Chapter 7.doc

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Management (MGT)
Chris Bovaird

Chapter 7: Pricing and Distributing Goods and Services Pricing Objectives and Tools Terms:  Pricing: deciding what the company will receive in exchange for its product.  Pricing objectives: goals that producers hope to attain in pricing products for sale. Profit Maximizing Objectives:  Pricing to maximize profits is tricky.  If the price is set too low, the company will probably sell many of its products, but it may miss the opportunity to make additional profit on each unit, and thus may in fact lose money on each exchange.  Conversely, if prices are set too high, the company will make a large profit on each item but will sell fewer units, resulting in excess inventory and a need to reduce production operations. This will also result in money loss.  To avoid these problems, companies try to set prices to sell the number of units that will generate the highest possible total profits.  In calculating profits, managers weigh receipts against costs for materials and labour to create the product.  But they may also consider the capital resources (plant and equipment) that the company must tie up to generate that level of profit.  The cost of marketing (such as maintaining a large sales staff) can also be substantial.  Concern over the efficient use of these resources has led many firms to set prices so as to achieve a targeted level of return on sales or capital investment. Market Share Objectives:  Market share: a company’s percentage of the total market sales for a specific product.  In the long run, a business must make a profit to survive.  Nevertheless, many companies initially set low prices for new products.  They are willing to accept minimal profits – even losses – in order to get buyers to try products.  In other words, they use pricing to establish market shares. Other Pricing Objectives:  In some instances, neither profit maximizing nor market share is the best objective.  During difficult economic times, for instance, loss containment and survival may become a company’s main objectives. Price-setting Tools Cost-oriented Pricing:  Cost-oriented pricing considers the firm’s desire to make a profit and takes into account the need to cover production costs.  Mark-up is usually stated as a percentage of selling price.  Mark-up percentage is calculated as follows (if mark-up is $7, the product cost is $8 and the selling price is $15) = Mark-up / Sales Price = ($7.00) / ($15.00) = 46.7%  As a result, it can be said that for every dollar taken in, 46.7 cents will be gross profit for the business.  The business must still pay rent, utilities, insurance and other costs as well.  Mark-up can also be expressed as a percentage of cost = Mark-up / Product Cost = ($7.00) / ($8.00) = 87.5% Break-even Analysis: Cost-Volume-Profit Relationships:  Variables costs: those costs that change with the number of goods or services produced or sold.  Fixed costs: those costs unaffected by the number of goods or services produced or sold.  Break-even analysis: an assessment of how many units must be sold at a given price before the company begins to make a profit.  Break-even point: the number of units that must be sold at a given price before the company covers all of its variable and fixed costs. It is calculated as follows ( if total fixed costs is $100,000, the price is $15 and the variable cost is $8)  Break-even point (in units) = Total fixed costs / Price – Variable Costs = $100,000 / $15 - $8 = $ 14, 286 units  So this would signify that if:  The business sells less than 14,286 units; it shows that it loses money for the year.  The business sells exactly 14,286 units; it shows that it covers all its costs but makes no profits.  The business sells more than 14,286 units; it shows that the profits will increase by $7 dollars for each unit sold (the $7 being the difference between the variable cost and the unit price)  Zero profitability at the breakeven point can also be seen using the following profit equation.  Profit = total revenue – (total fixed costs + total variable costs) = (14,286 units x $15) – ($100,000 fixed costs + [14,286 units x $8 (variable costs)]) $0 = (214,290) – ($100,000 + 114,288) (rounded to the nearest whole unit) Pricing Strategies and Tactics Terms:  Price leadership: the dominant firm in the industry establishes product prices and other companies follow suit.  Examples include Rolls-Royce (car manufacturers) and Godiva (chocolates)  Price-skimming strategy: the decision to price a new product as high as possible to earn the maximum profit on each unit sold.  Penetration-pricing strategy: the decision to price a new product very low to sell the most units possible and to build customer loyalty.  Price lining: the practice of offering all items in certain categories at a limited number of predetermined price points.  Psychological pricing: the practice of setting prices to take advantage of the non- logical reactions of consumers to certain types of prices.  Odd-even psychological pricing: a form of psychological pricing in which prices are not stated in even dollar amounts.  Discount: any price reduction offered by the seller to persuade customers to purchase a product.  Cash discount: a form of discount in which customers paying with cash, rather than buying on credit, pay lower prices.  Seasonal discount: a discount in which lower prices are offered to customers making a purchase at a time of year when sales are traditionally slow.  Trade discount: a discount given to firms involved in a product’s distribution.  Quantity discount: a form of discount in which customers buying large amounts of a product pay lower prices. The Distribution Mix Terms:  Distribution mix: the combination of distribution channels a firm selects to get a product to end-users.  Intermediary: any individual or firm other than the producer who participates in a product’s distribution.  Wholesalers: intermediaries who sell products to other businesses, which in turn resell them to the end-users.  Retailers: Intermediaries who sell products to end-users.  Distribution channel: the path a product follows from the producer to the end- user.  Direct channel: a distribution channel in which the product travels from the producer to the consumer without passing through any intermediary.  Sales agent (or brokers): an independent business person who represents a business and receives a commission in return, but never takes legal possession of the product.  Intensive distribution: a distribution strategy in which a product is distributed in nearly every possible outlet, using many channels and channel members.  Examples can be chocolate bars and milk, which can come from more than one channel (grocery store, convenience store, etc)  Exclusive distribution: a distribution strategy in which a product’s distribution is limited to only one wholesaler or retailer in a given geographic area.  Selective distribution: a distribution strategy that falls between intensive and exclusive distribution, calling for the use of a limited number of outlets for a products. Distribution of Consumer Products:  Channel 1: Direct Distribution of Consumer Products  The product travels from the producer to the consumer without intermediaries.  Channel 2: Retail Distribution of Consumer Products  Producers distribute products through retailers.  Channel 3: Wholesale Distribution of Consumer Products  Once the most widely method of non-direct distribution, Channel requires a large amount of floor space, both for storing merchandize and for displaying it in stores.  Faced wi
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