Pricing and Credit Decisions PART 4 Focusing on the Customer: Marketing Growth Strategies

Looking Ahead After studying this chapter, you should be able to: Discuss the role of cost and demand factors in setting a price. Apply break-even analysis and markup pricing. Identify specific pricing strategies. Explain the benefits of credit, factors that affect credit extension, and types of credit. Describe the activities involved in managing credit.

Setting a Price Price Credit A specification of what a seller requires in exchange for transferring ownership or use of a product or service. Prices set too low, loss in revenue Price set too high, loss in revenue Price and demand are related for many goods and services Credit An agreement between a buyer and a seller that provides for delayed payment for a product or service.

Price Changes Affect Revenues Situation A Quantity sold x Price per unit = Gross revenue 250,000 $3.00 $750,000 Situation B Quantity sold x Price per unit = Gross revenue 250,000 $2.80 $700,000 Difference in Revenue $50,000

Exhibit 16.1 The Three Components of Total Cost in Determining Price

Cost Determination for Pricing Total Cost The sum of cost of goods sold, selling expenses, and overhead costs. Variable Costs Costs that vary with the quantity produced or sold. Fixed Costs Costs that remain constant as the quantity product or sold varies. Average Pricing An approach in which total cost for a given period is divided by quantity sold in that period to set a price.

Exhibit 16.2 Cost Structure of a Hypothetical Firm, 2009

Exhibit 16.3 Cost Structure of a Hypothetical Firm, 2010 Average pricing overlooks the reality of higher average costs at lower sales levels

How Customer Demand Affects Pricing The Elasticity of Demand The degree to which a change in price affects the quantity demanded. Elastic Demand Demand that changes significantly when there is a change in the price of the product. Inelastic Demand Demand that does not change significantly when there is a change in the price of the product. Demand Price Elastic Inelastic

Pricing and Competitive Advantage Customers will demand and pay more for a product or service that they perceive as important to their needs. Prestige Pricing Setting a high price to convey an image of high quality or uniqueness (competitive advantage). Customers associate price with quality. Markets with low levels of product knowledge are candidates for prestige pricing.

Applying a Pricing System Break-Even Analysis A comparison of alternative cost and revenue estimates in order to determine the acceptability of each price. Steps in the analysis Examining revenue-cost relationships: the quantity at which the product will generate enough revenue to start earning a profit. Break-even units sold = total fixed costs and expenses selling price – unit variable costs and expenses

Exhibit 16.4 Break-Even Graphs for Pricing

Applying a Pricing System (cont’d) Examining Cost and Revenue Relationships Breakeven Point The sales volume at which total sales revenue equals total costs (fixed and variable)—the point at which profitability starts and losses cease. Contribution Margin The difference between the unit selling price and the unit variable costs and expenses. Incorporating Sales Forecasts Adjusted Break-Even Analysis Price has a variable impact and influence on demand. Adjusting for the indirect effect of price allows for a more realistic profit area to be identified.

Exhibit 16.5 A Break-Even Graph Adjusted for Estimated Demand

Applying a Pricing System (cont’d) Markup Pricing Cost plus pricing system that adds a markup percentage to cover: Operating expenses Subsequent price reductions Desired profit

Selecting a Pricing Strategy Penetration Pricing Skimming Pricing Follow-the-Leader Pricing Pricing Strategies Variable Pricing Dynamic Pricing Price Lining What the Market Will Bear

Selecting a Pricing Strategy (cont’d) Setting Prices: Controls and Situations The Sherman Antitrust Act generally prohibits competitors from conspiring to fix prices. The effect of the introduction of new products into an established product line. Offering discounts to match the needs of customers. If the initial price appears to be off target, make any necessary adjustments and keep on selling!

Benefits of Credit to Borrowers Offering Credit Benefits of Credit to Borrowers Provides working capital Ability to satisfy immediate needs and pay later Better records of purchases on credit billing Better service and greater convenience when exchanging purchased items Establishment of credit history

Offering Credit (cont’d) Benefits of Credit to Sellers Facilitates increased sales volume. Brings a closer association with customers. Fosters easier selling through telephone, mail and Internet. Helps smooth sales demand since purchasing power is always available. Provides easy access to a tool with which to stay competitive.

Selling on Credit Factors That Affect Selling on Credit Type of Business Credit Policies of Competitors Income Level of Customers Availability of Working Capital

Types of Credit Consumer Credit Trade Credit Financing granted by retailers to individuals who purchase for personal or family use. Trade Credit Financing provided by a supplier of inventory to a given company which sets up an account payable for the amount. Terms of sale may be 2/10, net 30—two percent discount on the invoiced amount if paid in full within 10 days of the invoice date, otherwise the full amount of the invoice is due in 30 days.

Types of Consumer Credit Accounts Open Charge Account A line of credit that allows the customer to obtain a product at the time of purchase. Installment Account A line of credit that requires a down payment, with the balance paid over a specified period of time. Revolving Charge Account A line of credit on which the customer may charge purchases at any time, up to a pre-established limit.

Entertainment Credit Cards Types of Credit Cards Bank Credit Cards Credit cards issued by banks that are widely accepted by retailers who pay a fee to the banks for handling their credit transactions. Entertainment Credit Cards Business credit cards originally used to purchase services, now widely accepted for merchandise. Retailer Credit Cards Credit cards issued by firms for specific use in their outlets or for purchasing their products or services.

Managing the Credit Process Evaluation of Credit Applicants Can the buyer pay as promised? Will the buyer pay? If so, when will the buyer pay? If not, can the buyer be forced to pay? The Traditional Five C’s of Credit Character Capital Capacity Conditions Collateral

Sources of Credit Information Individuals Customer’s previous credit history Dun & Bradstreet Business Information Reports Businesses Financial statements of the firm Other sellers to the firm Firm’s banker Trade-credit agencies Credit bureaus Online credit data

Exhibit 16.6 Hypothetical Aging Schedule for Accounts Receivable

Managing the Credit Process (cont’d) Billing and Collection Procedures Timely notification is a most effective collection method for keeping bills current. Warning consumers that they may do damage to their credit if they fail to pay. Bad debt ratio A number obtained by dividing the amount of bad debts by the total amount of credit sales.

Credit Regulation The Truth-in-Lending Act (1968) The Fair Credit Billing Act The Fair Credit Reporting Act The Equal Credit Opportunity Act The Fair Debt Collection Practices Act

Key Terms price credit total cost variable costs fixed costs average pricing elasticity of demand elastic demand inelastic demand prestige pricing break-even point contribution margin markup pricing penetration pricing strategy skimming price strategy follow-the-leader pricing strategy variable pricing strategy dynamic (personalized) pricing strategy price lining strategy consumer credit trade credit open charge account installment account revolving charge account trade-credit agencies credit bureaus aging schedule bad-debt ratio