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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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Chapter 11, Page 178
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
Copyright © 2019 Pearson Education, Inc.
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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Chapter 11, Page 180
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.
