CHAPTER
FIFTEEN
PRICE: ARRIVING AT THE
FINAL PRICE
15-1
© 2000 McGraw-Hill Ryerson Limited
AFTER READING THIS CHAPTER YOU
SHOULD BE ABLE TO:
• Understand how to establish the initial
“approximate price level” using demandoriented, cost-oriented, profit-oriented,
and competition-oriented approaches.
• Identify the major factors considered in
deriving a final list or quoted price from
the approximate price level.
15-2
© 2000 McGraw-Hill Ryerson Limited
AFTER READING THIS CHAPTER YOU
SHOULD BE ABLE TO:
• Describe adjustments made to the
approximate price level based on
geography, discounts, and allowances.
• Prepare basic financial analyses useful in
evaluating alternative prices and
arriving at the final sales price.
• Describe the principal laws and
regulations affecting pricing practices.
15-3
© 2000 McGraw-Hill Ryerson Limited
The Gillette Mach 3 Shaving System
Gillette’s world leading market share:
71% in North American and Europe
91% in Latin American
69% in India
New Mach 3 shaving system is priced 35% above their
highly successful Sensor Excel model, as marketing
research indicated that men would be willing to pay
45% more than they were paying for Sensor given the
additional benefits of the Mach 3.
15-4
© 2000 McGraw-Hill Ryerson Limited
PP15-1 Steps in Setting Price
Identify
pricing
constraints
and objectives
15-5
Estimate
demand
and
revenue
Estimate
cost, volume,
and profit
relationships
Select an
approximate
price level
-Demandoriented
approaches
-Cost-Oriented
approaches
-Profit-oriented
approaches
-Competitionoriented
approaches
Set list or
quoted price
-One price or
flexible prices
-Company,
customer, and
competitive
effects
-Incremental
costs and
revenues
Make special
adjustments to
list or quoted
price
-Discounts
-Allowances
-Geographical
adjustments
© 2000 McGraw-Hill Ryerson Limited
PP15–2 Four Approaches for Selecting an Approximate Price Level
Selecting an
approximate
price level
Demand-oriented
approaches
skimming
penetration
prestige
price lining
odd-even
target
bundle
yield management
15-6
Cost-oriented methods
standard markup
cost-plus
experience curve
Profit-oriented methods
target profit
target return on sales
target return on
investment
Competition-oriented
methods
customary
above, at, or below
market
loss leader
© 2000 McGraw-Hill Ryerson Limited
Demand-Oriented Pricing Approaches
Demand-Oriented Approaches include:
• skimming pricing
• penetration pricing
• prestige pricing
• price lining
• odd-even pricing
• target pricing
• bundle pricing
• yield management pricing
15-7
© 2000 McGraw-Hill Ryerson Limited
PP15–3 Demand Curves for Two Types of Demand-Oriented
Approaches
A
B
Prestige pricing
Price lining
PQ
B
Price
Price
A
P1
P2
P3
C
Quantity
15-8
Quantity
© 2000 McGraw-Hill Ryerson Limited
Concept Check
1.
What are the circumstances in pricing
a new product that might support
skimming or penetration pricing?
2.
What is odd-even pricing?
15-9
© 2000 McGraw-Hill Ryerson Limited
Cost-Oriented Pricing Approaches
Cost-Oriented Approaches include:
• standard markup pricing
• cost-plus pricing
• experience curve pricing
15-10
© 2000 McGraw-Hill Ryerson Limited
Mark-ups for a manufacturer, wholesaler and retailer on
a home appliance sold to the consumer for $100
Retailer
selling price = $ 100
$100
Wholesaler
selling price = $ 71.43
Price
80
60
40
20
Manufacturer
selling price = $ 59.93
Wholesaler mark-up
= $ 11.90 = 20%
Manufacturer mark-up
= $ 7.76 = 15%
Manufacturer
cost = $ 51.77
Retailer mark-up
=$ 28.57 = 40%
Retailer
cost = $ 71.43
Wholesaler
cost = $ 59.53
10
0
15-11
Manufacturer
Wholesaler
Retailer
© 2000 McGraw-Hill Ryerson Limited
Cellular phone unit sales, average cost and average price:
evidence of the experience effect
3,500
3,000
2,500
The Average Cost to
Produce Decreases . . .
2,500
As Cellular Phone
Volume Increases . . .
