Download Example costs

Pricing and Credit
Decisions
Part 4 Focusing on the Customer:
Marketing Growth Strategies
PowerPoint Presentation by Charlie Cook
The University of West Alabama
Copyright © 2006 Thomson Business & Professional Publishing.
All rights reserved.
Looking Ahead
After studying this chapter, you should be able to:
1.
Discuss the role of cost and demand factors in setting
a price.
2.
Apply break-even analysis and markup pricing.
3.
Identify specific pricing strategies.
4.
Explain the benefits of credit, factors that affect credit
extension, and types of credit.
5.
Describe the activities involved in managing credit.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–2
Setting a Price
• Price
–A specification of what a seller requires in exchange
for transferring ownership or use of a product or
service
• Prices set too low, loss in revenue
• Price set too high, loss in revenue
• Price and demand are related for many goods and services
• Credit
–An agreement between a buyer and a seller that
provides for delayed payment for a product or service
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–3
Price Changes Affect Revenues
Situation A
Quantity sold x Price per unit = Gross revenue
250,000
$3.00
$750,000
Situation B
Quantity sold x Price per unit = Gross revenue
250,000
$2.80
$700,000
Difference in Revenue
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
$50,000
15–4
The Three Components of Total Cost
in Determining Price
Total Cost
Selling Cost
Overhead Cost
Example costs:
Example costs:
Example costs:
Cost of item
Freight charges
Salesperson's time
Advertising
Storage, Salaries,
Taxes
Cost of Goods Sold
Exhibit 15.1
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15–5
Cost Determination for Pricing
• Total Cost
–The sum of cost of goods sold, selling expenses, and
overhead costs
• Total Variable Costs
–Costs that vary with the quantity produced or sold
• Total Fixed Costs
–Costs that remain constant as the quantity produced
or sold varies
• Average Pricing
–An approach in which total cost for a given period is
divided by quantity sold in that period to set a price
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–6
Cost Structure for a Hypothetical Firm, 2004
Sales revenue (25,000 units @ $8.00)
Total costs:
Fixed costs
Variable costs ($2.00 per unit)
Gross margin
$200,000
$75,000
50,000
125,000
$ 75,000
Average cost = $125,000 = $5.00
25,000
Exhibit 15.2
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–7
Cost Structure for a Hypothetical Firm, 2005
Sales revenue (10,000 units @ $8.00)
Total costs:
Fixed costs
Variable costs ($2.00 per unit)
Gross margin
$80,000
$75,000
20,000
95,000
$ (15,000)
Average cost = $95,000 = $9.50
10,000
Average pricing overlooks the reality of
higher average costs at lower sales levels
Exhibit 15.3
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–8
How Customer Demand Affects Pricing
• The Elasticity of Demand
–The degree to which a change in price affects the
quantity demanded
–Elastic Demand
• Demand that changes
significantly when there
is a change in the price
of the product
Price
Inelastic
Elastic
–Inelastic Demand
• Demand that does not change
significantly when there is a
change in the price of the product
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Demand
15–9
Pricing and a Firm’s
Competitive Advantage
• Pricing and Competitive Advantage
–Customers will demand and pay more for a product or
service that they perceive as important to their needs.
• Prestige Pricing
–Setting a high price to convey an image of high quality
or uniqueness (competitive advantage)
• Customers associate price with quality.
• Markets with low levels of product knowledge are candidates
for prestige pricing.
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15–10
Applying a Pricing System
• Break-Even Analysis
–A comparison of alternative cost and revenue
estimates in order to determine the acceptability of
each price
–Steps in the analysis
• Examining revenue-cost relationships: the quantity at which
the product will generate enough revenue to start earning a
profit
• Incorporating actual sales forecasts into the analysis
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–11
Break-Even Graphs for Pricing
Exhibit 15.4
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15–12
Applying a Pricing System (cont’d.)
• Examining Cost and Revenue Relationships
–Breakeven Point
• The sales volume at which total sales revenue equals total
costs (fixed and variable)
• The point at which profitability starts and losses cease
• Incorporating Sales Forecasts
–Adjusted Break-Even Analysis
• Price has a variable impact and influence on demand.
• Adjusting for the indirect effect of price allows for a more
realistic profit area to be identified.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–13
A Break-Even Graph Adjusted
for Estimated Demand
Exhibit 15.5
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15–14
Applying a Pricing System (cont’d.)
• Markup Pricing
–Cost plus pricing system that adds a markup
percentage to cover:
• Operating expenses
• Subsequent price reductions
• Desired profit
Markup
100  Markup as a percentage of selling price
Selling Price
Markup
100  Markup as a percentage of cost
Cost
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–15
Selecting a Pricing Strategy
• Penetration Pricing
–Setting lower than normal prices to hasten market
acceptance of a product or service or to increase
market share
• Skimming Pricing
–Setting very high prices for a limited period before
reducing them to more competitive levels
• Follow-the-Leader Pricing
–Using a particular competitor as a model in setting
prices
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–16
Selecting a Pricing Strategy (cont’d.)
