Entrepreneurship and Small Business Management Chapter 8 Pricing and Credit Strategies

Ch. 8 Performance Objectives Understand the relationship between price and overall strategy. Describe various pricing strategies. Calculate markups from manufacturer through the consumer. Explore the role of trade credit in pricing. Consider discounts, incentives, and other price adjustments.

Relationship Between Price and Overall Strategy The price helps to position the product/service in the market. The pricing strategy should reflect the company’s overall strategy. A low price is not always better; consumers may make quality judgments based on the price.

Steps to Better Pricing Assess what value your customers place on the product/service. Look for variations in the way customers value the product/service. Assess customers’ price sensitivity. Identify an optimal pricing structure. Consider competitors’ reactions.

Steps to Better Pricing (continued) Monitor prices realized at the transaction level. Assess customers’ emotional response. Analyze whether the returns are worth the cost to serve.

Pricing Strategies Value pricing—offer more for less cost Prestige pricing—set a high price to convey high quality or uniqueness Cost-plus pricing—use your cost plus a desired profit margin Markup pricing—apply a predetermined percentage to the product’s cost Penetration pricing—charge a lower initial price to capture market share

Pricing Strategies (continued) Skimming price—charge a higher initial price while there are few competitors Meet-or-beat-the-competition pricing—match or undercut competitors’ prices Follow-the-leader pricing—use a particular competitor (usually the dominate one in the industry) as the model for pricing

Pricing Strategies (continued) Personalized (dynamic) pricing—charge certain customers a premium over the standard price Variable pricing—use different prices for the same product or service (to allow for discounts, credit terms, price concessions) Price lining—create a range of distinctive pricing levels

Common Use of Pricing Strategies by Business Type Pricing Strategy Mfg. Wholesale Retail Service Cost-Plus X Follow-the-Leader Meet-or-Beat-the -Competition Penetration Personalized Prestige Skimming Value Variable

Calculating Markups Manufacturers and retailers often double (keystone) their cost. Wholesalers often operate on smaller margins. Service businesses may use cost plus a mark-up on hourly labor rates and materials costs.

Example Chain of Markups $1.00 Manufacturer’s Cost x Markup % = $2.00 Manufacturer’s Price $2.00 Wholesaler’s Cost x Markup % = $2.40 Wholesaler’s Price $2.40 Retailer’s Cost x Markup % = $4.80 Retailer’s Price Consumer’s Cost = $4.80

Pricing by Service Businesses Primary “product” cost is labor Other pricing factors include: Competitive environment Cost of materials used to deliver the service Overhead costs Desired profit levels

Service Business: Calculating Cost Per Hour Fixed Costs + Variable Costs – Materials Hours

Service Business: Pricing Example Cost of Services (15 hours x $95.50/hr.) Cost of Materials Cost of Materials Markup (70%) Total Service Price $1,432.50 200.00 140.00 $1,772.50

Demand Affects Pricing Market clearing price—point at which supply of product matches demand Flexibility of pricing depends on the demand elasticity of your customers: Elastic—demand changes significantly up or down when the price changes Inelastic—demand does not change much when the price changes

Extending Credit to Customers Pros Cons Raises revenues and promotes business growth; product or service is accessible to many more people Reduces the loss of customers to competitors who offer credit Slower cash flow Risk of unpaid loans Start-up and ongoing fees Additional management processes required to approve and maintain credit accounts

Types of Credit Store or merchant credit cards Installment credit: Loan is paid back, with interest, over a specified time period in installments Purchased item serves as collateral Trade credit: Cash-in-advance (COA) terms Cash-on-delivery (COD) terms

Types of Price Adjustments Order size (quantity) discounts Annual, quarterly, or monthly volume discounts/bonuses Dealer and distributor discounts Promotion discounts and bonuses Merchandising discounts Co-op advertising and marketing allowances Product rebates Exception discounts Freight/shipping allowances

Price Adjustment Analysis Pocket price—what remains after all pricing factors, such as discounts and allowances, are deducted from the list or invoice price to reach the final price Pocket price band—range of prices for a given unit volume of a particular item at a given point in time