Cellular Phone
in Service
2,000
2,000
1,500
1,500
1,000
Average cost
of Least-Expensive
Models
1,000
500
0
’83’84’85’86’87’88’89’90’91’92’93’94’95
Dollars
3,000
2,500
2,000
Followed by Price
Decreases
500
0
’83’84’85’86’87’88’89’90’91’92’93’94’95
Dollars
Average Price of
Least-Expensive
Models
1,500
1,000
500
Dollars
15-12
0
’83’84’85’86’87 ’88’89’90’91’92’93’94’95
© 2000 McGraw-Hill Ryerson Limited
Profit-Oriented Pricing Approaches
Profit-Oriented Approaches include:
• target profit pricing
• target return-on-sales pricing
• target return-on-investment pricing
15-13
© 2000 McGraw-Hill Ryerson Limited
PP15-4 Results of Computer Spreadsheet Simulation to Select
Price to Achieve a Target Return on Investment
Assumptions
or Results
Financial Element
Year
A
Assumptions
Price per unit (P)
$50
$54
$54
$58
$58
1.000
Change in Unit Variable Cost (UVC)
0%
Unit variable cost
$22.00
Total expenses
$8,000
Owner’s salary
$18,000
Investment
$20,000
State and federal taxes
50%
Net Sales (P x Q)
$50,000
Less: COGS
22,000
(Q x UVC)
Gross Margin
$28,000
Less: total expenses
8,000
Less: owner’s salary
18,000
Net profit before taxes
$ 2,000
Less: taxes
1,000
Net profit after taxes
$ 1,000
Investment
$20,000
1,200
+10%
$24.20
Same
Same
Same
Same
$ 64,800
29,040
1,100
+10%
$24.20
Same
Same
Same
Same
$59,400
26,620
1,100
+20%
$26.40
Same
Same
Same
Same
$63,800
29,040
1,000
+20%
$26.40
Same
Same
Same
Same
$58,000
26,400
$ 35,760
8,000
18,000
$ 9,760
4,880
$ 4,880
$20,000
32,780
8,000
18,000
$6,780
3,390
3,390
$ 20,000
$ 34,760
8,000
18,000
$8,760
4,380
4,380
$20,000
$31,600
8,000
18,000
$5,600
2,800
2,800
$20,000
24.4%
17.0%
21.9%
14.0%
Units Sold (Q)
Spreadsheet
simulation
results
15-14
Return on Investment
5%
SIMULATION
B
C
D
© 2000 McGraw-Hill Ryerson Limited
Competition-Oriented Pricing Approaches
Competition-Oriented Approaches
include:
• customary pricing
• above-, at-, or belowmarket pricing
• loss leader pricing
15-15
© 2000 McGraw-Hill Ryerson Limited
Concept Check
1.
What is standard markup pricing?
2.
What profit-based pricing approach
should a manager use if he or she wants to
reflect the percentage of the firm’s
resources used in obtaining the profit?
3.
15-16
What is the purpose of loss-leader pricing
when used by a retail firm?
© 2000 McGraw-Hill Ryerson Limited
One-Price versus Flexible-price Policies
• One-Price Policy: setting the same price for similar
customers who buy the same product and quantities
under the same circumstances. An example would
be Saturn’s “no hassle-one price” policy for new and
used cars.
• Flexible-Price Policy: offering the same product and
quantities to similar customers but at different
prices. When buying a house, the seller generally
uses a flexible-price policy in getting to the final sale
price.
15-17
© 2000 McGraw-Hill Ryerson Limited
PP15-5 The Power of Marginal Analysis in Real-World Decisions
Suppose the owner of a picture framing store is considering buying a series of
magazine ads to reach her up-scale market. The cost of the ads is $1,000, the average
price of a framed picture is $50, and the unit variable cost(materials plus labor) is $30.
This is a direct application of marginal analysis that an astute manager uses to
estimate the incremental revenue or incremental number of units that must be
obtained to at least cover the incremental cost. In this example, the number of extra
picture frames that must be sold is obtained as follows:
Extra fixed cost
Incremental number of frames =
Price - Unit variable cost
$1,000 of advertising
=
=
15-18
$50 - $30
50 frames
© 2000 McGraw-Hill Ryerson Limited
PP15-6 Three special adjustments to list or quoted price
Special adjustments
to list or quoted price
Discounts
Quantity
cumulative
noncumulative
Trade (functional)
Cash
15-19
Allowances
Trade-in
Promotional
Geographical
adjustments
FOB origin pricing
Delivered pricing
Single-zone pricing
Multiple-zone
pricing
FOB with freightallowed pricing
Basing-point pricing
© 2000 McGraw-Hill Ryerson Limited
PP15–7 The Structure of Trade Discounts
Manufacturer’s
Manufacturer’s
suggested
suggested
(minus)
list
Price
list Price
($ 30.00)
Retailer’s
Retailer’s cost
cost
or
wholesaler
or wholesaler
sales
sales price
price
$100.00
Retail
Retaildiscount:
discount:
30%
30%ofofmanufacturer’s
manufacturer’s
suggested
suggestedprice
price
15-20
$ 70.00
(minus)
($ 7.00)
Wholesaler
Jobber
Wholesaler cost
cost
Jobber cost
cost or
or
or
jobber
manufacturer’s
or jobber
(minus) manufacturer’s
sales
price
sale
sales price
sale price
price
($ 3.15)
$ 63.00
Wholesaler’s
Wholesaler’sdiscount:
discount:
10%
10%ofofwholesaler’s
wholesaler’s
sales
salesprice
price
$ 59.15
Jobber
Jobberdiscount:
discount:
5%
5%ofofjobber
jobbersales
salesprice
price
© 2000 McGraw-Hill Ryerson Limited
PP15-8 Five Most Common Deceptive Pricing Practices
Bait and switch
Bargains conditional on other purchases
Comparable value comparisons
Comparisons with suggested prices
Former price comparisons
15-21
© 2000 McGraw-Hill Ryerson Limited
Concept Check
1.
2.
3.
15-22
Why would a seller choose a flexible-price
policy over a one-price policy?
If a firm wished to encourage repeat
purchases by a buyer throughout the
year, would a cumulative or
non-cumulative quantity discount be a
better strategy.
What pricing practices are covered by the
Competition Act?
© 2000 McGraw-Hill Ryerson Limited