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.
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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.
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Price Changes Affect Revenues
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Situation AQuantity sold x Price per unit = Gross revenue
250,000 $3.00 $750,000
Situation BQuantity sold x Price per unit = Gross revenue
250,000 $2.80 $700,000
Difference in Revenue $50,000
Cost Determination for Pricing
• Total Cost The sum of cost of goods sold, selling expenses, and
overhead costs.
• Variable Costs Costs that vary with the quantity produced or sold.
• Fixed Costs Costs that remain constant as the quantity product 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.
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Cost Structure of a Hypothetical Firm, 201316.1
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Cost of Structure of a Hypothetical Firm, 2014
Average pricing overlooks the reality of higher average costs at lower sales levels
16.2
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How Customer Demand Affects Pricing
• 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.
Inelastic Demand Demand that does not change
significantly when there is a change in the price of the product.
16–8
Demand
Price
Elastic
Inelastic
Pricing and Competitive Advantage
• Pricing and a Firm’s 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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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.
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Break-even units sold
=total fixed costs and expenses
selling price – unit variable costs and expenses
units
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Break-Even Graphs for Pricing16.3
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.
Contribution margin The difference between the unit selling price
and the unit variable costs and expenses.
• 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.
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A Break-Even Graph Adjusted for Estimated Demand16.4
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
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price selling of percentage aas Markup100PriceSelling
Markup
cost of percentage aas Markup100Cost
Markup
Retail adage: Markup on purchased cost, markdown on selling price
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Selecting a Pricing Strategy
16–15
Penetration Pricing
Follow-the-Leader Pricing
Dynamic Pricing
What the Market Will
Bear: Adaptive Pricing
Price Lining
Variable Pricing
Skimming Pricing
Pricing Strategie
s
Selecting a Pricing Strategy (cont’d)
• Setting Prices: Controls and Situations The Sherman Antitrust Act generally 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.
If the initial price appears to be off target, make any necessary adjustments and keep on selling!
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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
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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 over the Internet.
Helps smooth sales demand since purchasing power is always available.
Provides easy access to a tool with which to stay competitive.
16–18
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Selling on Credit
16–19
Type of business
Economic conditions
Credit policies of competito
rs
Factors that Affect Selling on Credit
Income level of
customers
Availability of
working capital
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 invoiced amount if paid in full within 10 days of the invoice date, otherwise the full invoice amount is due in 30 days.
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Types of Consumer Credit Accounts
• Open Charge Account Is a line of credit that allows the customer to obtain a
product at the time of purchase.
• Installment Account Is a line of credit that requires a down payment, with
the balance paid over a specified period of time.
• Revolving Charge Account Is a line of credit on which the customer may charge
purchases at any time, up to a pre-established limit.
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Types of Credit Cards
• Bank Credit and Debit Cards Are issued by banks that are widely accepted by
retailers who pay a fee to the banks for handling their credit transactions.
• Travel and Entertainment Credit Cards Were originally used to purchase services, now widely
accepted for merchandise.
• Retailer Credit Cards Are issued by firms for specific use in their retail
outlets or for purchasing their products or services.
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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 C’s of Credit Character Capacity Capital Collateral Conditions
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Sources of Credit Information
• Individuals Customer’s previous credit history Credit information exchanges
• Businesses Financial statements of the firm Other sellers to the firm Firm’s banker Trade-credit agencies Credit bureaus Online credit data
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Hypothetical Aging Schedule for Accounts Receivable16.5
Managing the Credit Process (cont’d)
• Billing and Collection Procedures Timely notification is a most effective collection
method 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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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
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Key Termsadaptive pricing
aging schedule
average pricing
bad-debt ratio
break-even analysis
break-even point
consumer credit
contribution margin
credit bureaus
credit card
credit
debit card
elastic demand
elasticity of demand
follow-the-leader pricing strategy
inelastic demand
installment account
markup pricing
open charge account
penetration pricing strategy
prestige pricing
price lining strategy
revolving charge account
skimming price strategy
trade credit
trade-credit agencies
value
variable pricing strategy
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