Determining the Price Section 7.1

Determining the Price There are two key factors that determine price: 1. The cost of doing business 2. The profit the company hopes to make from the sale of its product or service

Markup  The amount of money that a company adds to the original cost of the product in order to cover its business expenses and to make a profit. Ex. HMV buys a CD for $15 from the CD manufacturer. It sells all CD’s in its store with a $5 markup or ($5 ÷ $15 = 33.3% markup)

Margin/Profit Margin The percentage of the price charged to the consumer that is not used to pay for the cost of the item. Profit Money left over after all expenses are paid is earned and be kept by the owners. Ex. HMV buys the CD for $15 from the DVD manufacturer and decides to sell it for $25. The margin is (15 ÷ 25) x 100 = 60% Margin

Break-even Analysis Determining how many units must be sold at a given price to cover operating costs Variable Costs Costs which are directly dependant on the quantity of goods sold Fixed Costs Costs which stay the same regardless of how many goods are produced or sold

Economies of Scale  The more products a company makes, the lower the cost of production for each item.

Private-Label Products  The private-label or store brand (ie. no name brand) of many products are identical to the brand-named competitive product it sits beside on the shelf.

Other Strategies using Economies of Scale 1. Creating a barrier to entry for competitors 2. Creating new brands 3. Merging with Competitors

5 Most Common Pricing Mistakes 1. The Price War: Slashing prices, just because the competition is doing so, may not work to the company’s advantage. 2. Lost value: If a cost or a service is not factored in when a price is established, there may not be a way of recovering the cost. 3. Cost-Based Pricing: Adding a markup to the cost of the good can create a selling price that may be too high or not high enough. 4. Underpricing Your Service: May increase business, but it may cove at a cost if the increased demand cannot be met and makes customers frustrated. 5. The Psychology of Price: Image, not price, may dictate pricing. Convenience for the consumer can be create by adjusting price so that the total comes to $5.00 rather than $5.09.

Diseconomies of Scale  Maximizing the output of production does not always lead to economies of scale.  Occasionally, a firm will become too large. Bureaucracy is often created in large firms which slows down a company’s reaction times and limits their creativity