• Variable Pricing
–Setting more than one price for a good or service in
order to offer price concessions to certain customers
• Dynamic Pricing
–Charging more than the standard price when the
customer’s profile suggests that the higher price will
be accepted
• Price Lining
–Setting a range of several distinct merchandise levels
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–17
Selecting a Pricing Strategy (cont’d.)
• What the Market Will Bear
–A strategy of charging the highest prices that
customers will pay; used only when the seller has little
or no competition.
• Setting Prices: Controls and Situations
–The Sherman Antitrust Act prohibits competitors from
conspiring to fix prices
–The effect of the introduction of new products into an
established product line
–Offering discounts to match the needs of customers
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–18
Offering Credit
• Benefits of Credit to Borrowers
–Provides working capital
–Ability to satisfy immediate needs and pay later
–Better records of purchases on credit billing
–Better service and greater convenience when
exchanging purchased items
–Establishment of credit history
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–19
Offering Credit (cont’d.)
• Benefits of Credit to Sellers
–Facilitates increased sales volume
–Brings a closer association with customers
–Fosters easier selling through telephone, mail, and
Internet
–Helps smooth sales demand since
purchasing power is always available
–Provides easy access to a tool
with which to stay competitive
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–20
Offering Credit (cont’d.)
• Factors That Affect Selling on Credit
–Type of business
• Durable goods retailers offer more credit.
–Credit policies of competitors
• Competitors are expected to match other competitors’ credit
offerings.
–Income level of customers
–Availability of working capital
• Credit sales increase the amount of working capital.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–21
Types of Credit
• Consumer Credit
–Financing granted by retailers to individuals who
purchase for personal or family use
• Trade Credit
–Financing provided by a supplier of inventory to a
given company which sets up an account payable for
the amount
• Terms of sale may be 2/10, net 30—two percent discount on
the invoice amount if paid in full within 10 days of the invoice
date, otherwise the full amount of the invoice is due in 30
days.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–22
Types of Consumer Credit Accounts
• Open Charge Account
–A line of credit that allows the customer to obtain a
product at the time of purchase
• Installment Account
–A line of credit that requires a down payment, with the
balance paid over a specified period of time
• Revolving Charge Account
–A line of credit on which the customer may charge
purchases at any time, up to a pre-established limit
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–23
Types of Credit Cards
• Bank Credit Cards
–Credit cards issued by banks that are widely accepted
by retailers who pay a fee to the banks for handling
their credit transactions
• Entertainment Credit Cards
–Business credit cards originally used to purchase
services, now widely accepted for merchandise
• Retailer Credit Cards
–Credit cards issued by firms for specific use in their
outlets or for purchasing their products or services
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15–24
Managing the Credit Process
• Evaluation of Credit Applicants
–Can the buyer pay as promised?
–Will the buyer pay?
–If so, when will the buyer pay?
–If not, can the buyer be forced to pay?
• The Traditional Five Cs of Credit
–Character
–Capital
–Capacity
–Conditions
–Collateral
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15–25
Sources of Credit Information
• Individuals
–Customer’s previous credit history
–Dun & Bradstreet Business Information Reports
• Businesses
–Financial statements of the firm
–Other sellers to the firm
–Firm’s banker
–Trade-credit agencies
–Credit bureaus
–Online credit data
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–26
Hypothetical Aging Schedule for Accounts Receivable
• Aging Schedule
–A categorization of accounts receivable based on the
length of time they have been outstanding
Exhibit 15.6
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15–27
Managing the Credit Process (cont’d.)
• Billing and Credit Procedures
–Timely notification—one of the most effective
collection methods for keeping bills current
–Warning consumers that they may do damage to their
credit if they fail to pay
–Bad debt ratio
• A number obtained by dividing the amount of bad debts by
the total amount of credit sales
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15–28
Credit Regulation
• The Truth-in-Lending Act (1968)
• The Fair Credit Billing Act
• The Fair Credit Reporting Act
• The Equal Credit Opportunity Act
• The Fair Debt Collection Practices Act
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–29
Key Terms
price
follow-the-leader pricing
credit
strategy
total cost
variable pricing strategy
total variable costs
dynamic pricing strategy
total fixed costs
price lining strategy
average pricing
consumer credit
elasticity of demand
trade credit
elastic demand
open charge account
inelastic demand
installment account
prestige pricing
revolving charge account
break-even point
trade-credit agencies
markup pricing
credit bureaus
penetration pricing strategy
aging schedule
skimming price strategy
bad-debt ratio
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
15–30