 50 per item. This strategy creates a sense of value and can help boost sales volume by encouraging the purchase of multiple items.

� Promotional pricing is the psychological pricing strategy in which a price is temporarily lowered in order to attract customers. � Price lining is an effective form of psychological pricing for companies with an extensive product line; it involves creating a price range for a particular line, for example a budget clothing line with items all priced below $10.

Geographical Pricing. � Geographical pricing sees variations in price in different parts of the world. For example rarity value, or where shipping costs increase price. In some countries there is more tax on certain types of product which makes them more or less expensive, or legislation which limits how many products might be imported again raising price.

Segmentation Pricing � If you plan a product segmentation strategy, you may incur higher product development or manufacturing costs to create different versions, so it is important to focus on segments where you can make a profit. Price segmentation enables you to offer the same basic product, but add features that customers are willing to pay for or remove cost elements that are not important to customers.

Part IV � a. � b. � c. � d. � e. Define the following terms: floors, ceilings, and elasticity. Describe the importance of determining pricing floors and ceilings. Explain process for setting prices. Estimate demand for product. Implement process for setting prices.

Price Ceilings and Floors � Price ceiling is the highest price that is allowed to be charged for a certain good or survive in an economy, while the price floor is the lowest possible price

Setting Prices Your event must have a high-enough price to cover the costs of your event, as well as to provide you a revenue stream, if you're expecting to make a profit from the event attendance itself � The price of your event determines, in part, the venue that you select. You shouldn't charge thousands of dollars for an event and host it in a 'budget' venue. Conversely, you need to charge enough that your event price covers the cost of your venue and other event costs. �

� Demand forecasting is the activity of estimating the quantity of a product or service that consumers will purchase. Demand forecasting involves techniques including both informal methods, such as educated guesses, and quantitative methods, such as the use of historical sales data or current data from test markets

Demand forecasting may be used in making pricing decisions, in assessing future capacity requirements, or in making decisions on whether to enter a new market. Is the demand elastic or inelastic. Elastic means that if price changes, demand changes. Inelastic means demand will not change if price changes.