Entrepreneurship The Price Strategy

Objectives: 1. Recognize the factors that affect price strategy. 2. Identify marketing objectives related to pricing. 3. Describe the components that go into making price strategy decisions. 4. Apply formulas used in setting prices. 5. List considerations for updating price strategy.

Key Terms: Price Skimming Penetration Pricing Psychological Pricing Prestige Pricing Odd/Even Pricing Price Lining Promotional Pricing Discount Pricing Inelastic Demand Break-even Point Markup Markdown Special Market Circumstances Cash Discounts Quality Discounts Seasonal Discounts Promotional Discounts Investment Trade Discounts Product Life Cycle Cost-based pricing Demand-based Pricing Competition-based pricing Fixed Costs Variable Costs Elastic Demand

I. Price Strategy Considerations

Factors Affecting Price Setting a price for a good or service is not easy. You have to consider costs, expenses, economic forces, government regulations, and technological trends. Each of these factors can affect the market price. 1. Costs and expenses to continue to operate your business, you have to make a profit. This means that your prices must be higher than your costs and expenses.

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a. Fixed Costs expenses that do not change with the number of units produced. Examples - rent, utilities, and insurance premiums b. Variable Costs - expenses that change with each unit produced. Examples sales commission, delivery charges. c. Distribution channel those who handle your product must also make a profit. Therefore, your product costs are also affected by their pricing structure. 2. Supply and demand If demand for your product is high and supply is low, you can command a high price and if demand is low and supply is high you will have to lower your prices. If consumers will buy a product no matter what, then prices are not affected by supply and demand a. Elastic demand a small change in price causes a significant change in the quantity demanded. Ex. luxury items b. Inelastic demand a change in price has little or no affect change on the quantity demanded. Ex. gasoline or milk 3. Consumer Perceptions The price of your product helps create your image in the minds of customers. a. Very low prices can lead customers to believe that your product lacks quality. b. High prices may convey quality and status. 4. Competition Your prices should be competitive with similar goods and services. a. Charge higher prices by adding services. Customers will pay more for personal attention, credit, and warrantees 5. Government Regulations Federal and state laws also affect prices. a. Businesses cannot use any type of price discrimination, price gouging, or price fixing. b. Laws also address minimum pricing, price advertising, and unit pricing. 6. Technological Trends while Borders and Barnes and Noble were competing with each other in the mid-1990s, Amazon.com was changing the way people buy books. a. Amazon.com provides customers with easy access to prices, product information and services. Amazon also has no overhead because they dont run a store and the savings is passed on to their customers in the form of discount prices.

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Pricing Objectives Pricing objectives are included in your marketing plan. 1. Obtaining a Target Return on-Investment The profitability objective involves pricing products to obtain a certain percentage return-on-investment. Example a company might create a goal of 20 percent return-on-investment. a. Investment refers to what it costs to make and market the product. 2. Obtaining Market Share businesses set their prices to try to obtain the competitors customers. a. Set lower prices to obtain customers who want value b. Set higher prices to give the perception of higher quality.

Price Strategy Options Determining a price strategy involves several considerations, including selecting a basic approach to pricing, determining your pricing policy, and identifying effective pricing tactics. 1. Basic Price Strategies the strategies you choose must be compatible with your target market and consistent with your pricing objectives. a. Cost Based Pricing this dictates that you consider your business costs and your profit objectives. i. Figure your cost to make or buy the product. ii. Figure the related cost of doing business. iii. Add your projected profit margin to arrive at your price. This is called your markup. b. Demand Based Pricing requires you to find out what your customers are willing to pay for your product and set the price accordingly. i. Demand for your product must be inelastic. ii. Customers must believe that your product is of greater value than the competitions c. Competition Based Pricing You must find out what your competitors charge. Then decide if you should price below their prices, in line with their prices, or above their prices. Pricing Strategy Page 3 of 3

