After completing this unit, you should be able to: Understand how most wholesalers and retailers set their prices using markups, understand why turnover is so important in pricing, understand the advantages and disadvantages of average-cost pricing, know how to use break-even analysis to evaluate possible prices, know the many ways that price setters use demand estimates in their pricing.
Chapter 18: Price Setting in the Business World For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Chapter 18 Objectives When you finish this chapter, you should 1. Understand how most wholesalers 5. Understand the advantages of and retailers set their prices— marginal analysis and how to using markups. use it for price setting 2. Understand why turnover is so important in pricing 3. Understand the advantages and disadvantages of averagecost pricing. 4. Know how to use breakeven analysis to evaluate possible prices. 182 6. Understand the various factors that influence customer price sensitivity 7. Know the many ways that price setters use demand estimates in their pricing. 8. Understand the important new terms For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Key Factors That Influence Price Setting Pricing objectives Price of other products in the line Demand Price flexibility Price settin g Cost Competition Exhibit 181 183 Markup chain in channels Discounts and allowances Legal environment Geographic pricing terms For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Markups 50.00 30.00 Markup = 20.00 = 40% 24.00 Markup = 6.00 = 20% Markup = 2.40 = 10% Cost = 21.60 = 90% Producer Exhibit 182 184 Cost = 24.00 = 80% Wholesaler Cost = 30.00 = 60% Retailer For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Six Types of Costs Total Cost Total Fixed Cost Total Variable Cost Average Fixed Cost Average Variable Cost Average Cost 185 For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Prices Along the Demand Curve Total revenue $30,000 $40,000 $57,000 $66,000 $75,000 $72,000 Price per unit $3.00 = Price x Quantity = $3.00 x 10,000 = $2.00 x 20,000 = $1.90 x 30,000 = $1.65 x 40,000 = $1.50 x 50,000 = $1.20 x 60,000 2.00 1.90 1.65 1.50 1.20 10 Exhibit 186 186 20 30 40 50 60 70 Quantity (000) For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Summary of Relationships Affecting Price ? Estimated quantity to be sold Quantity demanded at selling price Cost-oriented selling price per unit Average fixed cost per unit Variable cost per unit Average total cost per unit Profit per unit Exhibit 187 187 For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Break-even Analysis Higher Total Revenue and Cost Profit Area Total Revenue Curve Total Cost Curve Break-Even Point Loss Area Total Variable Costs Total Fixed Costs More Units of Production Exhibit 188 188 For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Marginal Analysis 800 Total cost 700 600 500 Dollars 400 300 Best profit for quantity at best price 200 100 Total revenue = $106 =6 = $79 Quantity -100 -200 -300 -400 Exhibit 1810 189 Note: curves here are approximate (you can’t sell part of a unit!) Total profit For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Evaluating a Customer’s Price Sensitivity Are there substitute ways of meeting a need? Is it easy to compare prices? Who pays the bill? How great is the total expenditure? How significant is the end benefit? Is there already a sunk investment related to the purchase? 1810 For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Demand-Oriented Pricing Psychological Bait Leader Odd-Even Types of Demand-Oriented Pricing Prestige Price Lining DemandBackward Value-in-Use Reference 1811 For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Full-Line Pricing ????? ????? ????? ????? ????? 1812 MarketMarket- or or Firm Firm Oriented? Oriented? Complementary Complementary Pricing? Pricing? Product-Bundling Product-Bundling Pricing? Pricing? For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Bid and Negotiated Pricing Bid pricing means offering a specific price for each possible job. Determining costs is a complicated process Negotiated pricing involves setting a price as the result of a bargaining process between the buyer and seller 1813 For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Key Terms Markup Markup (percent) Markup Chain Stockturn Rate Average-Cost Pricing Total Fixed Cost Total Variable Cost Total Cost Average Cost Average Fixed Cost Average Variable Cost Experience Curve Pricing Target Return Pricing Long-Run Target Return Pricing 1814 Break-Even Analysis Break-Even Point (BEP) Fixed-Cost (FC) Contribution per Unit Marginal Analysis Marginal Revenue Marginal Cost Rule for Maximizing Profit Marginal Profit Price Leader Value in Use Pricing Reference Price Leader Pricing Bait Pricing Psychological Pricing Odd-Even Pricing Price Lining Demand-Backward Pricing Prestige Pricing Full-Line Pricing Complementary Product Pricing Product-Bundle Pricing Bid Pricing Negotiated Price For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill ... Costs Total Cost Total Fixed Cost Total Variable Cost Average Fixed Cost Average Variable Cost Average Cost 18? ?5 For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc.,... Exhibit? ?18? ?7 18? ?7 For use only with Perreault and McCarthy texts © The McGraw-Hill Companies, Inc., 1999 Irwin/McGraw-Hill Break-even Analysis Higher Total Revenue and Cost Profit Area Total Revenue... (percent) Markup Chain Stockturn Rate Average-Cost Pricing Total Fixed Cost Total Variable Cost Total Cost Average Cost Average Fixed Cost Average Variable Cost Experience Curve Pricing Target Return