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
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.
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 Slower cash flow Risk of unpaid loans Start-up and ongoing fees Additional management processes required to approve and maintain credit accounts • 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
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