Download Answers to exploring the web exercises

15
—
1
Pricing and Credit Decisions
CHAPTER 15 LECTURE NOTES
Discuss the role of cost and demand factors in setting a price.
PPT 15-1
A.
Chapter 15
Pricing and Credit Decisions
PPT 15-2
Looking Ahead
PPT 15-3/TM 15-3
Setting a Price
PPT 15-4/TM 15-4
Price Changes
Affect Revenues
PPT 15-5
The Three Components of
Total Cost in Determining Price
[Acetate 15-5]
PPT 15-6
Cost Determination for Pricing
PPT 15-7
Cost Structure for a
Hypothetical Firm, 2004
PPT 15-8
Cost Structure for a
Hypothetical Firm, 2005
PPT 15-9
How Customer Demand Affects
Pricing
PPT 15-10
Pricing and a Firm's
Competitive Advantage
2
Setting a price
 Definition of price: what the seller requires to transfer ownership or use of a
product or service. Discuss credit and pricing.
 Bring out the importance of pricing by explaining the following two points:
1.
2.
(1) one-half of one side of the revenue equation is price! (Sales × Price =
Revenue) and (2) price has an indirect impact on quantity sold.
Cost determination for pricing

Emphasize that careful study of costs may keep a business from pricing
too low.

Review the behavior of total fixed and total variable costs.

Explain the concept of average pricing and highlight its dangers.
How customer demand affects pricing
a. The Elasticity of demand (the effect of a change in price on quantity
demanded)

Elastic demand—an increase in price lowers total revenue.

Inelastic demand—an increase in price raises total revenue.

Ask the students to think of products or services to which they are price
sensitive and some to which they are not.
b. Pricing and a firm’s competitive advantage

A product/service that will address unmet needs yields demand.

Most products/services are different, but similar products/services
can be marketed differently.

Product price—using prestige pricing to signal quality, uniqueness.
Apply break-even analysis and markup pricing.
PPT 15-11/TM 15-11
Applying a Pricing System
PPT 15-12
Break-Even Graphs for Pricing
[Acetate 5-12]
PPT 15-13/TM 15-13
Applying a Pricing System
PPT 15-14
A Break-Even Graph Adjusted
for Estimated Demand
[Acetate 15-14]
PPT 15-15
Applying a Pricing System
B.
Applying a pricing system
1. Break-even analysis
a. Examining cost and revenue relationships—cost break-even analysis is
used to determine the quantity at which the product (with an assumed
price) will generate enough revenue to start earning a profit.
b. Incorporating sales forecasts—cost-adjusted break-even analysis is
used to evaluate alternative prices by merging cost break-even analysis
and the appropriate demand schedules for these alternative prices.
2. Markup pricing—pricing effects from the involvement of intermediaries

Markup must cover (1) operating expenses, (2) subsequent price
reductions, and (3) desired profit.

A markup on cost differs from a markup on selling price.

Converting from one type of markup to the other.
144
Chapter 15 Pricing and Credit Decisions
3
145
Identify specific pricing strategies.
PPT 15-16/TM 15-16
Selecting a Pricing Strategy
C.
PPT 15-17
Selecting a Pricing Strategy
Selecting a pricing strategy (seven alternatives):
1. Penetration pricing—pricing below “normal” to gain mkt share, acceptance
2. Skimming pricing—pricing above “normal” (esp. when competition is
weak)
3. Follow-the-leader pricing—setting the price at the prevailing level
4. Variable pricing—making price concessions to different buyers
 Dynamic pricing, a type of variable pricing—charge more after gauging a
PPT 15-18
Selecting a Pricing Strategy
4
5.
6.
7.
customer's financial means and desire for a product
Price lining—having a range of distinct prices
What the market will bear—maximizing price when competition is minor
A final note on price strategies

Be sure to comply with local, state, and federal laws.

Pricing in one product line may affect sales in another.

Continually adjusting price may confuse customers.