2. Pricing Policies Establishing a pricing policy frees you from making the same pricing decisions over and over again. The customers and employees know what to expect. a. Flexible Price Policy some times it is good policy to let your customers haggle over the price. This type of pricing takes into account the market conditions, increased or decreased demand, and the prices of competitors. Ex. Automobiles. b. One Price Policy This tells customers that everyone is treated equally. The price they pay is not based on their knowledge or bargaining skills. Saturn automobiles. 3. The Product Life Cycle All products go through four stages: Introduction, Growth, Maturity, and Decline. Each stage calls for different price considerations. a. Introduction One of two methods is often used when introducing a product to the market. i. Price Skimming charging a high price to recover costs as quickly as possible. Then, when the price is no longer unique, the price is dropped. ii. Price Penetration builds sales by charging a low initial price to keep unit costs to customers as low as possible. This approach may discourage competition. b. Growth Sales are increasing and unit costs are decreasing. If you chose skimming in the introduction stage, you will now need to lower prices to appeal to price-conscious shoppers. If you were penetrating, very little price changing is necessary, but promotion costs will increase. c. Maturity You will need to begin looking for new markets and possible make product improvements to hold prices. d. Decline You may need to cut prices to stimulate inventory or clear inventory. 4. Pricing Techniques After your product is introduced, you will need to arrive at a final price by finding the pricing that meets your needs and are most satisfying to customers. a. Psychological Pricing based on the belief that customers base perceptions of a product on price. i. Prestige Pricing uses higher than average prices. Cars that cost over $35,000 suggest exclusiveness, status and prestige ii. Odd/Even Pricing uses odd prices such as $19.99 to suggest bargains and even prices such as $20.00 to suggest higher quality.

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iii. Price Lining prices items according to a category Ex a store may sell basic television sets for $99, mid range sets for $249, and high end sets for $499. iv. Promotional Pricing offers lower prices for a limited time to generate sales. Burger King may promote a $.99 cent burger for a limited time only. b. Discount Pricing offers reductions from the regular price to customers. i. Cash Discounts given to customers for prompt payment. Example an invoice to your business may have on it 2/10, n/30. This means that the invoice may be reduced by 2% if the invoice is paid in 10 days. If it is not paid in 10 days, the full amount is due in 30 days. ii. Quantity Discounts encourages buyers to order in large amounts. Customers who buy over a minimum amount receive a discounted price. iii. Trade Discounts given to distribution channel members who provide marketing service for the manufacturer. Example a manufacturer may designate a 30-15 discount relationship. This means that the retailer takes 30% of the sale price to the customer and the wholesaler keeps 15% for handling, storing, and delivering merchandise to the retailer. iv. Promotional Discounts used when manufacturers want to pay wholesalers and retailers for carrying out promotional activities for manufacturer. v. Seasonal Discounts used for products that have a heavy seasonal demand. If you buy a winter coat off-season, you will probably buy it at a reduced price.

II. Calculating and Revising Prices 1. Break-Even Analysis break-even point is reached when money from product sales equals the costs of making and distributing the product. At this point you have covered your costs and are now ready to begin making a profit. Calculating this will let you know how many units you will have to sell at a given price to make a profit. To calculate this you will need to know three figures: the fixed expenses, the variable expenses, and the selling price. Fixed Expenses Unit sales price - Variable expenses = Break-Even Point

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For example a board game manufacturer is considering selling a new product for $10.00 per unit. The cost per unit is $6.50. The manufacturer must also buy a new piece of equipment costing $7,000. How many units will have to be sold at $10 for the manufacturer to break even? $7,000 $10 - $6.50 = 2,000 Units

2. Markup the amount added to the cost of an item to cover expenses and ensure a profit. For example suppose it costs $5 to make a ballpoint pen ($3 for the casing and $2 for the ink refill). The manufacturer must sell the pen for more than $5 to make a profit. If the manufacturer marks the cost up by $2, the cost and the markup are added to make a price of $7. a) Cost + Markup = Price $5 + $2 = $7 b) Price Markup = Cost $7 $2 = $5 c) Price Cost = Markup $7 $5 = Markup

