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TITLE Pricing Strategy. Unit 10. Level 2. Instructor Guide.PACE: Program for Acquiring Competence inEntrepreneurship. Third Edition. Research &Development Series No. 302-10.

INSTITUTION Ohio State Univ., Columbus. Center on Education andTraining for Employment.

PUB DATE 94

NOTE 27p.; For the complete set, i.e., 21 units, each doneat three levels, see CE 067 029092. Supported by theInternational Consortium for EntrepreneurshipEducation, the Coleman Foundation, and the Center forEntrepreneurial Leadership Inc.

AVAILABLE FROM Center on Education and Training for Employment, 1900Kenny Road, Columbus, OH 43210-1090 (order no.RD302-10 IG, instructor guide $4.50; RD302-10 M,student module, $3; student module sets, level1--RD301M, level 2--RD302M, level 3--RD303M, $45each; instructor guide sets, level 1--RD301G, level2--RD302G, level 3--RD303G, $75 each; 3 levels andresource guide, RD300G, $175).

PUB TYPE Gu"les Classroom Use Teaching Guides (For

Teac.ier) (052) Guides Classroom UseInstructional Materials (For Learner) (051)

EDRS PRICE MF01/PCO2 Plus Postage.DESCRIPTORS Behavioral Objectives; Business Administration;

*Business Education; Business Skills; *CompetencyBased Education; *Distributive Education;*Entrepreneurship; Learning Activities; PostsecondaryEducation; Secondary Education; Small Businesses;Teaching Guides

IDENTIFIERS *Pricing; *Program for Acquiring CompetenceEntrepreneurship

ABSTRACTThis instructor guide for a unit on pricing strategy

in the PACE (Program for Acquiring Competence in Entrepreneurship)curriculum includes the full text of the student module and lessonplans, instructional suggestions, and other teacher resources. Thecompetencies that are incorporated into this module are at Level 2 oflearning--planning for a business in one's future. Included in theinstructor's guide are the following: unit objectives, guidelines forusing PACE, lists of teaching suggestions for each unitobjective/subobjective, model assessment responses, and overview ofthe three levels of the PACE program. The following materials arecontained in the student's sLuide: activities to be completed inpreparation for the unit, unit objectives, student reading materials,individual and group learning activities, case study, discussionquestions, assessment questions, and references. Among the topicsdiscussed in the unit are the following: factors affecting pricedecisions, profit margin, computing markup, pricing incentiveoptions, and pricing strategy choices. (KC)

UNIT 10LEVEL 2

PACE.THIRD EDITION

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Objectives:

Identify factors that affect pricing decisions.

Describe profit margin.

Determine how to compute the markup.

Identify pricing incentive options.

Discuss pricing strategy choices.

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EDUCATIONAL RESOURCES INFORMATIONCENTER (ERIC

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I

Unit 10

Pricing StrategyLevel 2

HOW TO USE PACE

Use the objectives as a pretest. If a studentis able to meet the objectives, ask him orher to read and respond to the assessmentquestions in the back of the module.

Duplicate the glossary from the ResourceGuide to use as a handout.

Use the teaching outlines provided in theInstructor Guide for assistance in focusingyour teaching delivery. , left side ofeach outline page lists el,jectives with thecorresponding headings (margin questions)from the unit. Space is provided for you toadd your own suggestions. Try to increasestudent involvement in as many ways aspossible to foster an interactive learningprocess.

When your students are ready to do theActivities, assist them in selecting thosethat you feel would be the most beneficialto their growth in entrepreneurship.

Assess your students on the unit contentwhen they indicate they are ready. Youmay choose written or verbal assessmentsaccording to the situation. Model re-sponses are provided for each module ofeach unit. While these are suggestedresponses, others may be equally valid.

2RUST COPY AVAILABLE

Objective5 Teaching Suggestions

1. IDENTIFY FACTORS THATAFFECT PRICING DECISIONS

What are the factors that affectpricing decisions?

What is price power?

What is the product life cycle?

2. DESCRIBE PROFIT MARGIN

How is profit margin determined?

Ask the students to think of products which are priced higherthan their physical features seem to justify, such as perfume.What factors, other than physical features, do they think have animpact on price?

Ask students who they think has price power in various productlines. For example, for personal computers IBM and Apple.You may want to ask about vacuum cleaners, baby diapers, can-ned soup. Do similar competitive products usually have a higheror lower price? Why?

