Ch 3 Outline
1.
2.
3.
4.
5.
Introduction
Pricing Strategy
Price and Gross Margin
Core Prices and Discounting
Pricing and Competition
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3-1 Introduction
• The basic business process that underlies all
ventures, regardless of their industry or size, is:
– R – C = P (revenue minus cost equals profit).
• Understanding the business process is critical for
entrepreneurs and for people who practice the
skills of entrepreneurism.
– One of the last considerations that the entrepreneur
takes into account is the price that will be charged to
customers.
– Yet, setting price for products and services is a critical
factor in the success of a venture.
2
3-1 Introduction (cont.)
• Problem with cost-plus pricing: Customers
care about the price they have to pay for
products and services and the value they
receive for that price.
– If the entrepreneur uses the cost-plus pricing
approach:
• The price is set too high and the customer does not
buy.
• The price is set too low and each sale returns less
profit to the business than is possible.
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How Customer Demand Affects
Pricing
• The Elasticity of Demand
– The degree to which a change in price affects the
Price
quantity demanded.
Inelastic
– Elastic Demand
• Demand that changes
significantly when there
is a change in the price
of the product.
Elastic
– Inelastic Demand
• Demand that does not change
significantly when there is a
change in the price of the product.
Demand
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3-2 Pricing Strategy
• Price strategy is an attempt to affect
demand through alteration of prices.
• An effective price strategy is responsive to the type
of demand present in the market.
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3-3 Price and Gross Margin
• Entrepreneurs must also monitor the
effect of their pricing strategy on the
firm’s gross margin.
– Gross margin is the difference between the
selling price of a product or service and the
amount the entrepreneur had to pay for the raw
materials that make up that product or service.
– Gross margin is expressed as a percentage of
revenue, using the following equation:
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•
3-3 Price and Gross Margin
(cont.)
A price reduction
usually results in a reduction in
gross margin.
– Increased sales volume can lead to a reduction in the
average cost of goods sold because suppliers will often
provide discounts to clients that buy in large volumes.
• A price increase that increases sales volume—or,
at least, does not reduce sales volume—is a
powerful tool for profit.
– Businesses that are able to raise prices without cost
increases and without sacrificing sales volume possess
is called pricing power.
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3-4 Core Prices and Discounting
• One of the most important considerations in
any price strategy is to protect the core
prices of the business.
– The airline industry provides a good example
of the concept of core price protection.
– Another common method that companies use to
protect their core pricing is through product
downsizing.
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3-4 Core Prices and Discounting
– Discounting is the most widely used price
strategy.
• When the discounted prices are offered for a limited
time, the situation is usually referred to as a sale.
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•
3-4a Pricing and Finance
Discounting
The U.S. economy
has grown to its present
size in large part based on the use of credit.
– Because the use of credit has become so
pervasive, credit terms have become an
important part of price and volume strategy.
• The furniture and appliance industries offer
examples of the use of interest rate discounting.
• In 2000 the automotive industry instituted a novel
discounting strategy.
– When purchasing a car, the customer was not required to
make any payments for a period of one year.
– Payments toward the vehicle began in the second year
through what is known as a level payment plan.
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•
3-4a Pricing and Finance
When Discounting
starting a new business,(cont.)
many entrepreneurs are
tempted to set their prices below the general market. The
intent of such a strategy is to attract customers by offering
them a price advantage.
– Price is often regarded to be the advantage that customers
will respond to most readily.
– Sometimes this price strategy will lead to the opposite
reaction.
•
•
Customer perception is an important factor in the success
of any business.
Established competitors may also respond by offering
discounts, which could cause a price war the new entrant
will loose.
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3-5 Pricing and Competition
• Pricing strategy should never be executed without
thought to the reaction of competitors.
– If a price strategy is effective and encroaches on the
competitor’s market share, there is likely to be a
vigorous reaction.
• In an elastic market, a price change may bring
new customers into the market.
– When a price reduction is based on lower costs and the
price move results in a larger number of buyers in the
market, the strategy is a great success.
• The airline industry is an example of the price reduction cycle
in an elastic market.
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3-5 Pricing and Competition
(cont.)
• The reverse side
of the success of price
reductions based on lowered costs and
expanded market is also demonstrated in
the computer and consumer electronics
market.
– Discounters look for markets in which
consumers are price sensitive.
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