Many businesses decide on a standard percentage markup. They use an average for their industry and can easily match their competitors markup. If you decide to use a percentage markup strategy your formula is as follows. In the ballpoint pen example to determine what your markup percentage is: divide the markup by the cost ($2 / $5 = .4 or 40%). If you decide to markup all your similar products with the same percentage then: Cost x 1.40 = Price or $5 x .40 = $7 3. Markdown Businesses sometimes markdown their inventory to reduce it. A markdown is the amount of money taken from the original price. For example suppose a footwear store has a few$105 basketball shoes that are not selling. To tempt customers to but them, the manager decides to mark them down by 30%. First, compute the dollar amount of the markdown. (Price x markdown percentage = $ markdown or $105 x .30 = $31.50) Second, compute the sales price (Price Markdown = sales price or $105 - $31.50 = $73.50) 4. Discounts a reduction in price to the customer. This requires two steps. To get the dollar amount of the discount, multiply the price by the discount percentage. Then, subtract the discount from the price to get the actual amount the customer will pay. For example golf pro shop is overstocked on starter sets of clubs. In order to sell the $200 sets, a 20% discount is implemented. a. Step 1 Price x discount percentage = discount dollars or $200 x .20 = $40 b. Step 2 Price Discount dollars = discounted price or $200 - $40 = $60 Pricing Strategy Page 6 of 6

5. Possible price changes developing a pricing strategy is a complicated process. Once a business establishes a strategy, it is difficult to change prices without affecting the strategy. However, events in the market may require you to change prices and strategy. To protect and increase your market share, you will have to monitor your strategy continually. a. Adjusting prices to maximize profits Whether you gain a profit or lose money is determined by the difference between your sales and your costs. You can increase prices to increase profit or you can decrease prices to increase sales volume. Before you decide which strategy to use you must ask yourself two questions: Are your products prices elastic or inelastic and what are your competitors prices? b. Reacting to market prices occasionally special market circumstances call for a temporary price increase. For example - when a natural disaster occurs, prices for supplies and repair work may go up. c. Revising the terms of the sale you can change your pricing strategy by revising the terms of the sale. For example, you can change your credit policies, offering leasing or institute trade, quantity, or cash discounts. d. Revising the price strategy your price strategy should be reviewed regularly. The focus should be on basic strategies, policy review, and pricing tactics. Pricing objectives should be reviewed to confirm or reset sales goals. In some instances you may want to revise, add or delete objectives. Remember, if you change your marketing strategies and objectives, you may have to adjust your marketing plan too.

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Homework review the key terms and answer the following questions 1. Describe the factors that affect setting the price for a product or service. 2. What pricing objectives should companies consider when developing pricing strategies? 3. Explain the four stages in the life cycle of a product and their effects on price strategy. 4. What is the difference between psychological pricing and discount pricing? 5. If you were going to introduce a new perfume into the market, would you use price skimming or penetration pricing as your strategy? Defend your answer. 6. Leroy paid $34 for a poodle he plans to sell in his pet store for $103. What is the percentage of the markup on the cost of this dog? 7. Three months later, Otis still has not sold the poodle and he decides to mark it down 25%. What will it sell for now? 8. Determine whether the following are fixed costs or variable costs: a. Rent b. Overtime wages c. Insurance d. Packaging e. Raw materials 9. Calculate the price if the cost is $45 and the markup is 30%. 10. Calculate the price if the cost is $45 and the markdown is 25%. 11. What are two factors that must be considered before adjusting prices? 12. A game manufacturer is considering selling a new product for $25 per unit. The cost per unit is $15.30. The manufacturer must also buy a new piece of equipment costing $5,000. How many units will have to be sold at $25 for the manufacturer to break even?

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