Discuss the life cycle of black and white televisions from theirintroduction in the 1950's, growth in 1960's, and maturity/decline in the 1970's. Be sure to mention the heavy promotionof color television in the 1970s.

Ask what stage of the product life cycle the following productsare in: laundry detergents (maturity), CDs (growth), small calcu-lators (maturity to decline), videophones (introduction).

Ask students to identify the variable costs (ingredients, pack-aging, and labor) and the fixed costs (rent, insurance, salaries)involved in making a carry-out hamburgers.

Work the following problem on the board. Write the appropriateequation above the calculations.

If the total of the variable costs is $.50, and the total of thefixed costs is $1,000 a month, what is the total cost per ham-burger if 10,000 are sold in a month? ($.50 + $.10 = $.60).

What is the profit if the hamburger is sold for $2.00?($2.00 - $.60 = $1.40).

What is the profit margin? ($1.40 / $.60) X 100 = 233%.

Objectives

3. DETERMINE HOW TOCOMPUTE THE MARKUP

What is markup?

How are distributor costs justified?

Who pays for distribution?

Teaching Suggestions

Ask the class if anyone has ever shopped at a factory outletstore? How did the price at the factory outlet store compare tothe price of the same merchandise at a regular retail store? Howdo they account for the difference in prices? Answer: it is theretail markup.

Ask the individuals who have purchased at the factory outletstore whether the outlet was close to their home. In most cases,the outlet will not be close to their home. Then, ask how long ittook them to get the factory outlet store. Put a price tag on theround trip transportation time, such as $5.00 times 2 hoursequals $10.00. Finally, ask the students whether they found aswide an assortment of merchandise at the factory outlet store asat the regular retail store. Is it valuable to them to be able tochoose from a wide range of merchandise? Ask the individualswho purchased at the factory outlet stores whether they savedsufficient money to justify the trip. Discuss their responses.

Show the class several items with manufacturers prices printedon the label to demonstrate how a manufacturer might predeter-mine the retail price.

Through a contact in the retail business, find out their cost onone particular item. Be sure to specify size and brand name.Then, compare retail prices for this item at a convenience store,grocery store, and discount store. (Hint: Since conveniencestores carry a limited number of products, check to make surethe convenience store carries a particular item before talking toyour business contact.) Have students calculate the markups.Discuss and justify the higher markups.

4

Objectives Teaching Suggestions

4. IDENTIFY PRICINGINCENTIVE OPTIONS

What are price incentives?

What are my incentive options?

What is price elasticity?

What are the advantages and dis-advantages of incentive pricing?

5. DISCUSS PRICINGSTRATEGY CHOICES

What are my pricing strategychoices?

Ask students if they have purchased any products recently due toprice incentives. Discuss different types of price incentives, i.e.,straight discounts, two-for-one, rebates, etc.

Continue the above discussion by asking the same studentswhether they routinely purchase the discounted product or com-petitors' products. Determine whether they increased their usagerate. Generalize their purchasing behavior to the market as awhole. For example, if the student normally buys the discountedproduct, then the discount reduced the manufacturer's profitswithout increasing sales. On the other hand, if the studentbought a brand that they would not normally purchase, then themanufacturer may have achieved their objective of increasingmarket share.

Ask students to suggest products that have relatively inelasticdemand. Answer: utilities and drugs. Then, ask students tosuggest products that have particularly elastic demand. Answer:clothing, produce, etc. Ask for what types of products are pricediscounts most effective. Answer: products with elasticdemand.

Is there a business in your area that routinely discounts theirmerchandise? Refer to this business, and ask students how theywould feel about buying merchandise from that store at fullprice. Emphasize the fact that regular discounting teaches theconsumer to expect discounts.

Ask the class if a price discount is a pricing strategy. Afterhearing several responses, discuss the difference between occa-sional discounting and routine discounting. Note that evenorganizations with a high price objective may occasionally dis-count to clear out off season merchandise. Discuss the pricingstrategy in terms of long term commitment to price positioning.

Objectives Teaching Suggestions

How do you determine pricing ob-jectives?

How do I review these objectives?

Give the students a list of retail establishments, and ask them toindicate whether the stores have high, low or parity pricingobjectives. Your list might include Walmart, Kmart, Sears,JCPenney's, Federated Department Stores, and exclusive clothingstores.

Now, give the students a list of different blue jean brand namesand ask them to indicate whether they have high, low or paritypricing. Discuss the rationale behind the pricing objectives.

