1. Idil Yaveroglu Lecture Notes
Chapter 10 Pricing
Idil Yaveroglu
Lecture Notes

2. What is a Price?
The amount of money charged for a product or service, or the sum of the values that consumers exchange for the benefits of having or using the product or service.
To the seller... Price is revenue
and profit source
What is Price?
To the consumer... Price is the cost of something

3. Factors to Consider When Setting Prices

4. Customer Perceptions of Value (no demand above this price)
PRICE CEILING
Customer Perceptions of Value
(no demand above this price)
INTERNAL CONSIDERATIONS
Marketing Goals
Marketing-Mix Strategy
Costs
Organizational Considerations
EXTERNAL CONSIDERATIONS
Nature of Market
Consumer Demand
Competition
Environmental Factors
PRICE FLOOR
Product Costs
(no profits below this price)

5. Pricing Approaches Cost Based Pricing Value Based Pricing
Competition Based Pricing

6. Cost Based Pricing 1. Cost-Based Pricing: Cost-Plus Pricing
Adding a standard markup to cost
Popular pricing technique because:
It simplifies the pricing process
Price competition may be minimized
It is perceived as more fair to both buyers and sellers
Two kinds of mark-up applied:
Cost plus percentage of cost
Cost plus fixed fee

7. Disadvantages of Cost Based Pricing
Ignores demand (price sensitivity)
Does not account for competition
May result in underpricing or overpricing

8. Costs
Fixed Costs: Costs that do not vary with sales or production levels.
Overhead: Executive salaries, rent
Direct Fixed Costs: Advertising, marketing manager’s salary
Variable Costs: Costs that do vary directly with the level of production.
e.g. raw materials
Total Costs (for a given level of production)

9. Determining Costs
TC = FC + TVC
TC = FC + (UVC)xQ
AC = TC/Q

10. Mark up Pricing Margin = selling price – acquisition price of a good
( also called unit contribution, or markup )
Percent margin = margin / selling price
Mark up Percentage on Selling Price= margin / selling price
Mark up Percentage on Cost = margin / cost
Ex: If a retailer paid $150 for a lawnmower and sells it for $200, what is the markup as a percentage of selling price? what is the markup as a percentage of cost?

11. Mark up Pricing $5 $8 $10 $11 manufacturer’s wholesaler’s retailer’s
$5 $8 $ $11
manufacturer’s wholesaler’s retailer’s
Margin margin margin =
% =
manufacturer’s margin = $3
%37.5

12. Cost-Based Pricing Example
- Variable costs: $ Fixed costs: $ 500,000
Expected sales: 100,000 units - Desired Sales Markup: 20%
What is the selling price?
Variable Cost + Fixed Costs/Unit Sales = Unit Cost
$20 + $500,000/100,000 = $25 per unit
Unit cost + Markup (% of SP) = SP
$25 + SPx.20=SP
Unit Cost/(1 – Desired Return on Sales) = Markup Price (Selling Price)
$25 / ( ) = $31.25

13. Cost Based Pricing
2. Cost-Based Pricing: Break-Even Analysis and Target Profit Pricing
Break-even charts show total cost and total revenues at different levels of unit volume.
The intersection of the total revenue and total cost curves is the break-even point.
Companies wishing to make a profit must exceed the break-even unit volume.

14. Break Even Pricing
“At price X, how many units do we need to sell in order to break even?” (zero profit point)
Profit = TR – TC
TR =PxQ
TC = FC + (UVCxQ)
Profit = PxQ – (FC + UVCxQ)
0 = Q(P - UVC) – FC Q=
At break even price, TR=TC, and profits are zero
Breakeven Point $ TR TC
Profits
Loss FC
P - UVC
Quantity Produced and Sold

15. Break-even analysis chart for a picture frame store
Page #15
Slide 13-46

16. Break Even for Profit Goals
Break even + target profit level
Unit volume = Fixed cost + Profit Goal
Price – Variable Cost

17. Profit Pricing
Unit Contribution = Price – Unit variable cost = P – UVC Unit contribution is the amount that each unit contributes to covering fixed costs. Total Contribution = Total revenue – Total variable cost = PxQ – UVCxQ = ( P – UVC ) Q Profit = Total revenue – Total cost = Total contribution – Fixed cost = PxQ – FC – ( UVCxQ) = ( P – UVC ) Q – FC Break Even BE q = FC/(P – UVC)

18. Example Vandelay Ind. sells frozen pizza. Sales figures:
Price ($) Sales (weekly)
What is the price that maximizes total contribution if the unit variable cost is $4?
If FC are $2275/week how many more units would Vandelay have to sell to break even at a selling price of $7.5?