Pricing is not an exact science—make adjustments and keep selling.
Explain the benefits of credit, factors that affect credit extension, and
types of credit.
D.
Offering credit
 Remind students of the definition of a market used in Chapter 7 (that is,
people with unsatisfied needs and purchasing power).
 Describe credit as a means of boosting market purchasing power.
1.
PPT 15-19
Offering Credit
PPT 15-20
Offering Credit
PPT 15-21
Offering Credit
2.
PPT 15-22/TM 15-22
Types of Credit
PPT 15-23/TM 15-23
Types of Consumer
Credit Accounts
PPT 15-24
Types of Credit Cards
3.
Benefits of credit

To borrowers:
Satisfies needs now, while not requiring payment until later
Provides better purchase records
Provides better service and greater convenience in product
exchange
Establishes of a credit history

To sellers:
Provide working capital to the firm
Can create a closer association with customers
Can provide a marketing tool (e.g., for selling over the
Internet)
Tends to smooth out sales fluctuation (consistent purchasing
power)
Provides a tool for competitiveness
Factors that affect selling on credit
a. Type of business (online selling and the problem of credit card fraud)
b. Credit policies of competitors
c. Income level of customers
d. Availability of working capital
Types of credit
a. Consumer credit—extended to final consumers
(1) Open charge accounts—indefinite repayment period
(2) Installment accounts—for larger purchases
(3) Revolving charge accounts—installment accounts with credit limit
146
Part 4 Focus on the Customer: Marketing Growth Strategies
[Acetate 15-24]
b.
Credit cards
(1) Bank credit cards (e.g., Visa, MasterCard)
(2) Entertainment credit cards (e.g., American Express, Diner’s Club)
(3) Retailer credit cards (issued directly by the firm)
 Poll students to find out which types of credit cards they have.
c.
5
Describe the activities involved in managing credit.
PPT 15-25
Managing the Credit Process
PPT 15-26
Sources of Credit Information
PPT 15-27/TM 15-27
Hypothetical Aging Schedule
for Accounts Receivable
PPT 15-28
Managing the Credit Process
PPT 15-29/TM 15-29
Credit Regulation
[Acetate 15-29]
—
What do
they believe are the advantages and disadvantages of each?
Trade credit

Explain the role of trade credit.

Terms are established by tradition—difficult for small businesses to
implement a unique policy.
E.
Managing the credit process
1. Evaluation of credit applicants
a. The four credit questions

Can the buyer pas as promised?

Will the buyer pay?

If so, when will the buyer pay?

If not, can the buyer be forced to pay?

Ask students to evaluate the statement: “Every applicant is creditworthy
to some degree.” What is the point of the statement? Do they agree with
it?
b. The traditional five C’s of credit (character, capital, capacity, conditions,
collateral)
2. Sources of credit information

The use of credit histories

A firm’s financial statements as a source

Pertinent data from outsiders (e.g., other sellers)

The customer’s banker as a source

Trade-credit agencies (credit information on businesses, not customers)

Credit bureaus (credit information on individuals, even on-line)