Ask the students to imagine that they are the manufacturers of anew product. What would they need to know to set the retailprice of the product? Answer: fixed/variable costs, customarymanufacturer and retailer markup, manufacturer pricing power,stage of the product life cycle, and price elasticity.

G

MODEL ASSESSMENT RESPONSES

1. A company has pricing power if its product is highly sought after by consunwrs and yields a good profitmargin. A company with pricing power is able to dictate the product price, within reason, to the rest ofthe industry.

Pricing decisions are affected by the following factors: company pricing power, market demand, competi-tion as reflected in the product life cycle, product costs, and markup.

2. The product life cycle is a marketing concept used to evaluate the direction the market will take in the shortand long run. It divides the stages of the product's maturity into four periods: introduction, growth, matu-rity, and de: line.

3. The profit margin reflects the difference between the costs and the selling price. It is computed as apercentage:

Profit = Selling Price Costs

Profit Margin = Profit/Cost X 100

4. Some of the most common forms of pricing incentives are coupons, bulk buying discounts, and sale prices.

5. The fundamental pricing strategy choices are lower, higher, or parity pricing.

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Program. for AcquiringCompetence inEntrepreneurship

abiratoomot. ,-,..mooremmumIncorporates the needed competencies for creating and operating a small business at three levels of learning, with experiences and

outcomes becoming progressively more advanced.

Level 1 Understanding the creation and operation of a business.Level 2 Planning for a business in your future.Level 3 Starting and managing your own business.

Self-contained Student Modules include: specific objectives, questions supporting the objectives, complete content in form of answers

to the questions, case studies, individual activities, group activities, module assessment references. Instructor Guides include the full text

of each student module and lesson plans, instructional suggestions, and other resources. PACE,Third Edition, Resource Guide includes

teaching strategies, references, glossary of terms, and a directory of entrepreneurship assistance organizations.

For information on PACE or to order, contact the Publications Department at the

Center on Education and Training for Employment, 19(X) Kenny Road, Columbus, Ohio 43210-1090(614) 292-4353, (800) 848-4815.

Support for PACE, Third Edition provided in whole or in part by:

International Consortium for Entrepreneurship Educationand

International Enterprise AcademyCenter on Education and Training for Employment

The Ohio State University

The Coleman Foundation

Center for Entrepreneurial Leadership Inc.Ewing Marion Kauffman Foundation

Your Potentialas an

Entrepreneur

Nature ofSmall Business

Help forthe

Entrepreneur

LegalIssues

RecordKeeping

Types of

Ownership

BusinessOpportunities

MarketingAnalysis

Business HumanManagement Resources

FinancialAnalysis

PricingStrategy

I

Global Markets

Location

UNIT 10LEVEL 2

TheBusiness Plan

Financingthe Business

Promotion Selling

CustomerCredit

RiskManagement Operations

Program for Acquiringh Competence in

EntrepreneurshipI

CENTER ON EDUCATIONAND TRAINING FOR EMPLOYMENT

COLLEGE OF EDUCATIONTHE OHIO STATE UNIVERSITY

Research & Development Series No. 302-10

PRICING STRATEGY

BEFORE YOU BEGIN . . .

1. Consult the Resource Guide for instructions if this is your first PACE unit.

2. Read What are the Objectives for this Unit on the following page. If you thinkyou can meet these objectives now, consult your instructor.

3. These objectives were met in Level I:

Define pricing as part of the marketing mix.

Identify costs that affect pricing.

Explain how competition affects pricing.

Describe the impact of consumer demand on prices.

Discuss the relationship between image and price.

4. Look for these busin-5 terms as you read this unit. If you need help with themeanings, ask your instructor for a copy of the PACE Glossary contained in theResource Guide.

DistributionElasticityFixed/variable costsMarkupPrice incenti-v-cs

Copyright © 1994, Center on Education and Training for Employment.The Ohio State University. All rights reserved.

3

PRICING STRATEGY

WHAT ARE THE OBJECTIVES FOR THIS UNIT?

Upon completion of this unit you will be able to

identify factors that affect pricing decisions,

describe profit margin,

determine how to compute profit margin,

identify pricing incentive options, and

discuss pricing strategy choices.

WHAT IS THIS UNIT ABOUT?

There are many decisions that face theentrepreneur when bringing a product to themarket: decisions about product design andfeatures, methods of distribution, and promo-tional campaigns. Ultimately, it is the objec-tive of the entrepreneur to develop a viableproduct, thus creating a profitable business.

