Chapter 19 Pricing Concepts 19 1 The Importance of Price Price means one thing to the consumer and something else to the seller Consumer price is cost Seller price is revenue Price that which is given up in an exchange to acquire a good or service The sacrifice effect of price o Sacrifice is usually money could also be time lost while waiting to acquire the good service The information effect of price o We infer quality from price The price paid is based on the satisfaction consumers expect to receive from a product and not necessarily the satisfaction they actually receive Revenue the price charged to customers multiplied by the number of units Profit revenue minus expenses The increased availability of private and generic brands has put downward pressure on overall prices Many firms are trying to maintain regain their market share by cutting sold prices 19 2 Pricing Objectives Pricing objectives must be specific attainable and measurable Profit oriented objectives o Profit maximization Setting prices so that total revenue is as large as possible relative to total cost Many firms don t have enough data for maximizing profits Operate more efficiently to reduce costs or increase customer satisfaction o Satisfactory profits Reasonable levels of profits Risky industry 35 Low risk industry 7 o Target return on investment ROI net profit after taxes divided by total assets Aka return on total assets Measures management s overall effectiveness in generating profits with the available assets Use target ROI as their main pricing goal Want ROI in the 10 30 range Sales oriented objectives o Market share a company s product sales as a percentage of total sales for that industry Usually expressed in terms of revenue and not units Market share and ROI are related o Dollar unit sales Ignores profit competition and the marketing environment as long as sales are rising Can be effective on a temporary basis to sell off excess Status quo objectives inventory o Status quo pricing a pricing objective that maintains existing prices or meets the competition s prices o Requires little planning passive policy o Sup optimal pricing bc the strategy ignores customers perceived value of both the firm s good and those offered by competitors and ignores demand and costs 19 3 The Demand Determinant of Price After we establish pricing goals we must set specific prices to reach this goal The price they set for each product depends on the demand for the good and the cost to the seller Pricing goals are sales dominated then demand considerations dominate Demand the quantity of a product that will be sold in the market at various prices for a specified period o Demand curve downward sloping Supply the quantity of a product that will be offered to the market by a supplier at various prices for a specified period o Supply curve upward sloping Price equilibrium the price at which demand and supply are equal o A price below equilibrium will result in a shortage and prices will increase in price Elasticity of demand consumers responsiveness or sensitivity to changes Elastic demand a situation in which consumer demand is sensitive to changes in price greater than 1 Inelastic demand a situation in which an increase or decrease in price will not significantly affect demand for the product less than 1 Unitary elasticity a situation in which total revenue remains the same when prices change If price goes down and revenue goes up demand is elastic If price goes down and revenue goes down demand is inelastic If price goes up and revenue goes up demand is inelastic If price goes up and revenue goes down demand is elastic If prices goes up or down and revenue stays the same elasticity is unitary Factors that affect elasticity o Availability of substitutes demand is elastic o Price relative to purchasing power price is so low demand will be inelastic o Product durability demand is elastic o A product s other uses greater number of uses more elastic demand o Rate of inflation inflation is high demand is elastic 19 4 The Power of Yield Management Systems When competitive pressures are high a company must know when it can raise prices to maximize its revenues Yield management systems aka revenue management systems used to help adjust prices Yield management system YMS a technique for adjusting prices that uses complex mathematical software to profitably fill unused capacity by discounting early purchases limiting early sales at these discounted prices and overbooking capacity used by airlines 19 5 The Cost Determinant of Price Sometimes companies minimize or ignore the importance of demand and decide to price their products largely on the basis of cost Variable cost a cost that varies with changes in the level of output cost of Fixed cost a cost that does not change as output is increased or decreased materials rent salaries output change in output Average variable cost AVC total variable cost divided by quantity of Average total cost ATC total costs divided by quantity of output Marginal cost MC the change in total costs associated with one unit Markup pricing the cost of buying the product from the producer plus amounts for profit and for expenses not otherwise accounted for o Easy to employ o Based on experience o Keystoning the practice of marketing up prices by 100 or doubling the cost o Factors that influence markups merchandise s appeal to customers past response to the markup item s promotional value seasonality of the goods fashion appeal product s traditional selling price competition Profit maximization a method of setting prices that occurs when marginal revenue equals marginal cost o Producers use more complicated methods than distributors o Marginal revenue MR the extra revenue associated with selling an extra unit of output or the change in total revenue with a one unit change in output Break even analysis a method of determining what sales volume must be reached before total revenue equals total costs break even quantity total fixed costs fixed cost contribution o Provides a quick estimate of how much the firm must sell to break even and how much profit can be earned if a higher sales volume is obtained o It is hard to know whether a cost is fixed or variable o Ignores demand 19 6 Other Determinants of Price Stages in the product life cycle competition product distribution strategy promotion strategy and perceived quality can all affect pricing Stages in the product life cycle o Introductory stage prices are high to
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