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
More
Less