Among the most crucial of new product stra-tegic considerations is the price. The reasonfor this is that the price tells consumers a lotabout a product, and the organization thatproduced it. From a price, a consumer cantell the position of a product, and how it

1 I.

relates to its competitors. In addition, theprice indicates its stage in the product life-cycle, and the image of the product. Finally,the long- and short-term organizational ob-jectives for the product, and the market strat-egy are indicated in the price. All of thesefactors determine whether it is a viable pro-spect for the consumer to consider.

The purpose of this unit is to explore issuesin pricing. Specifically, this unit covers thefactors that affect pricing decisions, profitmargin, incentive pricing options, and pric-ing strategy choices.

4

WHAT ARE THEFACTORS THAT AI(14ECTPRICING DECISIONS?

On the surface, pricing seems to be a fairlysimple matter. Prices are determined by cal-culating the firm's costs in creating a pro-duct and taking it to the market, plus a pre-determined margin for profit. If the com-pany does not have too high a profit margin,then it can expect to be viable as long asthere is demand for the product.

Unfortunately, this is not a reflection ofreality. Pricing is a complicated issue be-cause it requires detailed analysis of both thefirm, and the environment in which the firmoperates. The price that a company chargesfor its products or services is a function ofthe firm's power within the marketplace andits ability to respond to the changing marketdemands.

WHAT IS PRICE POWER?

Your pricing flexibility ultimately a func-tion of the ability to simultaneously dictateand accommodate the pricing moves of com-petitors. Consider the position of two carmanufacturers. Company A produces thebest selling car in the compact class. Thiscar is highly sought after, and yields a goodprofit margin to the manufacturer CompanyB is also a car manufacturer in the compactclass. But, its product is not as popular, andits production processes are more costly.The profit margin that Company B enjoys isfar smaller per car than for Company A.

Who do you think holds the balance of pric-ing power in this market? Obviously Com-pany A does. Company A can afford tolower its prices and still remain profitable.Also, it can lower its prices and have aserious impact on the profitability of Com-pany B. The reason for this is that Com-pany B is likely to respond to the price

0

reduction by lowering its prices. This movehas a far more detrimental effect on Com-pany B than Company A. Company B is di-minishing an already narrow profit margin,and possibly losing money on every car thatis sold. This may force Company B to makesubstantial product revisions, or exit themarket altogether.

Because Company A has pricing power, it isable to dictate prices within a reasonablerange. Company A will have a completelydifferent pricing strategy than Company B.Clearly, the pricing strategy depends on thecompany's relationship with its competitors,and the balance of market power in theenvironment.

The balance of power in a .arket will de-pend on a variety of factors. Many of thesefactors are described in the product lifecycle. The product's position in the lifecycle will determine marketing strategies,and long- and short-term strategic objectives.

WHAT IS THE PRODUCTLIFE CYCLE?

The product life cycle is a marketing con-cept used to evaluate the direction the mar-ket will take in the short- and long-term.The life cycle, in its simplest form, dividesthe stages of a product's maturity into fourperiods. These are labelled introduction,growth, maturity, and decline.

At the point of introduction, there are veryfew products in the marketplace. This isbecause there are few companies in the mar-ket with the technology to manufacture theproduct. Since demand is likely to exceed

:3

5

supply, manufacturers can charge high pricesfor their products and make healthy profits.Price will play only a minor role in the con-sumer's decision-making process. Consum-ers pay more attention to benefits such asinnovation and features.

Over time, as more manui, urers developthe technology to produce the product, therewill be a greater variety of similar productsfrom which consumers can choose. With in-creased competition, the price of these pro-ducts will begin to play a more importantrole. Manufacturers will attempt to distractconsumers from pricing considerations by"differentiating" their products from thecompetitors' products. In other words, theywill promote unique qualities of their pro-ducts as a justification for their price.

An example of differentiation can be seen inthe toothpaste market. One brand may focusits promotion on the fact that it preventscavities, while another brand emphasizes thefact that it prevents the build up of tartar.The third brand may emphasize the fact thatit makes your breath smell fresh. The factof the matter is that these brands may bechemically similar. However, the manufac-turers have decided to emphasize one partic-ular benefit for each brand to "differentiate"their products.

