978-1305405745 Chapter 16

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Chapter 16: Pricing and Credit Decisions

CHAPTER 16: PRICING AND CREDIT DECISIONS

CHAPTER OUTLINE

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1) Setting a Price

LO1: Discuss the role of cost and demand factors in setting a price.

a) Pricing Starting with Costs

i) Total cost includes (Exhibit 16-1 Cost Structure of a Hypothetical Firm, 2015)

(1) Cost of goods offered for sale

(2) Selling cost

(3) Overhead cost applicable to the given product

ii) Variable costs increase in total as the quantity of product increases

iii) Fixed costs remain constant at different levels of quantity sold

iv) Average pricing is an approach in which total cost for a given period is divided by

quantity sold in that period to set a price

b) Pricing Starting with Customers

i) Cost analysis can identify a level below which a price should not be set under

normal circumstances, but does not show how much the final price might exceed

that minimum figure and still be acceptable to customers

ii) Elasticity of Demand – the degree to which a change in price affects the quantity

demanded.

(1) Elastic demand – demand that changes significantly when there is a change in

the price of the product or service.

(2) Inelastic demand – demand that does not change significantly when there is a

change in the price of the product or service

iii) Pricing and a Firm’s Competitive Advantage

(1) When customers perceive the product/service an important solution to their

unsatisfied needs, they are likely to demand more

(2) If competing firms offer identical products and services, then the services

offered by the companies generally differ

(3) Prestige pricing is setting a high price to convey an image of high quality or

uniqueness

2) Applying a Pricing System

LO2: Apply break-even analysis and markup pricing.

a) Break-Even Analysis

i) Examining Cost and Revenue Relationships

(1) First phase of break-even analysis is to determine the sales volume level at

which the product, at an assumed price, will generate enough revenue to start

earning a profit (Exhibit 16-3 Break-Even Graphs for Pricing)

(2) Contribution margin is the difference between the unit selling price and the

unit variable costs and expenses

(3) Unrealistic to assume that quantity sold can increase continually

Chapter 16: Pricing and Credit Decisions

ii) Incorporating Sales Forecasts

(1) Indirect impact of price on the quantity that can be sold complicates pricing

decisions

b) Markup Pricing

i) Retailing

(1) Applying a percentage to a product’s cost to obtain its selling price

(2) Manageable pricing system that allows quick pricing of many products

(3) Must cover operating expenses, subsequent price reductions (i.e., such things

as markdowns and employee discounts) and desired profit

3) Selecting a Pricing Strategy

LO3: Identify specific pricing strategies.

a) Penetration Pricing

i) a technique based on setting lower than normal prices to hasten market acceptance

of a product or service or to increase market share

ii) Strategy can sometimes discourage new competitors from entering the market

niche

b) Skimming Pricing

i) Sets prices for products/services at high levels for a limited period before

reducing prices to lower, more competitive levels

ii) Assumes certain customers will pay the higher price due to perception it is a

prestige item

c) Follow-the-Leader Pricing

i) Uses a particular competitor as a model in setting a price for a product/service

ii) Price differential options may not work with different size competitors

d) Variable Pricing

i) a technique based on setting more than one price for a product or service in order

to offer price concessions to certain customers

ii) Dynamic (personalized) a technique based on charging more than the standard

price when a customer’s profile suggest that the higher price will be accepted.

e) Price Lining

i) a technique based on setting a range of several distinct merchandise price levels

ii) Amount of inventory stocked at different quality levels depends on the income

levels and buying desires of a store’s customers

f) Optional Product and Service Pricing

i) Resale price maintenance—local, state, and federal laws must be considered;

protects small customer-service retailers from large discounters

ii) Product line pricing—A technique that places different prices on a range of

products or services to reflect the benefits to the customer of parts of the range.

iii) Adaptive pricing is when companies engage in placing different values on a

product or service for customers with different needs.

iv) Adjusting a price to meet changing marketing conditions

(1) Can be costly to the seller and confusing to buyers

(2) Alternative may be a system of discounting design to reflect a variety of needs

v) Pricing errors can be corrected

4) Offering Credit

Chapter 16: Pricing and Credit Decisions

LO4: Explain the benefits of credit, factors that affect credit extension, and types of

credit.

a) Benefits of Credit

i) Provides small firms with working capital, often allowing marginal businesses to

continue operations

ii) Additional benefits of credit to customers (borrowers) are:

(1) The ability to satisfy immediate needs and pay for them later

(2) Better records of purchases on credit billing statements

(3) Better service and greater convenience when exchanging purchased items

(4) Establishment of a credit history

iii) Benefits of credit to suppliers are:

(1) Closer association with customers because of implied trust.

(2) Easier selling through telephone- and mail-order systems and over the Internet

(3) Smoother sales peaks and valleys, since purchasing power is always available

(4) Easy access to a tool with which to stay competitive

b) Factors That Affect Selling on Credit

i) Credit sales should increase profits, but this is not a risk-free practice

ii) May shift or share credit risk by accepting credit cards

iii) Cost of accepting credit cards includes fraud protection, “chargebacks”

iv) Five factors related to business decision to extend credit:

