HTM 370 Chapter 8.docx

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Hospitality & Tourism Managmnt
HT-MGT 370
Atul Sheel

Hospitality & Tourism Management 370 CHAPTER 8 Cost Approaches to Pricing Prices influence the profitability of a firm. Four main factors are essential for price determination: 1. Demand  Demand sets the upper limit or ceiling of price. It determines what customers are willing to pay.  Elasticity of demand to changes in price is an important issue in setting prices.  The price elasticity of demand is measured as the change in quantity demanded per unit change in price. In numerical terms,  Price elasticity of demand =(% change in Quantity Demanded)/ (% change in Price) For instance, a budget hotel increases its room price from 20$ to 22$ per room night (10%). Consequent to this price increase, the demand declined from 100 to 950 rooms (5%). The price elasticity of demand for this motel would be (5%/10%) or 0.5. The airline and lodging industry recognize seasonal fluctuations in demand and price their products accordingly. Such demand-based approach to pricing is called yield management. 2. Costs Another important factor to consider in pricing is cost. Costs set the lower limit or floor of price. 3. Objectives Business objectives or goals of a firm constitute the third price setting factor. Objectives or goals provide the overall environment for setting prices. A 10% profit objective annually, for instance, provides a price-setting environment for a business firm. Such environment differs significantly if a firm happens to be a non-profit organization. 4. Competition Competition provides the fourth important price-setting factor. A firm’s competition sets the benchmark for comparing its various pricing alternatives. Skimming and penetrating price policies are examples substantiating this fact. Two other modifying factors must also be remembered in setting prices. First is the historical trend of prices. Dramatic price changes should be avoided if possible as they affect demand adversely. Second, the final price must be set after incorporating policies such as odd and even pricing (e.g., $9.99 instead of 10$ to create an illusion that price is in the lower range) or price rounding (e.g., price rounded up to the nearest $25). II. Mark-Up Approach to Pricing This is a traditional pricing approach in the Food and Beverage industry. The ingredient markup approach considers all product costs. For instance, as shown in exhibit 2, the ingredient costs total to $1.63 per portion. If the desired food cost percentage for this restaurant is 40%, then the chicken dinner is priced at ($1.63/0.4) = $6.52. The prime ingredient mark-up approach differs only in that the cost of prime ingredients (for instance, the $0.69cost of chicken in a chicken dinner, exhibit 2) is marked up, rather than the total cost of all ingredients. The multiple used here is based in experience, and is greater than the multiple used for the ingredient mark-up approach. III. Pricing or Rooms 1. $1 per $1000 Approach This is a traditional experience based approach for pricing rooms in hotels. According to this rule, the price of a room should be $1 for each $1,000 of project cost per room. For instance, if the average project cost for each room in a motel was $45,000, the price of each room should be set at $45 per night. This approach fails to consider all essential factors in price setting other than project costs. 2. Hubbart Formula This is a more comprehensive approach to room pricing that considers three of the four essential price setting factors – namely, desired profits (objective), costs, and expected rooms sold (demand). It is also called the bottom up approach to room pricing. It starts with desired profits or net income, adds income taxes, and then adds fixed costs and management fee, followed by operating overhead costs and direct oper
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