Eventually, as a wide variety of manufactur-ers are able to produce similar products.The product is then considered mature.There are few if any real differences be-tween products that are available to con-sumers. This type of product is known as a"commodity." Because these products havebeen )n the market for some time, consum-ers are aware of the features offered andrealize that the products are all very similar.Therefore, the price of the product becomes

6

a primary consideration. Unless consumerscan see a definite benefit in buying an ex-pensive product, they will buy a cheaper

one.

After maturity comes decline. Decline is aperiod in a product's life cycle at whichpoint there is a decreasing level of demand

for the entire category. Black and whitetelevisions are a good example. Regardlessof how advanced your black and white TVis, few people will buy it because it has beensuperseded. Can you think of any other pro-ducts that are in the decline stage of theirlife cycles?

In determining the pricing power, carefulconsideration must be given to the life cyclestage of your product. This can he analyzedby using a variety of methods, includingmarket research and competitive analysis.Your pricing strategy will depend on the

outcome of this analysis.

During the introduction stage of the productlife cycle, consumers are motivated by a de-

sire to have the most up-to-date products and

services. These consumers are willing topay a high price for innovative products andservices. The high price charged for these

innovative products helps manufacturers

offset the high research and developmentcosts and risks involved in developing them.

Companies that adopt a low-volume, high-profit method of pricing for the introductionof a new product are using a "skimming"model of pricing. The skimming model al-lows the manufacturer to "skim" the profitsout of a market before the competition isable to respond by introducing their own

products. Typically, manufacturers willcharge the absolute maximum that the mar-ket will hear for a product, then graduallyreduce the price as competition enters the

market.

In a growth market, companies must be pre-pared to spend money on promotion to dif-

ferentiate their product. Consumers are still

receptive to the notion that there are real

differences between products, and they areprepared to pay for those differences.

In a mature market, consumers place a great-er emphasis on the price because there arefew real differences between products.Therefore, the companies that can remainprice competitive will be successful in thismarket. It is important for these companiesto analyze their cost structures carefully, anddetermine exactly how much each unit costs.Companies that consistently sell their pro-ducts below their minimum price will even-tually go out of business.

Companies that introduce new products tomature markets often price the product be-low regular prices to induce the consumer totry it. This form of pricing is known as"penetration pricing," because the manufac-turer is penetrating the marketplace withprice induced trial. Often there is little or noprofit margin for the manufacturers. Thispricing policy is used to establish a marketfor a new product very quickly.

In the decline stage, companies reduce pricesto the lowest possible level. Since there isno growth potential in the market, the com-pany may stop promoting it. When the pro-duct is no longer profitable, the companymay cease production all together.

HOW IS PROFIT MARGINDETERMINED?

There are three major factors in most pric-ing decisions. These are the demand, thecompetition, and the costs. The competitiveaspect of pricing has been described abovein relation to the product life cycle. This

5

7

segment will discuss costs and their relationto long- and short-run profitability.

The price that the consumer ultimately paysis comprised of the manufacturer's and re-tailer's costs and profits. The manufac-turer's price is known as the "wholesale"price, and it represents the amount that theretailer pays for the product. The retailerthen adds his costs and profit margin todetermine the "retail" price. This is theprice that the consumer ultimately pays.

The costs allocated to a producer are usuallycomprised of the following:

The raw materials needed to manufacturethe product

The cost of manufacturing the product(labor & overhead)

The cost of distributing the product

The cost of marketing the product

The costs allocated to retailers for selling theproduct include the following:

The retailer's purchase price

The costs of real estate

The costs of selling the product (person-nel, marketing, overhead)

Costs of preparing and serving the pro-duct (wherever appropriate)

8

Both the manufacturer and the retailer mustdetermine the costs associated with a productin order to determine the selling price of aproduct.

Costs can be divided into two broad catego-ries. These are fixed and variable costs.Fixed costs are the costs that will be in-curred regardless of how many products aremanufactured. For example, salaries may bepaid to employees regardless of how manyproducts they make. In addition, machineswill be depreciated regardless of how manyproducts are produced. Variable costs in-crease as production increases. For example,raw materials costs will increase as the num-ber of products made increase.

The price that both the retailer and themanufacturer will eventually sell at mustcover both of their fixed and variable costs.The difference between the costs and theselling price is the profit margin.

The following example illustrates thisconcept.

A Swiss watchmaker spends $50 onthe raw materials for a gold watch.Because of the specialized machineryrequired to make the watch and thehighly skilled labor required to oper-ate the machines, the watchmakerspends another $50 per watch on fix-ed costs. The watchmaker sells thewatch to a jeweler for $250. Thejeweler allocates $50 per watch tocover his own fixed costs and sellsthe watch for $400.