Ask students what they believe to be the responsibilities of small businesses
when they use data from credit sources ( privacy, correcting inaccuracies, etc).
3. Aging of accounts receivable
4. Billing and collection procedures—discuss bad-debt ratio
5. Credit regulation
 Review the federal legislation related to credit management.
Ask students to
comment on which of these laws they think has had the greatest impact on
credit management practices.
SOURCES OF AUDIO, VIDEO, AND OTHER INSTRUCTIONAL
MATERIALS
Something Ventured is a comprehensive video series produced to parallel this textbook. The video titled
What the Market Will Bear: Pricing Products and Services investigates how cost, demand, and competitive
forces influence the price a small firm can charge for a product or service. For more information, contact
your South-Western/ITP sales rep or ITP Faculty Support (fax (415) 592-9081 or E-mail [email protected]).
Chapter 15 Pricing and Credit Decisions
147
Two videotapes on the subject of pricing are available through Nimco, P. O. Box 9, 102 Highway 81N,
Calhoun, KY 42327. Their toll-free telephone number is (800) 962-6662. The tape Pricing Goods and Services
discusses elasticity and the break-even concept. The other tape, entitled Pricing Strategies, investigates the
role of price in the marketing mix and intermediary price markups.
PSI Research/Oasis Press, 300 North Valley Drive, Grants Pass, OR 97526, offers a how-to workbook
entitled Collection Techniques for Small Business, which provides worksheets, checklists, and practical advice
on dealing with debt collection. Contact PSI Research/Oasis Press at (800) 228-2275.
—
ANSWERS TO END-OF-CHAPTER
DISCUSSION QUESTIONS
1.
Why does average pricing sometimes result in a pricing mistake?
Average pricing (or average-cost pricing) is the approach that involves dividing total cost over a
previous period by the quantity sold in that period. The resulting average cost is then used to set the
current price. Such a procedure overlooks the fact that there is a higher average cost at a lower sales
level. This higher average cost is due to a constant fixed cost, which must be spread over fewer units.
Small businesses that use the average pricing method are totally disregarding differences between fixed
and variable costs.
2.
Explain the importance of total fixed and variable costs to the pricing decision.
The major problem with average-cost pricing (or average pricing) explains why an understanding of
fixed and variable costs is important. Remember that average-cost pricing treats all costs as variable. It
ignores costs that are fixed and therefore not the same per unit at different levels of production.
Average fixed costs decrease as production increases, while average variable costs remain the same.
Since their behavior is different, they should not be grouped together in determining price.
3.
How does the concept of elasticity of demand relate to prestige pricing? Give an example.
Elasticity of demand relates to prestige pricing in that prestige pricing is appropriate when a product or
service is characterized by inelastic demand. A product or service is said to have inelastic demand if an
increase in its price raises total revenue. Prestige pricing is the setting of a higher price to convey an
image of high quality and uniqueness, which are two product or service characteristics that generate
inelastic demand.
4.
If a firm has fixed costs of $100,000 and variable costs per unit of $1, what is the break-even point in units,
assuming a selling price of $5 per unit?
Each item sold at $5 will contribute $4 to fixed costs, after $1 is allocated to variable costs. This means
that 25,000 units will have to be sold ($100,000 ÷ $4) to reach the break-even point. At this level, the total
cost of $125,000 ($100,000 fixed + $25,000 variable) will equal the total sales of $125,000 (25,000 units × $5
selling price).
5.
What is the difference between a penetration pricing strategy and a skimming pricing strategy? Under what
circumstances would each be used?
Penetration pricing involves pricing products or services lower than a normal, long-range market price
in order to gain more rapid market acceptance or to increase market share. This strategy may
discourage new competitors from entering the market if they view the penetration price as a long-term
price.
A skimming price strategy sets prices for products or services at high levels for a limited period
before reducing them to a lower level. This strategy is most practical when there is little threat of shortterm competition or when startup costs must be recovered rapidly.
6.
If a small business conducts its break-even analysis properly and finds the break-even volume at a price of $10 to
be 10,000 units, should it price its product at $10? Why or why not?
p. 333
p. 333
p. 333-334
p. 335
p. 338
148
Part 4 Focus on the Customer: Marketing Growth Strategies
Most students will probably say, “Yes, if the business can produce more than 10,000 units.” This is
correct, but more can be said. The yes answer assumes that (1) demand at $10 is equal to or greater than
10,000 units; (2) another, higher price will not provide greater profits, or this price-and-demand level
will reach a profit goal; and (3) price lining and similar policies are not appropriately implemented in
this case.
7.
What are the major benefits of credit to buyers? What are its major benefits to sellers?
For buyers, credit

