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Chapter 13
Price
Determination
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Objectives
1.
2.
3.
4.
5.
6.
7.
8.
Outline the legal constraints on pricing.
Identify the major categories of pricing objectives.
Explain price elasticity and its determinants.
List the practical problems involved in applying price
theory concepts to actual pricing decisions.
Explain the major cost-plus approaches to price setting.
List the chief advantages and shortcomings of using
breakeven analysis in pricing decisions.
Explain the superiority of modified breakeven analysis
over the basic breakeven model and the role of yield
management in pricing decisions.
Identify the major pricing challenges facing online and
international marketers.
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Legal Constraints on Pricing
The Robinson-Patman Act
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Known as the Anti-A&P Act.
Was technically an amendment to the Clayton Act.
Prohibits price discrimination in sales to
wholesalers, retailers, and others producers.
Differences in price must reflect cost differentials.
Prohibits selling at unreasonably low prices in
order to drive competitors out of business.
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Legal Constraints on Pricing
Unfair-Trade Laws
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Require sellers to maintain minimum prices for
comparable merchandise. These laws were
intended to protect small specialty shops.
Typical state laws set retail price floors at cost
plus some modest markup.
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Legal Constraints on Pricing
Fair-Trade Laws
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Allow manufacturers to stipulate minimum retail
prices.
Assert that a product’s image, determined in part
by its price, is a property right of the manufacturer.
Exclusivity is one method manufacturers use to
maintain minimum price.
Has its roots in the Depression era.
California became the first state to enact fair-trade
legislation.
These laws became invalid with the passage of
the Consumer Goods Pricing Act (1975).
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
The Other View On “Trade Laws”
The other side of Fair Trade Laws, are they
well written, and do they address perceived
problems?
– This web site addresses these and other
issues as they relate to U.S. Trade Laws.
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Four Major Groups of Pricing
Objectives
1.
2.
3.
4.
Profitability
Volume
Meeting Competition
Prestige
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Pricing Objectives
Objective
Purpose
Example
Profitability objectives
 Profit
maximization
 Target return
Low introductory interest rates on
credit cards with high standard
rates after 6 months
Volume objectives
 Sales
maximization
 Market share
 Value pricing
Dell’s low-priced PCs increase
market share and sales of service
 Lifestyle
 Image
High-priced luxury autos such as
Ferrari and watches by Rolex
 Profit
maximization
 Cost recovery
 Market incentives
 Market
suppression
High prices for tobacco and
alcohol to reduce consumption
Meeting competition
objectives
Prestige objectives
Not-for-profit objectives
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Price wars among major airlines
Pricing
For many consumers high price indicates quality.
– When viewing Gucci timepieces consumers
see quality.
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Profit Impact of Market Strategies
(PIMS) Project
• Study conducted by the Marketing Science
Institute.
• Analyzed more than 2,000 firms.
• Revealed that two important factors
influencing profitability were:
1. Product quality
2. Market share
• The leading brand typically generates aftertax ROI of 18 percent.
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Pricing of the Not-For-Profit
Organizations Goals
1. Profit maximization.
2. Cost recovery. Recover only the actual cost of
operating the unit.
3. Market incentives. Lower-than-average pricing
policy or offer a free service.
4. Market suppression. High prices help to accomplish
social objectives.
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Elasticity in Pricing Strategy
Elasticity is the measure of responsiveness of
purchasers and suppliers to price changes.
– The elasticity of demand is the percentage
change in the quantity of a good or service
demanded  the percentage change in its price.
– The price elasticity of supply of a product is the
percentage change in the quantity of a good or
service supplied  the percentage change in its
price.
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Determinants of Elasticity
• Availability of substitutes or complements.
• Depends on whether a product is perceived as
a necessity or a luxury.
• Depends on the portion of a person’s budget
that he or she spends on a good or service.
• Responds to consumers’ time perspectives.
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Problems of Price Theory
1. Many firms do not attempt to maximize
profits.
2. It is difficult to estimate demand curves.
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Cost-Plus Approaches to Price
Setting
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Cost-plus pricing, the most popular method, uses a base-cost figure per
unit and adds a markup to cover unassigned costs and to provide a profit.
Works well for a business that keeps its costs low.
Two most common cost-oriented pricing procedures:
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Full-cost pricing uses all relevant variable costs and allocates fixed
costs.
•
Allows the marketer to recover all costs plus the amount
added as a profit margin.
•
The full-cost deficiencies.
–
First, there is no consideration of competition or
demand for the item.
–
Second, any method for allocating overhead is arbitrary.
One way to overcome the arbitrary allocation of fixed expenses is:
2.
Incremental-cost pricing, which attempts to use only those
costs directly attributable to specific output in setting prices.
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Breakeven Chart
• Breakeven Analysis is
a means of determining
the number of goods or
services that must be
sold at a given price to
generate sufficient
revenue to cover total
costs.
• The breakeven point is
the point at which total
revenue just equals total
cost.
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Calculating Breakeven
While Breakeven Analysis is a means of
determining the number of goods or services
that must be sold at a given price to generate
sufficient revenue to cover total costs there is
another question. What information is
necessary in order to determine Breakeven?
– This web site provides the important questions to
determining Breakeven and also a means for
calculating the answer.
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Shortcomings of Breakeven Analysis
• First, the model assumes that costs can be
divided into fixed and variable categories.
• The model assumes that per-unit variable
costs do not change at different levels of
operation.
• Finally, the basic breakeven model does not
consider demand.
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.
Pricing Challenges Facing Online
and International Marketers
Five pricing objectives:
1. Profitability
2. Volume
3. Meeting competition
4. Prestige
5. Price stability
Copyright © 2004 by South-Western, a division of Thomson Learning, Inc. All rights reserved.