Pricing Techniques

Lesson Objectives Identify different pricing strategies Define mark-up Review objectives.

1. Cost-Oriented Pricing Markup Pricing Cost-Plus Pricing $ As we learned before, cost is an important consideration in setting price. For this reason, some businesses will follow a cost-oriented pricing strategy. There are 2 strategies that are used the most: markup pricing and cost-plus pricing. Let’s look at each one of these strategies. Show next slide.

Markup Pricing Markup – difference between price of an item and its cost Usually expressed as a % Used by wholesalers and retailers Used for goods acquired for resale With markup pricing, the business identifies its costs and then marks up to a price that it will charge its customers. Show 1st bullet: The markup is the difference between the price it is charging the customer and the cost to the business. To make it easier, the business usually expresses the markup in a percent (show 2nd bullet). For example, a clothing store may adopt the strategy of marking all jeans up 40% over cost. Question: Does this mean that all jeans are priced the same? NO. Some jeans cost more to the retailer and since the retail price is based on the cost some jeans will be priced higher to the consumer. Show next bullet: This strategy is most often used by wholesalers to sell to their customers (retailers) and by retailers to sell to the end consumer (you and me). Show next bullet: Also this strategy is used for goods that are purchased for resale, rather than by manufacturers or services. This strategy works best when the actual cost of the goods is known. Most retailers use markup pricing.

Cost-Plus Pricing Used by manufacturers and service businesses Used for individual goods and services More customer-specific All fixed and variable costs are calculated, then desired profit added Another cost-oriented pricing strategy that is used is cost-plus pricing. This strategy is used most by manufacturers and service businesses who deal more one-on-one with customers. For example, a building contractor will use this strategy rather than markup pricing because he is dealing with an individual consumer for a specific item whose costs may change as the product (house) is being constructed. Show last bullet: This strategy takes into account all costs to the business and then adds the desired profit. What are variable costs? (rent, utilities, interest on loans, salaries, etc. – costs that may change) How is this similar to markup pricing? Costs are taken into account. How does this differ from markup pricing? Markup pricing is based solely on the cost of the item – the percent markup is designed to cover all other costs (variable costs). Cost-plus pricing is not denoted by a percent, but by a dollar amount added to all costs. Can you think of a situation in the clothing industry that would cost-plus pricing? Custom-made clothing, shoes, jewelry, etc. Alterations. So – pricing strategies often take into account the cost of the product or items needed to perform a service. But we have learned that cost is not the only factor. Therefore, some businesses use other strategies. Show next slide.

2. Demand-Oriented Pricing Based on consumer perception of product value Effective when product demand is inelastic Few or no substitutes Necessity Effective when demand is based on time and/or place Matinee theater tickets vs. evening tickets Dugout vs. “nosebleed” seats We have learned that the consumer demand is a factor that affects pricing. Therefore, some businesses use a strategy called demand-oriented pricing. In this strategy, the consumer perception of the product or service is taken into account (remember we learned that consumer perception is an important factor?) Show next bullet: Demand-oriented pricing works best when the demand for the product is inelastic, when there are few or no substitutes and the product is considered a necessity. Why? If the demand is elastic, consumers will just go to a competitor that offers the same product at a lower price. Show next bullet: Demand-oriented pricing also works best when the demand is based on time or place. Ask: How many of you have gone to a movie in the afternoon? How many in the evening? What’s the difference in price? Why? Show next bullet. Movie theaters offer a reduced price for matinee tickets in order to entice customers to come during a usually slow time. Evening tickets are higher because that’s when most people are able to go to the movies. Do you think it costs more to show the movie in the afternoon than at night? NO. The pricing is not based on cost – it’s based on demand. Ask: How many of you have gone to a Braves game? What is the basis for the difference in ticket prices? Seat placement. Show next bullet. Tickets closer to the field are priced higher than tickets that are higher up. did it cost more for the stadium to place seats close to the field than up high? NO. The pricing is not based on cost – it’s based on demand. So – depending on the type of product, businesses will base their pricing on cost or demand. But there is another factor we learned that affects pricing. What is it? COMPETITION. Show next slide.

3. Competition-Oriented Pricing Prices based on what the competition does Not based on cost or demand Competition pricing is based solely on what the competition is charging rather than on cost or demand. The idea is that your competition is probably paying about the same for the products you carry, and the demand is about the same, so if you charge just slightly lower than your competition you can come out ahead. There are a couple of strategies that fall into this category. Let’s look at these. Show next slide.

Competitive Bid Pricing Determining the price for a product on the basis of bids submitted by competitors Most gov’t agencies required to accept lowest bid for desired product Companies bid low and take lower profit in order to gain contract This strategy is used most often in the government sector, but also can be used in the private sector. Show 1st bullet. In this strategy, businesses get “bids” or price quotes from suppliers; then, based on the bids, they are better able to set the price for their goods, services or projects. Show 2nd bullet. Used most often in the government sector. Example: The Dept. of Transportation must set a budget for widening a road 2 miles. Before it sets a budget and submits it to Congress for approval, it receives bids from contractors (companies that will actually do the work). The DOT then looks at the bids and sets its budget. In most cases, law requires that the lowest bids be taken. Why? Gov’t agencies are using taxpayer money. Show 3rd bullet. Because this strategy is based on competition, contracting companies will oftentimes give low bids and take a lower profit just to get the job, which can lead to other jobs. This type of competition-oriented pricing is usually secretive, and businesses will do anything to keep their bids hidden from their competitors. However, another form of competition-oriented pricing is based on what is known about the competition. Show next slide.

Going-rate Pricing Used by most companies in some way Used by businesses whose competing products are very similar Company with highest market share usually sets the price Competing companies may Price below Price above Price at This strategy is open to retail businesses since it’s impossible to keep your competition from knowing what you’re charging your customers. Businesses can easily enter another business and observe what their prices are. Show next bullet: Usually the business that has the highest market share (percent of industry sales) is the one that the other businesses look at. (K-mart looks at Wal-Mart; JC Penney looks at Macy’s; Wendy’s looks at McDonald’s, etc.) Show next bullet: The competing company may choose to set its price at the same, below or above its competitor. The Balloon Closet is a good example of this strategy. When we began, we researched what Kroger, Publix and Hallmark were charging for their balloons. Then we set our prices accordingly. Since Flowers Inc. was the main supplier for this area, we figured that our competitors were buying from them at approximately the same price. Also, since we didn’t have the variable costs they have, setting our price near theirs would ensure a profit. We found that the grocery stores were charging on average $2.99 for mylar and $.99 for latex. We just set the price at $3.00 and $1.00 to make it easier for our customers.

In reality, companies will use a combination of these 3 strategies – not just one WHY? Share responses. Because it depends on what they are trying to achieve. Let’s take a look. Show next slide.

Cost-oriented pricing helps determine the price floor – the lowest price it can go to make a profit (remember break-even point) Show each bullet, reviewing the concepts of its use. So, we can safely say that pricing strategies must use the factors we learned earlier: cost, demand and perception, and competition.

(consumer perceived value) Demand-oriented pricing helps establish a price range: price floor (cost) to price ceiling (consumer perceived value) Show each bullet, reviewing the concepts of its use. So, we can safely say that pricing strategies must use the factors we learned earlier: cost, demand and perception, and competition.

Competition-oriented pricing allows company to determine how the price selected relates to the competition Show each bullet, reviewing the concepts of its use. So, we can safely say that pricing strategies must use the factors we learned earlier: cost, demand and perception, and competition.