Pricing and Credit Strategies Chapter 13 Pricing and Credit Strategies In the Spotlight: Oregon Flavor Rack Small Business Management, 11th edition Longenecker, Moore, and Petty 2000 South-Western College Publishing 13-1

Learning Objectives: Chapter 13 1. Discuss the role of cost and demand factors in setting a price. 2. Apply break-even analysis and markup pricing. 3. Identify specific pricing strategies. 4. Explain the benefits of credit, factors that affect credit extension, and types of credit. 5. Describe the activities involved in managing credit. Small Business Management, 11th edition Longenecker, Moore, and Petty 2000 South-Western College Publishing 13-2

The Three Components of Total Cost Used in Determining Pricing Cost of goods sold Selling cost Overhead cost Small Business Management, 11th edition Longenecker, Moore, and Petty 2000 South-Western College Publishing 13-3

Cost Structure of a Hypothetical Firm, 1999 and 2000 Sales revenue (25,000 units @ $8) $200,000 Total costs: Fixed costs $75,000 Variable costs ($2 per unit) 50,000 Gross margin Average cost = = $5 Sales revenue (10,000 units @ $8) $ 80,000 Total costs: Fixed costs $75,000 Variable costs ($2 per unit) 20,000 Gross margin Average cost = = $9.50 $125,000 75,000 $125,000 25,000 2000 95,000 $(15,000) $95,000 10,000 Small Business Management, 11th edition Longenecker, Moore, and Petty 2000 South-Western College Publishing 13-4

Break-Even Chart for Pricing (a) Sales (Price = $12) 900 Profit Total Cost 700 Break-Even Point Total Variable Costs Costs and Revenue ($) 500 300 Loss Total Fixed Costs 100 10 30 50 70 90 Production in Units Small Business Management, 11th edition Longenecker, Moore, and Petty 2000 South-Western College Publishing 13-5

Break-Even Chart for Pricing (b) Sales (Price = $18) Sales (Price = $12) 900 Sales (Price = $7) 700 Total Cost Costs and Revenue ($) 500 300 Break-Even Points 100 10 30 50 70 90 Production in Units Small Business Management, 11th edition Longenecker, Moore, and Petty 2000 South-Western College Publishing 13-6

Formulas for Markup Calculations Cost + Markup = Selling price Cost = Selling price - Markup Markup = Selling price - Cost Markup Selling price x 100 = Markup expressed as a percentage of selling price x 100 = Markup expressed as a percentage of cost Markup Cost To convert markup as a percentage of selling price into a percentage of cost, or vice versa, the two formulas below are useful: Markup as percentage of selling price 100% - Markup as percentage of selling price x 100 = Markup as percentage of cost Markup as percentage of cost 100% + Markup as percentage of cost x 100 = Markup as percentage of selling price Small Business Management, 11th edition Longenecker, Moore, and Petty 2000 South-Western College Publishing 13-7

Types of Pricing Strategies Penetration pricing strategy Skimming pricing strategy Follow-the-leader pricing strategy Variable pricing strategy Flexible pricing strategy Price lining strategy What the traffic will bear Small Business Management, 11th edition Longenecker, Moore, and Petty 2000 South-Western College Publishing 13-8

Benefits of Credit to Buyers and Sellers 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 Benefits of Credit to Sellers 1. Closer association with customers because of implied trust 2. Easier selling through telephone- and mail-order systems 3. Smoother sales peaks and valleys, since purchasing power is always available 4. Easy access to a tool with which to stay competitive Small Business Management, 11th edition Longenecker, Moore, and Petty 2000 South-Western College Publishing 13-9

Types of Credit Consumer Credit Open charge accounts Installment accounts Revolving charge accounts Credit Cards Bank credit cards Entertainment credit cards Retailer credit cards Trade Credit Small Business Management, 11th edition Longenecker, Moore, and Petty 2000 South-Western College Publishing 13-10

Commonly Used Trade Credit Terms Credit Term Explanation Three percent discount if payment is made within the first 10 days, net (full amount) due by sixtieth day from invoice date 3/10, net 60 E.O.M. Billing at the end of the month, covering all credit purchases during that month C.O.D. Amount due is to be collected upon delivery of the goods 2/10, net 30, R.O.G. Two percent discount if payment is made within 10 days; net due by thirtieth day however, both discount period and 30 days start from the date of receipt of the goods 2/10, net 30, E.O.M. Two percent discount if payment is made within 10 days; net due by the 30th day however, both periods start from the end of the month in which the sale was made Small Business Management, 11th edition Longenecker, Moore, and Petty 2000 South-Western College Publishing 13-11

Hypothetical Aging Schedule for Accounts Receivable Customer Account Number Account Status 001 002 003 004 005 Total Days past due 120 days $50,000 $50,000 90 days $10,000 $10,000 60 days $40,000 $40,000 30 days $20,000 $20,000 $40,000 15 days $50,000 $10,000 $60,000 Total overdue $50,000 $30,000 $80,000 $40,000 $ 0 $200,000 Not due (beyond discount period) $30,000 $10,000 $ 0 $10,000 $130,000 $180,000 Not due (still in discount period) $20,000 $100,000 $ 0 $90,000 $220,000 $430,000 Credit rating A B C A A Small Business Management, 11th edition Longenecker, Moore, and Petty 2000 South-Western College Publishing 13-12

Federal Regulation of Credit 1968 Truth-in-Lending Act The Fair Credit Billing Act The Fair Credit Reporting Act The Equal Credit Opportunity Act The Fair Debt Collection Practices Act Small Business Management, 11th edition Longenecker, Moore, and Petty 2000 South-Western College Publishing 13-13