978-0134741086 Chapter 11 Part 1

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CHAPTER 11. PRICING AND CREDIT STRATEGIES

Part 1: Learning Objectives

1. Discuss the relationships among pricing, image, competition, and value.

2. Describe effective pricing techniques for introducing new products or services and for

existing ones.

3. Explain the pricing methods and strategies for retailers, manufacturers, and service

firms.

4. Explain the impact of credit and debit cards and mobile wallets on pricing.

Part 2: Class Instruction

Introduction

Setting prices is a business decision that is both an art and a science. Unfortunately many

small business owners set prices without enough information about their cost of operation

s and their customers. Research shows that proper pricing strategies have far greater

impact on a company’s profits than corresponding increase in unit volume and reductions

in fixed or variable costs. Refer to Figure 11.1, The Impact of Pricing and Cost

Improvements on Profitability.

Due to the Great Recession customers have become more price sensitive. In addition,

modern shoppers use technology such as smart phones and tablets to shop for the best

deals.

Setting prices too high drives customers away, but prices that are too low (a common

tendency for entrepreneurs) robs a business of its ability to generate a profit, creates the

impression that the products and services are of inferior quality, and threatens long-term

success.

Price is the monetary value of a product or service; it is a measure of what the customer

must give up to obtain what they want or need. Price is also a signal of the value of a

product or service, so price must be compatible with customers’ perceptions of value.

Three Potent Forces: Image, Competition, and Value LO 1

Companies that take a strategic approach to pricing and monitor its results can raise their

sales revenue between 1 and 8 percent.

Price Conveys Image.

The relationship between value and price are demonstrated with an equation that includes

the following variables: standards of doing business, product or service quality and

performance, doubt in customers’ minds that detract from the value of the company’s

standards and products or services, product or service price, and customers’ expectations

of a company and its products and services. Rather than ask, “How much should I

charge?” entrepreneurs should ask, “How much are my target customers willing to pay?”

Competition and Prices.

Today small companies face competition from local businesses as well as from online

businesses. Unless a small business can differentiate itself by creating a distinctive image

in customers’ minds or by offering superior service, quality, design, convenience, or speed,

then it must match its competitors’ prices or risk losing sales. Blindly matching

competitors’ prices can lead a company to financial ruin. Refer to Figure 11.2, The

Reality of Setting Prices.

Generally entrepreneurs should avoid head-to-head price competition with other firms that

can more easily achieve lower prices through lower cost structures. Nonprice competition

the option of purchasing addition product features that generate higher profit margins;

achieving high sales volume.

Entrepreneurs usually overestimate the power of price cuts. In reality, sales volume rarely

increases enough to offset the lower profit margins of a lower price. Customers who are

lured by the lowest price usually exhibit little loyalty to a business. Rather than joining in

unique features, benefits and value it offers its customer.

Focus on Value

The “right” price depends on the objective value and perceived value. The objective value

Techniques that companies can use to increase customers’ perception of value include

offering coupons and rebates, offering limited-time-only discounts, or launch a fighter

brand, which is a less expensive, no-frills version of a company’s flagship product that is

designed to confront lower-priced competitors head-on, satisfy the appetites of value–

conscious customers, and preserve the image of the company’s premium product.

addition, customers are less likely to notice small, regular price increases that result from

rising costs than a single, steep price increase.

One of the biggest mistakes an entrepreneur can make is underestimating the company’s

actual total cost of a product or service. When setting prices, some entrepreneurs think

strictly in terms of product or service costs and fail to consider the total cost of providing

 Offer products in smaller sizes or quantities.

 Focus on improving efficiency everywhere in the company.

 Emphasize the value your company provides to customers.

 Raise prices incrementally and consistently rather than rely on large periodic

increases.

 Differentiate your company and its products and services from the competition.

Costs impact pricing. It is important that price takes cost into consideration. These costs

should be passed along to customers and communicated through the value you offer.

When all is taken into consideration, the factors that small business owners must consider

 The company‘s competitive advantage

 Economic conditions

 Business location

 Seasonal fluctuations

 Psychological factors

and the price floor established by the company’s cost structure. The goal is to position

prices within this acceptable price range. Refer to Figure 11.3, What Determines Price?

Pricing Strategies and Tactics LO 2

Pricing strategies must be compatible with the firm’s overall strategy.

Introducing a New Product.

1. Get the product accepted. The acceptable price range depends on the product’s

position:

 Revolutionary products are so new and unique they transform existing

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 Me-too products offer the same basic features as existing products on the

market.

2. Maintain market share as competition grows

3. Earn a profit

1. Penetration: Set prices below competitors to gain market entry. This pricing

2. Skimming: Set higher prices for new products and for markets that have little or

3. Life Cycle Pricing: Set higher prices initially and, as technological advances or

additional experience enables the firm to lower costs, it can reduce the product’s

price one step ahead of competitors.

Pricing Established Goods and Services. Each of the following pricing tactics can

become part of the toolbox entrepreneurs can use:

 Freemium pricing – a pricing strategy that involves providing a basic product or

service to customers for free but charging a premium for expanded or upgraded

versions of the product or service.

