BMI3C Chapter 7 Pricing

All businesses use the same factors to establish prices What are the key factors in determining prices of products / services?

Pricing Key factors: 1. Cost of doing business 2. Profit company hopes to make

Pricing Assume the price of a product for sale in a store is $9.99 What does that tell us?  The cost of the product to the store is probably less than $9.99

Pricing Markup  Stores add an amount to the price they pay for a product in order to cover their costs of doing business  What are some of these costs?

Pricing Markup  Expressed in terms of a % of the cost  E.g., product costs $10 and store adds $5 markup to the cost, what is the markup %?

Pricing Margin  % of the price charged to consumer that is not used to pay for the cost of the item  E.g., if product sells for $19.99 and costs $10, how much is the margin?

Pricing Break-even Analysis  The first step in calculating the price of your product or service  Tells you how many units you need to sell to pay for operating costs

Pricing Break-even Analysis  Step 1: Calculate Variable Costs  For a lawn cutting business, gasoline is a variable cost  Example: Suppose the cost of gasoline is $1.04/litre, and to cut 1 lawn uses 0.5 litres of gas What is the variable cost of gas per lawn? How much does it cost to cut 25 lawns?

Pricing Break-even Analysis  Variable Costs – usually depend on the quantity of goods sold or services performed  Can you think of examples of variable cost that increase for other reasons? (Hint: when you walk into a store and wipe your feet on the mat)

Pricing Break-even Analysis  Step 2: Calculate Fixed Costs  Fixed costs are constant, independent of sales  Usually remain the same no matter how many goods a business sells or manufactures  Examples: rent, insurance, salaries

Pricing Break-even Analysis  Fixed Costs  Example: Assume McDonald’s pays $5,000/month in rent for one of it’s stores  If it sells 5,000 Big Mac’s in a month, what is the fixed cost per hamburger?

Pricing Break-even Analysis  Step 3: Calculate Gross Profit  Sometimes referred to as “contribution margin”  Refers to money available to pay fixed costs after variable costs have been paid  Gross Profit = Selling price – Variable Costs OR… = Sales – Variable Costs

Pricing Break-even Analysis  Gross Profit  The price for 1 lawn cutting is $20  Total variable costs = $10 per lawn  Gross Profit = $10 which is available for paying fixed costs

Pricing Break-even Analysis  Break-even Point (BEP) - the number of units that a business must sell at a given price to cover all costs  BEP = Fixed Costs Gross Profit

Pricing Break-even point shows us how many sales, in units, we need to make a profit

Pricing A video game company requires 20 employees, and total daily salary is $3,000 Insurance = $50 per day Rent = $100 per day Utilities (heat, hydro) = $20 per day Plastic for video game casing = $1 per game Administrative costs = $200 per day Sales costs = $300 per day

Pricing 1. Calculate: Total Fixed Costs per day 2. If the company produces 36,700 games per day, calculate the fixed costs per video game 3. What would happen if a snow storm caused them to only produce 1 video game that day?

Pricing Obviously, we don’t calculate fixed costs on a daily basis!

Pricing Suppose a shoe manufacturer sells shoes to retailers for $15/pair Variable costs = $3/pair of shoes Fixed costs = $120,000 Calculate the BEP

Pricing Graphing Break-even Analysis

Pricing Answer: Step 1: Gross profit = selling price – variable costs  Gross profit = $15 - $3  Gross profit = $12 Step 2: BEP = $120,000 / $12  BEP = 10,000 units

Pricing What if I told you they could only sell 5,000 units? What things can the company do?  Reduce variable costs to increase gross profit and reduce BEP  Increase selling price to increase gross profit and reduce BEP  Decrease the selling price to increase demand  Increase sales costs (advertising) which may increase demand  Reduce fixed costs

Pricing Economy of scale  The more products a company makes, the lower the cost of production of each item  Remember the video game manufacturer and the snowy day?

Economies of Scale Marketers use economies of scale to help them by: 1. Developing products for private-label companies Store-brand products have exactly the same ingredients as the brand-name products Only difference is price Fixed costs are already paid for

Economies of Scale 3 Benefits of Private-Labels i.The store gets a low-priced product to sell ii.Consumers get an option to buy the same product for a cheaper price iii.Manufacturer earns considerate profit

Economies of Scale 2. Creating a Barrier to Entry for Competitors First company on the market with a product is tempted to keep prices high (no competition) But competitors come in and sell lower and steal market share If original manufacturer uses economies of scale, they can price product lower to increase sales and make it unattractive for competitors to enter market

Economies of Scale 3. Creating New Brands If same labour and machinery can be used to make more products: This doesn’t increase fixed costs Has the benefit of increasing profits

Economies of Scale 4. Merging with Competitors Occurs via a merger of 2 competitors Usually result in reduced fixed costs The new, combined business operates more efficiently (i.e., lower costs) Greater profits results

Diseconomies of Scale Some companies can become too large: 1.Management loses touch with employees and customers Management may become centralized to try to be more efficient but… …those at “head office” may not have time to visit stores or talk to customers and lose touch with their business

Diseconomies of Scale 2.Machinery may become over-used  Some duplicate equipment may be sold off to cut costs but…  …now there is extra work for the remaining equipment, which may lead to more breakdowns

Diseconomies of Scale 3.When employees are laid off, remaining employees must do extra work Those who are kept by the company have to do more work because there are less employees Employees may be angry or not work hard feeling that the company may lay them off too

Diseconomies of Scale 4.Communication channels can become slower  With a larger company, branch offices may not have a clear idea of what head office allows them to do now These examples show how diseconomies of scale can result even when companies try to become more efficient

Pricing Strategies Pricing is a critical part in the marketing mix 3 basic pricing strategies exist

Pricing Strategies 1. Market Skimming When launching a new product, company may set a high price for its product before competitors enter the market By doing so, a company tries to reach break- even point sooner and recover its development costs Once these costs are recovered, then the company lowers the price when competitors enter the market

Pricing Strategies 2. Penetration Pricing Company sets a low price for their new product They hope to attract a lot of customers, make a lot of sales, and get a large market share

Pricing Strategies 3. Competitive Pricing The most popular pricing strategy Products in the same category match or follow the price of their competitors Companies advertise a lot A company leader usually sets the “benchmark price” Leader is usually the company with the largest market share