Satisfies needs now, while not requiring payment until later

Provides better purchase records

Provides better service and greater convenience in product exchange

Builds a credit history
For sellers, credit

Provide working capital to the firm

Can create a closer association with customers

Can provide a marketing tool

Tends to smooth out sales fluctuation

Provides a tool for competitiveness
8.
How does an open charge account differ from a revolving charge account?
With an open charge account, a customer incurs a debt, and payment is due when the customer is
billed. There is usually no finance charge if the customer pays in full when billed. Also, customers are
not generally required to make a down payment.
A revolving charge account is an installment charge account under the terms of which the seller
grants a line of credit that may be used by customers for credit purchases. A specified percentage of the
outstanding balance must be paid monthly.
9.
What is meant by the term 2/10, net 30? Does it pay to take discounts when they are offered?
The credit term 2/10, net 30 means that the seller offers the buyer 2 percent discount on the agreed-upon
price if the account is paid within 10 days of the invoice date. The full account is due 30 days from the
invoice date. It pays to take discounts if the cash is available and is not earning interest or if the money
can be obtained at an interest charge lower than what can be earned by taking the discount.
p. 340
p. 342
p. 343
10. What is the major purpose of aging accounts receivable? At what point in credit management should this
activity be performed? Why?
p. 345-346
Aging of accounts receivable is the process of dividing credit customer charges into age categories
based on the length of time they have been outstanding. The purpose of aging is to identify the status of
each credit charge in order to plan credit management strategies. There is no particular time when the
aging should be done. In some cases, weekly or monthly aging may be sufficient. At other times, a daily
report may be needed.
—
COMMENTS ON CHAPTER “YOU MAKE THE CALL” SITUATIONS
Situation 1
1.
What advice would you give Jones regarding the screening of new credit customers?
Jones should investigate clients, when possible, prior to supplying them with temporary help. If a
new client’s needs are immediate, help could be supplied and the credit investigation begun
concurrently. Banks and trade-credit agencies would be possible sources of credit information. Jones
must be careful not to offend new clients, but at the same time he must realize that the credit check is
simply a good business practice.
A client application form could be used to obtain relevant information for the credit evaluation.
Jones might also offer a discount for services paid for in cash.
2.
What action should Jones take to encourage current credit customers to pay their debts? Be specific.
Chapter 15 Pricing and Credit Decisions
149
The most important step is to provide timely billing. Most credit customers will pay their bills on
time if they receive proper notification and verification. Jones could offer a higher discount for credit
customers who pay early and/or on time. He could also devise a formal procedure with timely step-bystep collection actions.
3.
Jones has considered eliminating credit sales. What are the possible consequences of this decision?
The loss of business is the most obvious consequence of eliminating credit. Many businesses are set
up to make payments on credit, and requiring payment in cash is an inconvenience to them.
On the other hand, by eliminating credit sales, Jones can eliminate the loss of 2 percent of sales
revenue, which could amount to more than the gross revenue lost as a result of the new policy.
Situation 2
1.
What do you think Anderson means when he asks, "Is my business storage or real estate?" Why do you think he
feels a need to ask this question prior to developing a pricing strategy?
Anderson is probably asking whether he should be pricing the space (a real estate view) or is he
pricing the service (a storage company). The answer to this question may impact his promotion and
other elements of his marketing effort, but it is not really an issue right now. He needs to evaluate his
costs, both fixed and variable, and equate these relationships to what demand levels he believes he can
achieve.
2.
What pricing strategy would be effective in combating the existing contractual relationships between potential
customers and competitors?
Anderson should consider a combination of a penetration and variable pricing strategy. Some of
his customers need a concession on price to reflect the removal fee they would have to pay to switch to
Anderson’s storage business. The penetration pricing strategy will enable him to price lower than he
normally will to gain more rapid market acceptance.
3.
Assuming that business costs would allow Anderson to lower prices, what problems do you see with this
approach?
The main problem with lowing prices is the expectation that the strategy creates in the minds of
consumers. That is why a temporary reduction has to be clearly communicated as a discounted price,
not a price expected to last forever.
4.
Do you believe his business could benefit from offering credit to consumers? Why or why not?
Every firm should evaluate a credit system to decide if the benefits discussed in this chapter will
apply to their situation. It may be a standard practice in his industry and therefore difficult to avoid.
There is a cost associated with credit, and this must be balanced against the potential increase in sales
revenue related to offering credit.
Situation 3
1.
What would the nature of this industry suggest about the elasticity of demand affecting Bowlin’s pricing?
The nature of this industry is such that service is not standardized. There are large differences in
the services that can be provided. In other words, this service can be distinguished from other tree
removal and pruning businesses. This means that demand can be very inelastic within a certain range.
There is the opportunity to distinguish the services in such a way that small price increases will cause
little resistance from customers and thereby result in increasing total revenues.
2.
What types of costs should Bowlin evaluate when he is determining his break-even point?
The types of costs Bowlin must evaluate are the same as in any other business—fixed and variable
costs. For Bowlin, fixed costs may include such items as chain saws, tools, pick-up trucks, and
insurance. Variable costs would include gasoline and labor costs.
3.
What pricing strategies could Bowlin adopt to further his long-term success in this market?
150
Part 4 Focus on the Customer: Marketing Growth Strategies
A variable pricing strategy will be required in this type of business because no two jobs will be
exactly the same. Bowlin may also want to consider flexible pricing to reflect special market conditions
such as distant locations and adverse weather conditions.
4.
—
How can the high quality of Bowlin’s work be used to justify somewhat higher price quotations?
Bowlin might consider some degree of prestige pricing for certain high-income customers, which
could successfully convey an image of high quality or uniqueness. This approach could work well if
certain customers associate quality with price.
ANSWERS TO EXPLORING THE WEB EXERCISES
For each chapter, the instructor’s manual will include a short summary of suggested results students will have after
completing the various Web exercises. Because the Web is a constantly changing medium, the answers may vary, and
the links may change as well. Thus, answers are only suggested, and the URL for resources, where required, is
provided.
Exercise 1
a.
When the students explore the Web site, they will find the chart below:
b.
Students will place all six companies on the chart.
1. Wal-Mart launches a new range of own-label soups.
2. Cunard launches two new cruise ships.
3. A cable TV provider moves into a new area and needs to achieve a market share.
4. Holiday Inn tries to fill hotels during winter weekends.
5. Burger King introduces a new range of value meals.
6. Nokia launches a new videophone.
Students will print the results of a 10-question quiz. The quiz covers the following pricing strategies:

