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In this chapter, you will:
1. Discuss the relationships among pricing, image, competition, and value.
2. Describe effective pricing techniques for introducing new products or services and for existing ones.
3. Explain the pricing methods and strategies for retailers, manufacturers, and service firms.
4. Describe the impact of credit and debit cards and mobile wallets on pricing.
To survive, every business must make a profit. Although many factors determine a company’s ability to generate a profit, one of the most important is the prices its sets for its goods and services.
Research shows that proper pricing strategies have far greater impact on a company’s profits than corresponding increases in unit volume and reductions in fixed or variable costs.
Because pricing decisions have such a pervasive influence on all aspects of a small company, one of the most important considerations for entrepreneurs is to take a strategic rather than a piecemeal approach to pricing their companies’ products and services.
A company’s pricing policies communicate important information about its overall image to customers. Pricing sends an important signal to customers about a company, its brand, its position in the market, the quality of its products and services, the image it wants to create, and other important concepts.
When setting prices, entrepreneurs must take into account their competitors’ prices, but the decision to match or beat them is not automatic.
Price transparency due to the Internet, the ease of mobile shopping, and customers’ persistent post-recession price sensitivity impose constraints on companies’ ability to raise prices.
One of the most important determinants of customers’ response to a price is whether they perceive the price to be a fair exchange for the value they receive from the product or service. The good news is that, through marketing and other efforts, companies can influence customers’ perception of value.
Entrepreneurs often find themselves squeezed by rising operating and raw material costs but are hesitant to raise prices because they fear losing customers. Businesses facing rapidly rising costs in their businesses should consider these strategies.
The final price business owners set depends on the desired image they want to create for the business in their customers’ minds – discount, middle of the road, or prestige – and the perceived value it provides to customers.
Most entrepreneurs approach setting the price of a new product with a great deal of apprehension because they have no precedent on which to base their decisions.
Entrepreneurs have three basic strategies to choose from when establishing a new product’s price: penetration, skimming, and life cycle pricing.
Each of the following pricing tactics or techniques is part of the toolbox of pricing tactics entrepreneurs can use to set prices of established goods and services.
The basic premise of a successful business operation is selling a good or service for more than it costs to produce or provide. The difference between the cost of a product or service and its selling price is called markup (or markon).
Table 11.1 shows a breakdown of the cost of the components and markup calculations for Samsung’s Galaxy S6 Edge and Apple’s iPhone 7.
Table 11.1 shows a breakdown of the cost of the components and markup calculations for Samsung’s Galaxy S6 Edge and Apple’s iPhone 7.
Once entrepreneurs create a financial plan, including sales estimates and anticipated expenses, they can compute their companies’ initial markup. The initial markup is the average markup required on all merchandise to cover the cost of the items, all incidental expenses, and a reasonable profit.
The main advantage of the cost-plus pricing method is its simplicity. Given the proper cost accounting data, computing a product’s final selling price is relatively easy. In addition, because they add a profit onto the top of their companies’ costs, manufacturers are likely to achieve their desired profit margins.
Figure 11.5 illustrates the cost-plus pricing components.
One requisite for a successful pricing policy in manufacturing is a reliable cost accounting system that can generate timely reports to determine the costs of processing raw materials into finished goods. The traditional method of product costing is called absorption costing because all manufacturing and overhead costs are absorbed into a finished product’s total cost.
A more useful technique for managerial decision making is variable (direct) costing, in which the cost of the products manufactured includes only those costs that vary directly with the quantity produced.
When variable costs are subtracted from total revenues, the result is the manufacturer’s contribution margin – the amount remaining that contributes to covering fixed expenses and earning a profit.
The breakeven price can be found using this equation.
Service businesses must establish their prices on the basis of the materials used to provide the service, the labor employed, an allowance for overhead, and profit.
Customers expect businesses to accept multiple payment methods, including credit and debit cards, and mobile payments. In addition, some small companies offer their customers installment credit and trade credit.
Although customers prefer to use credit cards to make purchases more than any other form of payment, they prefer to use debit cards and cash for smaller daily purchases.
Fees operate on a multistep process.
When it comes to online business transactions, the most common method of payment is the credit card. Internet merchants are constantly challenged by the need to provide secure methods for safe, secure online transactions.
Credit and debit cards account for 72% of all consumer and business payments, and that percentage continues to grow. Small businesses that do not accept credit and debit cards operate at a significant disadvantage compared to their rivals that do.
Mobile payments are growing rapidly, particularly among members of the Millennial generation, 44% of whom prefer to pay for goods and services using their phones rather than cash.
Setting prices is a blend of both art and science. The prices that entrepreneurs set for the products and services they sell are key components in the sales revenue their businesses generate, the profits they earn, and the image they create for their companies.