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BMI3C
Chapter 7
Pricing
Pricing
• All businesses use the same factors to
establish prices
• What are the key factors in determining
prices of products / services?
Pricing
• Key factors:
1. Cost of doing business
2. Profit company hopes to make
Pricing
• Assume the price of a product for sale in
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a store is $9.99
What does that tell us?
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The cost of the product to the store is
probably less than $9.99
Pricing
• Markup
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Stores add an amount to the price they pay
for a product in order to cover their costs of
doing business
What are some of these costs?
Pricing
• Markup
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Expressed in terms of a % of the cost
E.g., product costs $10 and store adds $5
markup to the cost, what is the markup %?
Pricing
• Margin
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% of the price charged to consumer that is
not used to pay for the cost of the item
E.g., if product sells for $19.99 and costs
$10, how much is the margin?
Pricing
• Break-even Analysis
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The first step in calculating the price of your
product or service
Tells you how many units you need to sell to
pay for operating costs
Pricing
• Break-even Analysis
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Step 1: Calculate Variable Costs
For a lawn cutting business, gasoline is a
variable cost
Example:
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Suppose the cost of gasoline is $1.04/litre, and to
cut 1 lawn uses 0.5 litres of gas
What is the variable cost of gas per lawn?
How much does it cost to cut 25 lawns?
Pricing
• Break-even Analysis
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Variable Costs – usually depend on the
quantity of goods sold or services performed
Can you think of examples of variable cost
that increase for other reasons? (Hint: when
you walk into a store and wipe your feet on
the mat)
Pricing
• Break-even Analysis
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Step 2: Calculate Fixed Costs
Fixed costs are constant, independent of
sales
Usually remain the same no matter how
many goods a business sells or
manufactures
Examples: rent, insurance, salaries
Pricing
• Break-even Analysis
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Fixed Costs
Example: Assume McDonald’s pays
$5,000/month in rent for one of it’s stores
If it sells 5,000 Big Mac’s in a month, what is
the fixed cost per hamburger?
Pricing
• Break-even Analysis
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Step 3: Calculate Gross Profit
Sometimes referred to as “contribution
margin”
Refers to money available to pay fixed costs
after variable costs have been paid
Gross Profit = Selling price – Variable Costs
OR… = Sales – Variable Costs
Pricing
• Break-even Analysis
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Gross Profit
The price for 1 lawn cutting is $20
Total variable costs = $10 per lawn
Gross Profit = $10 which is available for
paying fixed costs
Pricing
• Break-even Analysis
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Break-even Point (BEP) - the number of
units that a business must sell at a given
price to cover all costs
BEP = Fixed Costs
Gross Profit
Pricing
• Break-even point shows us how many
sales, in units, we need to make a profit
Pricing
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A video game company requires 20 employees,
and total daily salary is $3,000
Insurance = $50 per day
Rent = $100 per day
Utilities (heat, hydro) = $20 per day
Plastic for video game casing = $1 per game
Administrative costs = $200 per day
Sales costs = $300 per day
Pricing
1. Calculate: Total Fixed Costs per day
2. If the company produces 36,700 games
per day, calculate the fixed costs per
video game
3. What would happen if a snow storm
caused them to only produce 1 video
game that day?
Pricing
• Obviously, we don’t calculate fixed costs
on a daily basis!
Pricing
• Suppose a shoe manufacturer sells
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shoes to retailers for $15/pair
Variable costs = $3/pair of shoes
Fixed costs = $120,000
Calculate the BEP
Pricing
• Graphing Break-even Analysis
Pricing
• Answer:
• Step 1: Gross profit = selling price –
variable costs
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Gross profit = $15 - $3
Gross profit = $12
• Step 2: BEP = $120,000 / $12
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BEP = 10,000 units
Pricing
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What if I told you they could only sell 5,000
units?
What things can the company do?
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Reduce variable costs to increase gross profit and
reduce BEP
Increase selling price to increase gross profit and
reduce BEP
Decrease the selling price to increase demand
Increase sales costs (advertising) which may
increase demand
Reduce fixed costs
Pricing
• Economy of scale
 The more products a company makes, the
lower the cost of production of each item
 Remember the video game manufacturer and
the snowy day?
Economies of Scale
• Marketers use economies of scale to help
them by:
1. Developing products for private-label
companies
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Store-brand products have exactly the same
ingredients as the brand-name products
Only difference is price
Fixed costs are already paid for
Economies of Scale
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3 Benefits of Private-Labels
i. The store gets a low-priced product to sell
ii. Consumers get an option to buy the same
product for a cheaper price
iii. Manufacturer earns considerate profit
Economies of Scale
2. Creating a Barrier to Entry for
Competitors
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First company on the market with a product
is tempted to keep prices high (no
competition)
But competitors come in and sell lower and
steal market share
If original manufacturer uses economies of
scale, they can price product lower to
increase sales and make it unattractive for
competitors to enter market
Economies of Scale
3. Creating New Brands
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If same labour and machinery can be used to
make more products:
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This doesn’t increase fixed costs
Has the benefit of increasing profits
Economies of Scale
4. Merging with Competitors
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Occurs via a merger of 2 competitors
Usually result in reduced fixed costs
The new, combined business operates more
efficiently (i.e., lower costs)
Greater profits results
Diseconomies of Scale
• Some companies can become too large:
1. Management loses touch with employees
and customers
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Management may become centralized to try to be
more efficient but…
…those at “head office” may not have time to visit
stores or talk to customers and lose touch with
their business
Diseconomies of Scale
2. Machinery may become over-used
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Some duplicate equipment may be sold off to cut
costs but…
…now there is extra work for the remaining
equipment, which may lead to more breakdowns
Diseconomies of Scale
3. When employees are laid off, remaining
employees must do extra work
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Those who are kept by the company have to do
more work because there are less employees
Employees may be angry or not work hard feeling
that the company may lay them off too
Diseconomies of Scale
4. Communication channels can become
slower
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With a larger company, branch offices may not
have a clear idea of what head office allows them
to do now
These examples show how diseconomies of
scale can result even when companies
try to become more efficient
Pricing Strategies
• Pricing is a critical part in the marketing
mix
• 3 basic pricing strategies exist
Pricing Strategies
1. Market Skimming
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When launching a new product, company
may set a high price for its product before
competitors enter the market
By doing so, a company tries to reach breakeven point sooner and recover its
development costs
Once these costs are recovered, then the
company lowers the price when competitors
enter the market
Pricing Strategies
2. Penetration Pricing
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Company sets a low price for their new
product
They hope to attract a lot of customers,
make a lot of sales, and get a large market
share
Pricing Strategies
3. Competitive Pricing
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The most popular pricing strategy
Products in the same category match or
follow the price of their competitors
Companies advertise a lot
A company leader usually sets the
“benchmark price”
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Leader is usually the company with the largest
market share