Price Setting NDFS Tree Promotion / NDCDEA Meeting – Mar. 19, 2014 © 2013 Board of Regents, South Dakota State University iGrow.org

Price setting can be complicated. Seems to be guesswork. Today, try to simplify © 2013 Board of Regents, South Dakota State University, iGrow.org

Pricing Objectives Cover Costs/Generate Profit Market Positioning Market Share New Product Branding © 2013 Board of Regents, South Dakota State University, iGrow.org

Pricing Objectives Cover Costs/Generate Profit Market Positioning Market Share New Product Branding © 2013 Board of Regents, South Dakota State University, iGrow.org

Main Pricing Strategy Cost-plus Pricing Cost/unit + Profit/unit = Price/unit Profit 1. Return on good decisions 2. Use to expand, invest 3. Financial cushion © 2013 Board of Regents, South Dakota State University, iGrow.org

What is Profit? Revenue/unit TR -Cost/unitor- TC Profit/unitProfit © 2013 Board of Regents, South Dakota State University, iGrow.org

Profit Margin in grocery stores is typically about 1 to 2 percent of sales (volume business)

© 2013 Board of Regents, South Dakota State University, iGrow.org Profit Margin in restaurants is typically about 5-6 percent (Forbes, 2011)

© 2013 Board of Regents, South Dakota State University, iGrow.org Profit Margin in greenhouses, nurseries, is 5-10 percent

Costs of Selling Product (Cost of Production) Costs are broken up into two areas – variable, operating, or direct costs and fixed, ownership, or indirect costs. 10

© 2013 Board of Regents, South Dakota State University, iGrow.org Costs of Selling Product 1.Fixed Costs - Do not change directly with production/sales 2.Variable Costs - Do change directly with production/sales

Costs of Selling Product Cost of Production varies depending on how much produced As production increases, cost per unit goes down (to a point) Fixed costs are spread over more units Assuming variable costs per unit are constant 12

© 2013 Board of Regents, South Dakota State University, iGrow.org Costs of Selling Product 1.Fixed Costs 2.Materials/Supplies 3.Labor 4.Marketing (transportation, packaging, advertising)

© 2013 Board of Regents, South Dakota State University, iGrow.org Costs of Selling Product 1.Fixed Costs These are property and building costs, equipment costs, insurance, utilities, property taxes, office expenses, and interest

© 2013 Board of Regents, South Dakota State University, iGrow.org Costs of Selling Product Fixed Costs – Segment If selling trees is 25% of your “business” – estimate 25% of these costs and divide by # of plants

© 2013 Board of Regents, South Dakota State University, iGrow.org Costs of Selling Product 2. Materials/Supplies This is your tree cost and any associated costs on a per tree basis (variable costs) (COGS)

© 2013 Board of Regents, South Dakota State University, iGrow.org Costs of Selling Product Materials/Supplies Or, cost of seedling, fert., soil, container, etc.

© 2013 Board of Regents, South Dakota State University, iGrow.org Costs of Selling Product 3. Labor Labor can be a variable cost if time per unit can be determined (5 workers x 10 hours x $12.00/hr for 1,000 trees = $0.60 per tree)

© 2013 Board of Regents, South Dakota State University, iGrow.org Costs of Selling Product Labor Labor can be handled as a fixed cost if workers are paid a salary

© 2013 Board of Regents, South Dakota State University, iGrow.org Relative importance of employer costs for employee compensation, June 2013 Compensation Civilian Private State and local component workers industry government ___________________________________________________________________ Wages and salaries 69.2% 70.3% 64.5% Benefits Paid leave Supplemental pay Insurance Health benefits Retirement and savings Defined benefit Defined contribution Legally required

© 2013 Board of Regents, South Dakota State University, iGrow.org Costs of Selling Product 4. Marketing (fixed or variable cost) - estimate cost per tree

© 2013 Board of Regents, South Dakota State University, iGrow.org Costs of Owning Machinery 1.Fixed Costs 2.Repairs and Maintenance 3.Labor 4.Fuel

© 2013 Board of Regents, South Dakota State University, iGrow.org Costs of Owning Machinery 1.Fixed Costs These are housing costs, depreciation, insurance, interest, and property taxes

© 2013 Board of Regents, South Dakota State University, iGrow.org Costs of Leasing Machinery 1.Lease Costs 2.Labor 3.Fuel

Must at least cover VC! Grass seed is product - Fixed Cost is a Forklift © 2013 Board of Regents, South Dakota State University, iGrow.org VolumePrice/ Unit ($) VC/unit ($) FC/unit ($) TC/unit ($) Profit/ Unit ($) 2, , , ,

Breakeven Volume Number units at which Revenue equals Total Cost Minimum sale volume Fixed costs of $5,000/month Variable costs of $20/tree Price set at $50/tree Breakeven volume is 167 trees per month © 2013 Board of Regents, South Dakota State University, iGrow.org

Breakeven Volume $ Trees © 2013 Board of Regents, South Dakota State University, iGrow.org 5k FC 100 Revenue 167 VC TC 8,350

