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McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. LEARNING OBJECTIVES (LO) AFTER READING CHAPTER 12, YOU SHOULD BE ABLE TO: LO1 LO2 LO3 Describe the nature and importance of pricing and the approaches used to select an approximate price level. Explain what a demand curve is and the role of revenues in pricing decisions. Explain the role of costs in pricing decisions and describe how various combinations of price, fixed cost, and unit variable cost affect a firm’s breakeven point. 12-2 LEARNING OBJECTIVES (LO) AFTER READING CHAPTER 12, YOU SHOULD BE ABLE TO: LO4 LO5 Recognize the objectives a firm has in setting prices and the constraints that restrict the range of prices a firm can charge. Describe the steps taken in setting a final price. 12-3 VIZIO, INC.—WHERE VISION MEETS VALUE™ IN HDTV 12-4 NATURE AND IMPORTANCE OF PRICE LO1 WHAT IS A PRICE?: THE PRICE EQUATION Price Barter Price Equation Final Price = List Price Š (Incentives + Allowances) + Extra Fees 12-5 FIGURE 12-1 The “price” a buyer pays can take different names depending on what is purchased 12-6 LO1 NATURE AND IMPORTANCE OF PRICE PRICE: AS AN INDICATOR OF VALUE; IN THE MKT MIX Value Value = $ Perceived Benefits Price = $ Profit Equation Profit = Total Revenue Š Total Costs = (Unit Price Quantity Sold) Š (Fixed Cost + Variable Cost) 12-7 FIGURE 12-2 Four approaches for selecting an approximate price level 12-8 LO1 GENERAL PRICING APPROACHES DEMAND-ORIENTED PRICING APPROACHES Skimming Pricing Prestige Pricing Penetration Pricing Odd-Even Pricing $500.00 vs. $499.99 12-9 MARKETING MATTERS LO1 Energizer’s Lesson in Price Perception— Value Lies in the Eye of the Beholder 12-10 LO1 GENERAL PRICING APPROACHES DEMAND-ORIENTED PRICING APPROACHES Target Pricing Bundle Pricing Yield Management Pricing 12-11 LO1 GENERAL PRICING APPROACHES COST-ORIENTED PRICING APPROACHES Standard Markup Pricing Cost-Plus Pricing 12-12 FIGURE 12-A Markups for a manufacturer, wholesaler, and retailer on a home appliance sold to consumers for $100 12-13 LO1 GENERAL PRICING APPROACHES PROFIT-ORIENTED PRICING APPROACHES Target Profit Pricing Target Return-on-Sales Pricing Target Return-on-Investment (ROI) Pricing 12-14 GENERAL PRICING APPROACHES LO1 COMPETITION-ORIENTED PRICING APPROACHES Customary Pricing Above-, At- or Below-Market Pricing Loss-Leader Pricing 12-15 USING MARKETING DASHBOARDS LO1 Are Cracker Jack Prices Above, At, or Below the Market? Price Premium (%) Dollar Sales ($) Market Share for a Brand Price Premium (%) = Š1 Pound Volume (Units or #) Market Share for a Brand 12-16 LO2 ESTIMATING DEMAND AND REVENUE FUNDAMENTALS OF ESTIMATING DEMAND Demand Curve • Consumer Tastes • Price and Availability of Similar Products • Consumer Income • Demand Factors 12-17 FIGURE 12-3 Demand curves for Newsweek showing the effect on annual sales (quantity demanded per year) by a change in price caused by (A) a movement along and (B) a shift of the demand curve 12-18 FIGURE 12-3A Demand curve for Newsweek showing the effect on annual sales by a change in price caused by a movement along the demand curve 12-19 FIGURE 12-3B Demand curve for Newsweek showing the effect on annual sales by a change in price caused by a shift of the demand curve 12-20 LO2 ESTIMATE DEMAND AND REVENUE FUNDAMENTALS OF ESTIMATING DEMAND Price Elasticity of Demand Price Elasticity of Demand (E) = Percentage Change in Quantity Demanded Percentage Change in Price • Elastic Demand • Inelastic Demand 12-21 LO2 ESTIMATE DEMAND AND REVENUE FUNDAMENTALS OF ESTIMATING DEMAND Price Elasticity of Demand • Product Substitutes • Necessities • Large Cash Outlays 12-22 FIGURE 12-4 Fundamental revenue concepts Total Revenue Total Revenue = (Unit Price Quantity Sold) TR = (P Q) Total Profit = Total Revenue Š Total Cost 12-23 FIGURE 12-5 Fundamental cost concepts Total Cost (TC) Total Cost (TC) = Fixed Cost (FC) + Variable Cost (VC) Unit Variable Cost (UVC) = Variable Cost (VC) Quantity (Q) 12-24 LO3 DETERMINING COST, VOLUME, AND PROFIT RELATIONSHIPS BREAK-EVEN ANALYSIS AND BEP Break-Even Analysis Break-Even Point (BEP) BEPQuantity Fixed Cost FC Unit Price Š Unit Variable Cost P Š UVC 12-25 FIGURE 12-6 Calculating a break-even point for the picture frame store shows its profit starts at 400 framed pictures per year 12-26 LO6 STEP 3: DETERMINE COST, VOLUME, AND PROFIT RELATIONSHIPS BREAK-EVEN ANALYSIS Break-Even Chart Applications of Break-Even Analysis 12-27 FIGURE 12-7 Break-even analysis chart for a picture frame store shows the break-even point at 400 pictures 12-28 LO4 PRICING OBJECTIVES AND CONSTRAINTS IDENTIFYING PRICING OBJECTIVES Pricing Objectives • Profit Managing for Long-Run Profits Managing for Current Profit Target Return (ROI) 12-29 FIGURE 12-8 Where each dollar of your movie ticket goes 12-30 LO4 PRICING OBJECTIVES AND CONSTRAINTS IDENTIFYING PRICING OBJECTIVES Pricing Objectives • Sales ($) • Survival • Market Share ($ or #) • Social Responsibility • Unit Volume (#) 12-31 LO4 PRICING OBJECTIVES AND CONSTRAINTS IDENTIFYING PRICING CONSTRAINTS Pricing Constraints • Demand for the Product Class (Cars), Product (Sports Cars), and Brand (Tesla Roadster) • Newness of the Product: Stage in the Product Life Cycle 12-32 LO4 PRICING OBJECTIVES AND CONSTRAINTS IDENTIFYING PRICING CONSTRAINTS Pricing Constraints • Cost of Producing and Marketing a Product • Competitors’ Prices • Legal and Ethical Considerations 12-33 FIGURE 12-B Several pricing practices are affected by legal and regulatory restrictions, which benefit both consumers and business 12-34 FIGURE 12-C Five most common deceptive pricing practices 12-35 LO5 SETTING A FINAL PRICE Step 1: Select an Approximate Price Level Step 2: Set the List or Quoted Price • One-Price Policy/ Fixed Pricing • Flexible Price Policy 12-36 MAKING RESPONSIBLE DECISIONS LO5 Flexible Pricing—Is There Discrimination in Bargaining for a New Car? Buying a New Car: Some Folks Pay More 12-37 LO5 SETTING A FINAL PRICE Step 3: Make Special Adjustments to the List or Quoted Price • Discounts Quantity Trade (Functional) Seasonal Cash 12-38 LO5 SETTING A FINAL PRICE Step 3: Make Special Adjustments to the List or Quoted Price • Allowances Trade-In Promotional Everyday Low Pricing (EDLP) 12-39 LO5 SETTING A FINAL PRICE Step 3: Make Special Adjustments to the List or Quoted Price • Geographical Adjustments FOB Origin Pricing Uniform Delivered Pricing (Multiple Zone) 12-40 VIDEO CASE 12 WASHBURN GUITARS: USING BREAK-EVEN POINTS TO MAKE PRICING DECISIONS 12-41 VIDEO CASE 12 WASHBURN GUITARS 1. What factors are most likely to affect the demand for the lines of Washburn guitars (a) bought by a first-time guitar buyer and (b) bought by a sophisticated musician who wants a signature model? 12-42 VIDEO CASE 12 WASHBURN GUITARS 2. For Washburn, what are examples of (a) shifting the demand curve to the right to get a higher price for a guitar line (movement of the demand curve) and (b) pricing decisions involving moving along a demand curve? 12-43 VIDEO CASE 12 WASHBURN GUITARS 3. In Washburn’s factory, what is the break-even point for the new line of guitars if the retail price is (a) $349, (b) $389, and (c) $309? Also, (d) if Washburn achieves the sales target of 2,000 units at the $349 retail price, what will its profit be? 12-44 VIDEO CASE 12 WASHBURN GUITARS 4. Assume that the merger with Parker leads to the cost reductions projected in the case. What will be the (a) new breakeven point at a $349 retail price for this line of guitars and (b) new profit if it sells 2,000 units? 12-45 VIDEO CASE 12 WASHBURN GUITARS 5. If for competitive reasons, Washburn eventually has to move all its production back to Asia, (a) which specific fixed and variable costs might be lowered and (b) what additional fixed and variable costs might it expect to incur? 12-46 Price (P) A price (P) is the money or other considerations (including other products and services) exchanged for the ownership or use of a product or service. 12-47 Value Value is the ratio of perceived benefits to price; or Value = (Perceived benefits ÷ Price). 12-48 Profit Equation The profit equation is: Profit = Total revenue − Total cost; or Profit = (Unit price × Quantity sold) − (Fixed cost + Variable cost). 12-49 Demand Curve A demand curve is a graph relating the quantity sold and the price, which shows the maximum number of units that will be sold at a given price. 12-50 Price Elasticity of Demand The price elasticity of demand is the percentage change in quantity demanded relative to a percentage change in price. 12-51 Total Revenue (TR) Total revenue (TR) is the total money received from the sale of a product; the unit price of a product multiplied by the quantity sold. 12-52 Total Cost (TC) Total cost (TC) is the total expenses incurred by a firm in producing and marketing a product; total cost is the sum of fixed costs and variable costs. 12-53 Break-Even Analysis Break-even analysis is a technique that analyzes the relationship between total revenue and total cost to determine profitability at various levels of output. 12-54 Pricing Objectives Pricing objectives are expectations that specify the role of price in an organization’s marketing and strategic plans. 12-55 Pricing Constraints Pricing constraints are factors that limit the range of prices a firm may set. 12-56