19. Value Based Pricing Value-Based Pricing: Good-Value Pricing
Uses buyers’ perceptions of value rather than seller’s costs to set price.
Measuring perceived value can be difficult.
Consumer attitudes toward price and quality have shifted during the last decade.
Good-Value Pricing
Everyday low pricing (EDLP) vs. high-low pricing
Value-Added Pricing
Adding value added features and services to be able to charge high prices

21. Competition Based Pricing
Also called going-rate pricing
May price at the same level, above, or below the competition
Bidding for jobs is another variation of competition-based pricing
Sealed bid pricing

22. Other Internal and External Considerations Affecting Pricing Decisions
Overall Marketing Strategy, Objectives and Mix
Company pricing objectives may include;
Survival
Low prices to cover variable costs and some of fixed costs
Current profit maximization
Choose the price that maximizes current profit, cash flow or ROI
Market share leadership
As low as possible to increase market share
Product quality leadership
High prices to cover higher performance quality

23. Price vs. Non Price Positioning

24. Other External Considerations Affecting Pricing Decisions – Nature of the Market
Pure competition
Many buyers and sellers who have little effect on price
Commodity markets such as wheat, copper, produce
Monopolistic competition
Many buyers and sellers trading over a range of prices
Sellers can differentiate their offer to the market
Most consumer goods
Oligopolistic competition
Few sellers, each sensitive to others’ pricing and marketing strategies
Car companies
Pure monopoly
Single seller
May not charge full price: prevent entry, faster penetration, fear of regulation
Utilities

25. Other External Considerations Affecting Pricing Decisions – Consumer Demand
Consumers compare the Perceived Value of the alternatives
In general, consumers buy if perceived value > price
Price Elasticity of Demand: how responsive the demand will be to a change in price.
What does elasticity depend on?
Higher elasticity (ease of not buying)
Availability of substitutes
Inventory capabilities
Lower elasticity
Price=quality assumptions
Uniqueness
Low price relative to budget
Purchasing for someone else

26. Price Elasticity A. Inelastic Demand - Demand Hardly Changes With
a Small Change in Price.
Price P2 P1 Q2 Q1
Quantity Demanded per Period
B. Elastic Demand -
Demand Changes Greatly With
a Small Change in Price.
Price
P’2
P’1 Q2 Q1
Quantity Demanded per Period

27. Total Revenue and Price Elasticity
Percentage change in Q
Elasticity (E) =
Percentage change in P
Inelastic Demand  E < 1  when P increases, TR increases
Elastic Demand  E > 1  when P increases, TR decreases
Unitary Elasticity  E = 1  P increase is offset by increase in Q
 no change in TR

28. Total Revenue and Price Elasticity
Elasticity is defined in terms of changes in total revenue. If the total revenue will increase if the price is lowered, then demand is inelastic. In unitary elasticity ---the total revenue stays the same when prices change.
With elastic demand, total revenue will decrease if the price is raised. With inelastic demand, however, total revenue will increase if the price is raised --- means PROFITS (total revenue- total cost, where total cost will be the same). So when the demand is inelastic, profit will increase as price is increased.

29. Price Elasticity Buyers are less sensitive to price changes when,
Product they are buying is unique
When it is high in quality, prestige, or exclusiveness
Substitutes are hard to find
When the total expenditure for a product is low relative to their income or when cost is shared by another party

30. Other External Considerations Affecting Pricing Decisions
Nature of Market and Demand
Competitors’ Strategies
Economic Conditions
Government Actions