1. Pricing I Professor S.J. Grant Spring 2007 BUYER BEHAVIOR, MARKETING 3250

2. Outline Economic approaches used to understand and determine pricing Cost basis (seller focused, supply side) Breakeven analysis Margin, markup calculations Market share objectives Demand basis (customer focused, buy side) Elasticity

3. Cost Basis Pricing A seller-focused approach takes into account the cost of production Material costs Labor costs Distribution costs Opportunity costs

4. Break-Even Analysis Cost vs. Price Cost refers to the seller’s cost Price refers to buyer’s price

5. Break-Even Analysis Calculating the break-even point is helpful for understanding what price is needed to cover costs Total Cost = Fixed Cost + Variable Cost Revenues = Total Cost Revenues = Quantity x Price Break-even point Sometimes COGS, or cost of goods sold Quantity x Price = Fixed Cost + Variable Cost

6. Margin Margin refers to profit in terms of revenue, expressed as a percent Manufacturer’s margin Retailer’s margin ManufacturerRetailerConsumer Cost of sales: $1 Selling price: $1.50 Profit: $.50 Margin: 33% $1.50$2.00 Cost of sales: $1.50 Selling price: $2.00 Profit: $.50 Margin: 25%

7. Markup Markup refers to profit in terms of cost, expressed as a percent Manufacturer’s markup Retailer’s markup ManufacturerRetailerConsumer Cost of sales: $1 Profit: $.50 Markup: 50% $1.50$2.00 Cost of sales: $1.50 Profit: $.50 Markup: 33%

8. Contribution Margin Contribution margin calculations allow managers to understand the added benefit of increasing production Unit Selling Price – Unit Variable Cost = Unit Contribution Contribution Margin = Unit Contribution/Unit Selling Price

9. Market Share Share of market is calculated based on total market sales Half of $300 million market is worth $150 million $20,000 represents 20% share of $100,000 market Company with 75% market share has revenues of $3 billion in $4 billion industry

10. Demand Basis Pricing Pricing may be determined according to what the market will bear Real estate Auctions Used cars Calculation of price sensitivity can be helpful to understand consumer demand

11. Demand Elasticity Elasticity is a measure of responsiveness Elasticity of demand tells us how much the quantity demanded changes when the price changes Demand is elastic Demand is inelastic http://hadm.sph.sc.edu/COURSES/ECON/Elast/Elast.html

12. Elastic Demand At low prices, greater quantities are sold More consumers may buy Consumers may buy more (stockpiling) At high prices, smaller quantities are sold Fewer consumers may buy Consumers may buy fewer Consumers may find substitutes

13. Inelastic Demand Same quantities are sold, regardless of price Lower prices do not encourage consumption Higher prices do not discourage consumption Few substitutes available E.g. medical care

14. Calculating Elasticity Elasticity can be defined as: ΔQ/Q ΔP/P or (Q 2 -Q 1) /Q 1 (P 2 -P 1) /P 1 http://www.digitaleconomist.com/elasticity_tutorial.html

15. More on Elasticity Price elasticity is the % change in demand that occurs in response to a % change in price E.g.10% fall in the price of a good increases the quantity demanded by 20% => 20%/-10% = -2 The minus is understood, often omitted When does demand for a good rise as its price rises? Giffen goods or Veblen goods Examples?