(1) Type of Business

(a) Retailers of durable goods typically grant credit more freely than those

that sell perishables or primarily serve local customers

(b) Big ticket items often must be sold on an installment basis

(2) Credit Policies of Competitors

(3) Age and Income Level of Customers

(4) Availability of Working Capital

(5) Economic conditions

c) Types of Credit

i) Consumer credit – financing granted by retailers to individuals who purchase for

personal or family use

(1) Trade credit – financing provided by a supplier of inventory to a client

company

(2) Open Charge Accounts – a line of credit that allows the customer to obtain a

product or service at the time of purchase, with payment due when billed

(3) Installment Accounts – a line of credit that requires a down payment, with the

balance paid over a specified period of time

(4) Revolving Charge Accounts – a line of credit on which the customer may

charge purchases at any time, up to a pre-established limit

ii) Credit Cards

(1) Bank Credit Cards

(2) Entertainment Credit Cards

(3) Retailer Credit Cards

(4) Debit cards

iii) Trade Credit

(1) Terms may be specified (such as 2/10, net 30)

(2) Depends on product sold and the buyer’s and the seller’s circumstances

(3) Affected by tradition within industries

5) Managing the Credit Process

LO5: Describe the activities involved in managing credit.

a) Evaluation of Credit Applicants

i) The Four Credit Questions

(1) Can the buyer pay as promised?

(2) Will the buyer pay?

(3) If so, when will the buyer pay?

(4) If not, can the buyer be forced to pay?

ii) The Traditional Five C’s of Credit

(1) Character

(2) Capacity

(3) Capital

(4) Conditions

(5) Collateral

b) Sources of Credit Information

i) Customer’s previous credit history

ii) Trade credit agencies collect credit information on businesses

iii) Credit bureaus summarize a number of firms’ credit experiences with particular

individuals

c) Aging of Accounts Receivable

i) Aging schedule (see Exhibit 16-5 Hypothetical Aging Schedule for Accounts

Receivable)

d) Billing and Collection Procedures

i) Timely notification of customers indicating the status of their accounts is most

effective method of keeping credit accounts current

ii) Overdue credit accounts time seller’s working capital

iii) Effective weapon in collecting past-due accounts is reminding the debtors that

their credit standing may be impaired

iv) Bad-debt ratio is the ratio of bad debts to credit sales

e) Credit Regulation

i) Variety of federal and state laws that vary from state to state

ii) Federal legislation includes:

(1) The Fair Credit Billing

(2) The Fair Credit Reporting Act

(3) The Equal Credit Opportunity Act

(4) The Fair Debt Collection Practices Act

iii) Pricing and credit decisions have a direct impact on the firm’s financial health

ADDITIONAL DISCUSSION QUESTIONS

1. How does price relate to value in the eyes of a customer?

Because a value must be placed on a product or service by the provider before it

license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 16-5

2. Give an example of a product for which there is an elastic demand. Give

another example for inelastic demand.

3. Think of a brand that has been successful using prestige pricing? How is the

company able to use that strategy?

4. If a firm has fixed costs of $100,000 and variable costs per unit of $1, what is

the break-even point in units, assuming a selling price of $5 per unit?

5. What is the difference between a penetration pricing strategy and a price lining

strategy? Under what circumstances would each be used?

Penetration pricing involves pricing products or services lower than a normal,

long-range market price in order to gain more rapid market acceptance or to

6. If a small business conducts a break-even analysis properly and finds the

break-even volume at a price of $10 to be 10,000 units, should it price its

product at $10? Why or why not?

Most students will probably say, “Yes, if the business can produce more than

7. What are the major benefits of credit to buyers? What are its major benefits to

sellers?

For buyers, credit

8. What does a company have to consider in establishing a credit policy?

The major reason for granting credit is to make sales; credit encourages

9. What are the four key questions in evaluating a credit application?

10. What are the five C’s credit? Why are they important?

1. Character is the fundamental integrity and honesty that should underline

SUGGESTED ANSWERS TO YOU MAKE THE CALL EXERCISES

Situation 1

1. Are Balogh and Dawson offering too many services? What do you advise?

license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 16-7

2. Are Balogh and Dawson charging too low a price? What would you suggest to

them?

3. If the owners raise their prices, how do you think their customers will react?

Situation 2

1. Should a small business owner push customers to pay when times are tough?

Why or why not?

The nature of this industry is such that service is not standardized. There are large

2. What problems do you think a business service company might have when their

customers do not pay?

Situation 3

1. What do you think makes selling works of art different from selling other kinds

of products? What makes it the same?

Student answers will vary but may include discussion about the subjective nature

any product.

2. Have you bought anything on eBay? If so, do you feel you received good value

for the price you paid? If not, ask someone who has shopped successfully on

eBay for advice on how to shop on that site, and report what you were told.

Student answers will vary on this.

3. How would you price a work of art? What do you think the advantages and

disadvantages of using an auction would be?

Student answers will vary on this.

SUGGESTED SOLUTION TO CASE 16: DYNAMIC NETWORK SERVICES, INC.

1. Explain the importance of fixed and variable costs to Dyn’s pricing decisions.

Since the bulk of Dyn’s costs are fixed, they need to have accurately defined which of

2. Basing your answer on the discussion of prestige pricing in Chapter 16 and on the

Dyn Inc. video, how does the concept of elasticity of demand relate to Dyn’s pricing

structure? Or does it?

Because customer demand for a product or service is often sensitive to the price level,

Dyn has to be careful about how it structures its pricing. So far, Dyn has experienced

3. Do you think Dyn would benefit from offering credit to its customers?

Offering credit to their customers provides several benefits, such as:

• The ability to satisfy immediate needs and pay for them later

Chapter 16: Pricing and Credit Decisions

license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 16-9

pay a service fee to these companies. There’s also the issue of internet fraud. There’s also the

issue of “charegebacks” whenever a buyer disputes a transaction.

It’s probably best if Dyn do a thorough analysis to see if the use of credit would be of

benefit to it’s existing customers and see if this benefit would be a deciding factor for new

customers.