 Dynamic (customized) pricing – a technique in which a company sets different

prices for the same products and services for different customers using the

merchandise to customers across a wide range of geographic regions. One type of

geographic pricing is zone pricing, which is a technique that involves setting

different prices for customers located in different territories because of different

transportation costs. Another option is delivered pricing, a technique in which a

company charges all customers the same price regardless of their locations and

Chapter 11, Page 179

pay all shipping costs.

 Discounts – There are five variations of discounts:

o Discount markdowns are reductions from normal list prices.

o Earned discounts which customers earn by making repeat purchases at a

business.

o Limited time offers provided by retailers for a limited amount of time with

the goal of creating a sense of urgency and excitement among customers.

o Steadily decreasing discount is a limited duration discount that declines

over time.

o Multiple unit pricing is a technique offering customers discounts if they

purchase in quantity.

 Bundling is grouping together several products or services or both into a package

that offers customers extra value at a special price.

 Optional-product pricing is a technique that involves selling the base product for

one price but selling the options or accessories for it at a much higher markup.

 Captive product pricing is a technique that involves selling a product for a low

inconsistent with the company’s image, cost structure, or competitive situation.

 Follow-the-leader pricing

Consider using You Be the Consultant: “The Psychology of Pricing?” or Ethics and

Entrepreneurship “The Ethics of Dynamic Pricing” at this point.

Pricing Strategies and Methods for Retailers LO 3A

to the cost to procure. It must be large enough to produce a profit.

Markup is based on this equation:

Dollar markup + Retail price – Cost of the merchandise

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For example, if a shirt costs $14 and the sales price is $30, the markup is $16. Percentages

can easily be calculated. Additional calculations are included in this chapter. Refer to

Table 11.1, Costs and Markup Calculations for Samsung’s Galaxy S6 Edge and Apple’s

iPhone 7.

Once entrepreneurs create a financial plan, including sales estimates and anticipated

expenses, they can compute their companies’ initial markup. The initial markup is the

average markup required on all merchandise to cover the cost of the items, all incidental

expenses, and a reasonable profit. Operating costs, such as rent, utilities, depreciation and

reductions must also be taken into consideration. Entrepreneurs must be aware of the

impact that discounts have on their markup percentages. Refer to Figure 11.4, The

Mathematics of Markups and Markdowns.

Finally, retailers must verify that the retail price they have calculated is consistent with

their companies’ image. Perhaps most important, customers must be willing and able to

pay this price.

Pricing Concepts for Manufacturers LO 3B

Cost-plus pricing is a pricing technique in which a manufacturer establishes a price that

covers the cost of direct materials, direct labor, factory overhead, selling and

administrative costs, and a desired profit margin, which is the most commonly used pricing

technique for manufactures. While it is a simple way to determine prices, it does not

encourage the manufacturer to use resources efficiently. In addition, it fails to consider

 Variable (direct) costing is a more useful method of product costing that includes

in the product’s cost only those costs that vary directly with the quantity produced.

Variable costing encompasses direct materials, direct labor, and factory overhead

costs that vary with the level of the company’s output of finished goods.

Overhead costs that are fixed (rent, depreciation, and insurance) are not included.

The break-even selling price allows a manufacturer to determine at what point revenues

equal expenses. This is the break-even point and the next unit sold represents the first

dollar of profit.

Pricing Strategies and Methods for Service Firms LO 3C

Service firms must establish prices on the basis of the materials used to provide the

service, the labor employed, an allowance for overhead, and profit. Most service firms

base their prices on an hourly rate, usually the actual number of hours required to perform

the service. Others base their feeds on a standard number of hours, determined by the

average number of hours needed to perform the service. Calculations are provided in the

chapter. Refer to Table 11.3, Direct–Cost Income Statement, Ned’s Computer Repair

shop.

Pocket price is the price a company receives for a product or service after deducting all

discounts and purchase incentives.

credit offers a company, and equally important to take steps to protect it.

Credit Cards. Accepting credit cards broadens a small company’s customer base and

closes sales that would normally be lost if customers had to pay in cash. However,

companies incur additional expenses for offering this convenience. Businesses must pay to

use the system, typically 1percent to 6 percent of the total credit card charge, which they

5 to 25 cents per charge. Refer to Figure 11.7, How a Typical Credit Transaction Works.

An interchange fee is the fee banks collect from retailers whenever customers use a credit

or debit card to pay for a purchase. Some entrepreneurs offer customers incentives to pay

with cash in order to avoid the fees.

 E-Commerce and Credit Cards. Online merchants must ensure their customers’

privacy and the security of their credit card transactions by using encryption

software. There are steps online merchants can take to avoid credit card fraud,

including:

o Verification of customers’ billing address information.

o Require customers to provide the CVV2 number on the back of a credit

card.

o Check customers’ Internet protocol (IP) address.

o Monitor activity on the Web site using a Web analytics software package.

o Verify large orders.

o Post notices on the Web site that your company uses antifraud technology.