Breakeven Price Price at which Revenue equals Total Cost Minimum sale price Everything constant except tree price Fixed costs of $2,000/month Variable costs of $20/tree On average, sell 200 trees/month Breakeven price per tree is $30 $2,000 + $20(200) = x(200) © 2013 Board of Regents, South Dakota State University, iGrow.org

Pricing Strategies Penetration pricing - very low margin, or at cost, or below total cost - low price generally means large sales Benefit – get established, sell product Downside - later raising prices causes backlash © 2013 Board of Regents, South Dakota State University, iGrow.org Source: Setting Your Price, Ag Decision Maker, File C5-17, Iowa State University Extension

Pricing Strategies Penetration pricing - works well when demand is elastic © 2013 Board of Regents, South Dakota State University, iGrow.org P Q Source: Setting Your Price, Ag Decision Maker, File C5-17, Iowa State University Extension Demand

Pricing Strategies Penetration pricing - works well with high (large) fixed costs - fixed costs spread over large number of sales (production) © 2013 Board of Regents, South Dakota State University, iGrow.org Source: Setting Your Price, Ag Decision Maker, File C5-17, Iowa State University Extension

Selling grass seed Assume FC = $10,000 © 2013 Board of Regents, South Dakota State University, iGrow.org VolumePrice/ Unit ($) VC/unit ($) FC/unit ($) TC/unit ($) Profit/ Unit ($) , , , , ,

Pricing Strategies Premium Pricing Setting price relatively high - works well when demand is inelastic - works well when no good substitutes © 2013 Board of Regents, South Dakota State University, iGrow.org P Q Source: Setting Your Price, Ag Decision Maker, File C5-17, Iowa State University Extension Demand

Pricing Strategies Premium pricing very large margin, but don’t sell many units, or, don’t have to sell many units © 2013 Board of Regents, South Dakota State University, iGrow.org

Pricing Strategies Premium pricing - new product - product without substitutes - segmented market (high end users) - few buyers, so that dictates high price © 2013 Board of Regents, South Dakota State University, iGrow.org

Pricing Strategies Bundling Bundling something desired, but expensive, with something less desirable, but profitable © 2013 Board of Regents, South Dakota State University, iGrow.org

Pricing Strategies Bundling You buy a tree for $50, sell for $60 (profit of $10), or offer to plant same tree for $80 (your planting cost is $10, profit of $20) © 2013 Board of Regents, South Dakota State University, iGrow.org

Pricing Strategies Bundling You buy a tree for $55, sell for $60 (profit of $5), or have expenses, seedling, fert., container, soil, labor, fixed costs, at $50, sell for $60 (profit of $10) © 2013 Board of Regents, South Dakota State University, iGrow.org

Pricing Strategies Value Added Adding value such that additional revenue is greater than additional cost You buy a seedling for $5 and sell for $10, or you buy seedling for $5, add $45 worth of stuff, and sell for $70 Added cost = $45 Added value = $65 © 2013 Board of Regents, South Dakota State University, iGrow.org

Pricing based on Quality Consumers evaluate on price and quality. Perceived quality (quality is subjective). Higher price may signal more value. More perceived value can garner higher price. Value = Quality/Price © 2013 Board of Regents, South Dakota State University, iGrow.org Source: Setting Your Price, Ag Decision Maker, File C5-17, Iowa State University Extension

Value Pricing © 2013 Board of Regents, South Dakota State University, iGrow.org Differentiated Product ProductPrice/unitQualityValue Commodity ProductPrice/unitQualityValue Source: Setting Your Price, Ag Decision Maker, File C5-17, Iowa State University Extension

Economies of Scale As scale increases, cost per unit decreases Renting a warehouse, thinking about doubling the size Revenue will double Variable costs will double Fixed costs increase, but if any do not double Economies of Scale – Cost/unit 42

Economies of Scale Volume discounts are essentially the passing along of savings from economies of scale (and specialization) 43

© 2013 Board of Regents, South Dakota State University, iGrow.org Competitor’s Prices Know what these are, if any. Can you undercut? Should you undercut?

© 2013 Board of Regents, South Dakota State University, iGrow.org Prices ending in 9 “Was $40, now only $29” “Was $40, now only $25” Advertising Ideas

© 2013 Board of Regents, South Dakota State University, iGrow.org Weber’s Law Price increases of around 10% upper limit of acceptability - consumer don’t notice or don’t care Advertising Ideas

© 2013 Board of Regents, South Dakota State University, iGrow.org Anchoring Placing premium products and services close to standard items - less expensive items may seem like a bargain Advertising Ideas

© 2013 Board of Regents, South Dakota State University, iGrow.org Price Similar Products Differently Avoids “action paralysis” - consumer defer decision Advertising Ideas

© 2013 Board of Regents, South Dakota State University, iGrow.org A lot of research done in advertising on context “Experience” product or service provides Advertising Ideas

© 2013 Board of Regents, South Dakota State University, iGrow.org Kim Douglas Dillivan Crops Business Mgmt Field Specialist