Q. What is the profit margin for thewatchmaker?

A. Total cost = $50 + $50 = $100Selling Price = $250Profit = $250 - $100 = $150Profit Margin = Profit/Cost x 100= $150/$100 x 100 = 150%

Q. What is the profit margin for thejeweler?

A. Total Cost = $250 + $50 = $300Selling Price = $400Profit = $400 - $300 = $100Profit Margin = Profit/Cost x 100= $100/$300 x 100 = 33.3%

WHAT IS MARKUP?

For every product or service sold, thereshould be a marketing plan. The marketingplan should incorporate the four elements ofthe marketing mix. These elements are pro-duct, promotion, place, and price.

The reason that price is such an importantpart of the marketing mix is that it is theprice that ultimately pays for the other ele-ments of the mix. The costs incurred duringpromotional efforts must be recouped whenthe product is sold. The costs incurred inthe development of the product must also berecouped. Finally, the cost of distributingthe product to a place where consumers areable to purchase the product must also beincorporated into the price and ultimatelypaid for, if the company is to make a profit.

In addition to these costs are the overheadcosts that are associated with the productionof each unit. These include the employeesalaries, rent, and insurance, etc. The dollarvalue of the allocation of fixed costs and

profit is called the "markup" on the variablecosts, often presented as a percentage.

Once the product is sold to the retailer,another type of markup is added to thewholesale cost of the product. This markup,known as "retail markup" is a payment formaking the product available. Effectively,this is a way that the consumer pays thedistributor for the convenience of having theproduct available in the present location.

HOW ARE DISTRIBUTORCOSTS JUSTIFIED?

The distributor gets the product to the cus-tomer. Distribution and product placementare very important to the success of a pro-duct. If the product is not distributed con-veniently, then consumers will purchase thecompetitor's product.

The selection of a distribution system andlocation is an important decision. The con-sumer must know where the product is soldand have easy access to it. For example,where would you go to buy milk? Youwould probably take a trip to the cornergrocery store, not the clothing store acrosstown. So, if a company produces milk,where should the product to be sold? Obvi-ously, at a convenience store, or the grocerystore. It is most profitable for companies toplace their products in locations that havethe most likelihood of attracting potentialconsumers.

Distributors provide a service at some ex-pense and expect to make a profit. Themethod most commonly used for paying dis-tributors is a markup. The markup is added

9

directly to the price of the product. Theamount paid to the distributor is determinedby the quantity of product sold. The markupis usually a percentage increase over andabove the wholesale price. The wholesaleprice is the price at which the distributorbuys the product from the manufacturer.

WHO PAYS FORDISTRIBUTION?

There are a variety of arrangements that canbe created to finance distribution. The mostcommon of these is that the distributor pu,chases the product at one price, then chargesthe consumer a higher price. If a distributorcharges $1.30 for a gallon of milk for whichthey paid $1.20, then they make $0.10 pergallon. Effectively, the distributor makesmoney by providing an outlet for the manu-facturer.

Often the distributor, not the manufacturer,is responsible for setting the price. How-ever, even though the distributor has theultimate authority to set the price, themanufacturer may predetermine the price forthe distributor. In this case, the manufac-turer determines the price at which the re-tailer (distributor) will sell to the consumer,then subtracts the retail markup from theselling price to allow the retailer a reason-able profit. Thus, the manufacturer sets theretail price, and then calculates the wholesaleprice by subtracting the retailer's markupfrom the retail price.

For example, assume that your companymanufactures shampoo. Through intensivemarket research, you have determined thatthere is demand for a shampoo that is priced

10

at slightly less than the premium product

(most expensive), but slightly higher than the

general product. Let's assume that the most

expensive shampoo on the shelf costs $3.50

to buy. The average price is $3.25. Youhave determined that your price should be

$3.40. In order to control the price to the

consumer, you sell the shampoo to the retail-

er for $2.72 to allow the retailer a 24 percent

($0.68/$2.72) markup.

But, how much of a markup does the retailer

need? The answer to this question will de-

pend on a number of factors. The most im-portant of these is the amount of leverage

that you as a manufacturer have with the re-

tailer. If your products traditionally sell well

with retailers, then the retailer has a higherprobability of making money with your pro-

duct. For that reason, the markup that the

retailer will charge will be less than if yourproducts are untested in the marketplace.

