Chapter 17 Pricing Objectives and Policies

Pricing Strategy Determines 1] How flexible prices will be 2] At what level prices will be set over the Product Life Cycle 3] To whom and when discounts and allowances will be given. 4] How transportation costs will be handled

Review some Terms Profit = Revenues - Costs Contribution = Revenues - Direct Variable Costs Unit Contribution = Selling Price – Unit Variable Costs Variable costs increase with every unit sold or produced Most (but not all) marketing costs are variable costs

Price Cuts & Increases Have a Direct Profit Impact You have a contribution margin of 20%, unit price = $100, 80 units were sold last month. You decide to cut your price 5%. How many units will you have to sell to have the same contribution as last month?

Price Cuts & Increases Last month’s unit contribution = $20 $20 unit contribution x 80 units sold = $1,600 contribution last month We would like to have a contribution of $1,600 or better this month.

Price Cuts & Increases New unit contribution = $20 - ($100 x.05) = $15 To make same contribution as last month $1,600 = $15x x = or 107 units (round up since you can’t sell partial units). Your sales must increase (107-80)/80 = 33.75% to make the same contribution

Price Cuts & Increases Note: Increasing or cutting prices usually does not effect the costs of a firm. If you can make a price increase stick and demand does not fall (much), your profitability is sharply increased. If you cut your price, you have to sell a LOT MORE UNITS to make the same profit level

Second Example Unit contribution = $15. Unit price = $50 Sold 300 units last year. You decide to cut prices 10%. How many units do you have to sell to have the same contribution as last year?

Example 2 continued Old total contribution = $15 x 300 = $4,500 New unit contribution = $15 - ($50 x.10) = $10 Units needed to be sold to make the same contribution as last year = $4,500 = 10x = 450 units Sales increase of ( )/300 = 50% Can you get this 50% sales increase?

Example 3 Unit contribution = $9, unit price = $90, sold 900 units last year. You decide to raise prices $10. How many units do you have to sell to have the same contribution as last year?

Example 3 cont. Total Contribution = $9 x 900 = $8,100 New unit contribution = $9 + $10 = $19 $8,100 = $19x = 427 units

Pricing Objectives 1] Target Return (459) 2] Profit Maximization (460) 3] Sales Oriented –Market share = Firms sales in units (dollars)/ – Industry sales in units ($s) Status Quo (460)

Product Life Cycle & Pricing Skimming (464) vs Penetration (466) Skimming –Recoup Costs Quickly –Aim at members of the target that have strongest desire –Helps with production & distribution Penetration - discourages competitive entry & builds market share quickly

Quantity Discounts Discounts offered to encourage customers to buy in larger amounts (469). Can be price cuts or free goods Often given due to economies of scale in production, distribution, & ordering Two types –Cumulative Quantity Discounts (469) –Noncumulative Quantity Discounts (469)

Cumulative vs Noncumulative Your firm sells plastic containers. Your price structure is: Less than 1000 units - $0.65 each units - $0.60 each units - $0.55 each 10,000 + units - $0.50 each

Cumulative vs Noncumulative 2 Zed buys 1200 units in January, 500 units in February and 3,800 units in March. What was the total price paid if the discounts were: –Cumulative? –Noncumulative?

Cumulative vs Noncumulative $3,025Cumulative: = 5500 units. Total price = 5500 x $0.55 = $3,025 Noncumulative 1200 x $0.60 = $ x $0.65 = $ x $0.60 = $2,280 $3,325Total = $3,325

Cash Discounts Reduction in price to encourage buyers to pay in cash (470). Ex: 2/10, net 30. Reads: 2% discount if paid in 10 days of the invoice date; full amount due in 30 days. What is the annual interest rate here?

Cash Discount Paying for 20 days use of the money (net day discount period) How many annual periods? 365/20 = Annual interest rate = 36.5% You can change credit terms by altering the net date, the discount period, or the discount %

Distribution Pricing F.O.B. - Free on Board some vehicle at some place. FOB delivered - seller pays freight and retains title until product is delivered (474) F.O.B. Shipper - buyer pays freight and takes title at the shippers loading dock.

Distribution Pricing F.O.B. Delivered (474) Zone Pricing (474) Uniform Delivered Pricing (474)

Legal Issues Price Fixing (480) (mins & maxes) Robinson Patman Act (480) –illegal to sell to different business buyers at different prices if it injures competition –Can have different prices if: Based on cost differences Meet the actions of competitors Must make allowances available to all customers on a proportionally equal basis unless there is a cost basis for doing so.