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 = 106.67 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 (450-300)/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

• 2] Profit Maximization

• 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

• 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

• 1000 - 4999 units - $0.60 each

• 5000 - 9999 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

• Cumulative: 1200 + 500 + 3800 = 5500 units. Total price = 5500 x $0.55 = $3,025$3,025

• Noncumulative

• 1200 x $0.60 = $720

• 500 x $0.65 = $325

• 3800 x $0.60 = $2,280

• Total = $3,325$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 30 - 10 day discount period)

• How many annual periods? 365/20 = 18.25

• 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

• 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)

Meeting Competition

Meeting Competition

Cost Differences

Cost Differences

“Like Grade & Quality”

“Like Grade & Quality”

Robinson-Patman ActRobinson-

Patman Act

KeyIssuesKeyIssues

“Proportionately Equal” Basis

“Proportionately Equal” Basis

Price Discrimination