Premium Pricing

Penetration Pricing

Economy Pricing
Chapter 15 Pricing and Credit Decisions









151
Price Skimming
Psychological Pricing
Product Line Pricing
Optional Product Pricing
Captive Product Pricing
Product Bundle Pricing
Promotional Pricing
Geographical Pricing
Value Pricing
Exercise 2
a.
b.
—
The Web site provides a list of fees that one might encounter when accepting credit cards. They are as
follows:

Start-up fees of $50 to $200

Equipment costs of $250 to $1,000, depending on whether you decide to lease or purchase a
handheld terminal or go electronic

Monthly statement fees of $4 to $20

Transaction fees of $.05 to $.50 per purchase

The discount rate—the actual percentage you are charged per transaction based on projected card
sales volume, the degree of risk, and a few other factors (the percentage ranges from 1.5 percent to
3 percent; the higher your sales, the lower your rate)

Charge-back fees of up to $30 per return transaction

Miscellaneous fees, including a per-transaction communication cost of $.05 to $.12 for connection to
the processor, a postage fee for sending statements, and a supply fee for charge slips
All of the fees are negotiable except the discount rate.
SUGGESTED SOLUTION TO CASE 15:
WACO COMPOSITES I, LTD.
1.
What type of elasticity of demand does this product face? Explain.
His product was much like the example of certain products in the personal computer industry,
used in the chapter. They are so much alike a decrease in price will draw customers to the lowest priced
product! This means the demand he faces for his product is very elastic—demand changes significantly
when there is a lowering of price. This means that customers see many available substitutes—such as
Hampton’s competitor.
2.
What is your evaluation of the competitive advantage strategy mapped out by Waco Composites? What other
ideas might help the firm gain competitive advantage?
His competitive advantage strategy is a great idea and seemingly the only strategy in light of the
low profit margins related to matching his competitor’s prices. He is wise not to base the competitive
strategy on only one factor. He has improved and distinguished his product but his total product
offering has been enhanced with better shipping and improved professional service.
Additional efforts to carve out a competitive advantage might focus on developing an even more
distinctive brand image and also through promotional efforts that create an association with the
product. Development of more innovative but related products could also allow the company to
continue its competitive advantage efforts.
152
Part 4 Focus on the Customer: Marketing Growth Strategies
3.
Do you believe the strategy being used to create a competitive advantage—without pricing as a major
component—will work in this industry? Why or why not?
There is nothing to suggest that it will not work. Even if Hampton was able to cut costs, so he
could be price competitive, this would not necessarily be the best option. This is an industry with
relatively few manufacturers. It is also an industry marked by low levels of product knowledge and
therefore is a good candidate for prestige pricing. This is particularly true for the residential home
market—for use in safe rooms.
4.
Do you think it would be feasible for Hampton to implement a variable pricing strategy? Why or why not?
Yes, this is probably a good situation to use a variable pricing strategy. Lower prices can be offered
for various reasons, including a customer’s knowledge and bargaining strength. The “uniform price”
will not likely be widely promoted so this offers the opportunity for adjustments both up and down.