The retailer makes money on the space they

have available to consumers. Therefore, the

price that the retailer will charge the manu-facturer will be determined by the return on

the space that the retailer provides. This

return will be calculated as a function of the

amount of profit per sale multiplied by theexpected number of sales in a given time

period. If your product is a high-volume,low-margin product, then the retailer will

charge a small markup, but expect to receive

it many times. If your product is a low-

volume, high profit margin item, then theretail:r will charge a large markup to com-

pensate for the fact that sales are low.

Grocery stores will charge as little as 2 or 3

percent markup on items such as milk oreggs, whereas jewelers may charge two orthree times the price they paid for exotic

jewelry.

WHAT ARE PRICEINCENTIVFS?

Assume that your company manufactures

breakfast cereal. You have noticed a steady

decline in sales growth over the past couple

of months. Among many options to improve

short-term performance, you might consider

a temporary reduction in your prices to stim-

ulate sales. This is a form of incentive pric-

ing option that may make your product moreattractive to the consumer. The consumer

will buy your product because at a lower

price it becomes a better value. This form

of temporary price reduction is extremelypopular, especially in industries where it is

difficult to differentiate between brands.

Price reductions are commonly found in gro-

cery stores where many brand name products

are very similar.

WHAT ARE MYINCENTIVE OPTIONS?

Price incentives can take an infinite variety

of forms depending on the level of imagina-

tion of the discounter. The most common

forms of incentive are coupons, bulk buying

discounts (two for the price of one), and sale

prices. In many cases, the incentive isdesigned to encourage people who would not

normally buy the product to try it. The

expectation is that once a consumer tries the

product, they will buy it again. In general,

incentives are used to:

increase market share by taking custom-

ers away from competitors,

increase usage rates among existingcustomers,

encourage people to buy this type of pro-duct for the first time, and

discourage your customers from switch-ing to another product.

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As mentioned earlier, products are dis-counted for a variety of reasons. Each pric-ing strategy may require a different deduc-tion in order to achieve its objective. Theway to determine the appropriate deductionis to establish a strategy with an objective,for example to build market share by 2 per-cent, then measure the effectiveness of thediscount against the objective.

WHAT IS PRICEELASTICITY?

The question now is by how much do youdiscount in order to attract the right custom-ers? Obviously the answer to this questiondepends on a number of complicated issues,each of which will be different for everyproduct on the market. Like pricing, dis-counting is an inexact science. The mostsuccessful discount may not be calculatedmathematically, but may be discoveredthrough experimentation and by experience.

Ultimately, the way consumers will respondto the discount will depend on their pricesensitivity. Price sensitivity is simply theamount of change in the quantity that con-sumers purchase for a given reduction inprice. For example, if you drop the price ofyour cereal by 5 percent and sales do notincrease, then your customers are price in-sensitive within the given price range. Anyprice reduction is a complete waste ofmoney because it does not encourage peopleto buy more of your product. On the otherhand, if there is an overwhelming change inthe amount of product sold when the price isreduced, then the consumer is price sensitivewithin the given price range. In this case,

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price incentives may be a very effective pro-motional tool.

WHAT ARE THEADVANTAGES ANDDISADVANTAGES OFINCENTIVE PRICING?

The single largest criticism of incentivepricing is that discounters teach consumersto purchase products because they are dis-counted rather than for their unique featuresand benefits. Price cutting may not buildcustomer loyalty, but instead attracts priceshoppers. It allows people who would havebought the product anyway (loyal customers)to buy it at a cheaper price. If that is thecase, then regular customers will stock uptheir pantries whenever their favorite pro-ducts are on sale.

WHAT ARE MY PRICINGSTR 'TEGY CHOICES?

Ultimately, the pricing strategy is a key tolong-term profitability and a company'soverall viability. The pricing strategy that isadopted is the culmination of setting pricingobjectives and reviewing the most appropri-ate way of achieving those objectives.

HOW DO YOU DETERMINEPRICING OBJECTIVES?

