20 Setting the Right Price Professor Close

Introduction to Price Setting (1) Setting price: –Cost-Based Pricing: most firms Markup: Amount added to cost –(High Markup High Profits) –What is marked up most? (slow sellers; Ford vs. Mercedes) Usually % of sales PRICE* (keystone) Often standard for industry –Easy – supermarkets (1%) –(similar operating expenses)

Introduction to Price Setting (2) Methods: Average Cost –mean cost (+) markup –example: »50,000 cans »Fixed Costs: $30,000 (salaries, mortgage, utilities) »Variable costs: 40 cents/can (costs change w/produce) –Total Cost: $30,000 + (.40 x 50,000) = $50,000 –Avg Cost: $50,000 / 50,000 = $1 –Price: add markup to avg cost – 25 cents –Revenues: $1.25 x 50,000 = $62,500 –Profit: Revenue – Total Cost = $62,500 – 50,000 = $12,500

Introduction to Price Setting (3) Problem with average cost: may not sell projected # For example: sell 20,000 cans for $1.25 Revenues: 20,000 x 1.25 = $25,000 Costs: $30,000 + (1 x 20,000) = $50,000 Loss: $25,000

Introduction to Price Setting (4) Markup Strategy (general: faster turn needs less markup) High: emphasize earnings on each item (luxury; jewelry) Low: emphasize turnover and decreasing inventory costs (bread; milk)

Introduction to Price Setting (5) Demand-Based Pricing: –Basis: Customer Price sensitivity Substitute awareness (gasoline: hometown vs. trip) Total expenditure (higher markup on low-priced items) Difficulty in comparison (medical services) Benefits vs. price: benefit, sensitivity (education)

Introduction to Price Setting (6) Demand-Based Pricing (cont…) Situation (eating out on a date vs. eating out otherwise) Responsibility for payment (airline tickets) Sunk costs (computers: Apple vs. IBM); rational?

Introduction to Price Setting (7) Demand-Based Pricing (cont…) –Demand-based methods Leader pricing –Low prices draw customers, also buy others –May just buy leaders (Food Lion) Bait pricing –Add low priced items, switch to higher price/lesser brand –Illegal in interstate commerce Odd-even pricing – psychological ($19.95) –Loss prevention – open register –Depends on thought (up/down) –Traditionally on lower-priced items (now more often…)

Summary Read: –Target Return Pricing (pg. 524) Any questions??