Pricing objectives generally focus on thefollowing three issues:

Lower, higher, or parity pricing

Geography of pricing

Timing of the pricing

In order to determine if your companyshould occupy a lower, higher, or parityprice position, you should review your mar-keting strategies and consider the followingfactors:

Low price objective. The reasons for lowprice are usually the following:

To expand the market and attract newcustomers who would ordinarily not pur-chase your products

To indnce trial among your competitor'scustom_ base

To help improve profitability due to alarge increase in the volume of a lessprofitable product

To help steal market share and discour-age or deflect competitive moves

To remain competitive on the basis ofprice

To discourage competitors from enteringthe market

High price objective. Often a higher pricedproduct will yield substantial profits in spiteof lower volumes of sales. Justification forhigher prices include the following:

A need for a fast recovery of the firm'sinvestment

A commitment to generating revenues tocover research and development costs

To support the image of superior quality

Where price increases result in only mi-nor reductions in sales volume

The product is in the introductory phaseof the product life cycle

The product has a short life span inwhich the entire profit on the productmust be realized

The product has patent protection orother monopoly qualities

Parity price objective. For this pricingstrategy the price of a product is roughly thesame as the price of a competitor's product.The manufacturer chooses to use other pro-duct features, such as superior image or ser-vice, rather than price to differentiate theproduct.

HOW DO I REVIEWTHESE OBJECTIVES?

The following steps should be taken whensetting pricing objectives:

Review marketing strategies and theirrelationship to price. Price is anintegral part of the way the company

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communicates with its customers.Therefore, the price must mesh with therest of the marketing plan.

Review your pricing mathematics.You should completely understand yourcost base and your break-even quantities.Ensure that the overall profit and growthstrategies can be accomplished with theforecast profitability of your selectedprice.

Once these elements of the plan have beenthoroughly reviewed, you can begin to writeand execute specifi3 strategies for accom-plishing your growth, market share, andprofitability objectives.

Pricing is both a science and an art. Toselect a profitable price, the entrepreneurmust first be sure to cover their fixed andvariable costs. Then, they must understandthe market and their competition. Most suc-cessful business owners have a feeling fortheir product's market position. With thisqualitative and quantitative information, theentrepreneur can set the product price highenough to be profitable and low enough tosell.

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ACTIVITIES

The following activities are designed to helpyou apply what you have learned in thisunit.

INDIVIDUAL ACTIVITIES

A.

Collect coupons for a large category of gro-cery store products (breakfast cereal wouldbe a good choice). Tabulate a list of currentbrands that are available in the store andrank order them based on price. Be carefulto ensure that the products are the same sizeor weight for comparison purposes.

Questions:

1. What do you notice about the featuresand packaging differences between themost expensive products and the leastexpensive products?

2. Are the differences meaningful or valu-able to you personally?

Now reorder the products based on the cou-pon prices, including those products thathave no coupon or discount offered.

3. Does the order change significantly?Does the price change affect yourimpression of the product?

B.

A bicycle manufacturer produces a mid-range mountain bike for resale through fullline sporting goods stores. Each bicyclecosts $70 in raw materials, is allocated $30in fixed costs, and costs $10 to ship to thestore. The manufacturer sells the bike to thesporting goods store for $180. The storethen adds $20 to cover the costs of assemblyand $50 as a profit margin.

Questions:

1. What is the selling price of the bike tothe consumer?

2. What is the profit margin for the re-tailer?

3. What is the profit margin for the manu-facturer?

GROUP ACTIVITIES

A.

As a group, select a product that you are allfamiliar with. Each group member shouldselect one of the following areas for investi-gation:

Product features

Promotion

Distribution points

Price

Identify the current manufacturer's strategyregarding these features. Does the strategyappear consistent across the categories?

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For each of these products, determine itsposition in the product life cycle. Thinkabout the following issues when attemptingthis problem:

B. 1. Are the prices falling, rising or stayingstable for this product over time?

Each group member should choose one ofthe following products:

Sugar

In-line skates

Automobiles

Breakfast cereals

2. Do manufacturers promote on the basisof product features or price?

3. How long has the product category beenactive?

4. How many competitors are there in thecategory?

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CASE STUDY

John Dickson makes guitars by hand in hisshop in Boston. He has been making guitarsby hand for 15 years and has developed aclientele that includes some of the world'smost successful musicians. The reason thatJohn has such high demand for his productsis that he uses traditional methods and mate-rials for production. He is known for hisattention to detail.

For the first time, John has decided to beginto produce a line of guitars for the generalpublic. His line will carry his name and willbe priced at the high end of generally avail-able instruments. The guitars will still bemade by hand, but due to the volume of gui-tars required, John has decided to hire threeguitar makers to help him cope with themanufacturing demands. Each of the makerswill be paid a straight salary.

DISCUSSION QUESTIONS

As part of his move to become more produc-tive, John has decided to do a thorough anal-ysis of his costs, which will then assist himin his pricing strategy. His cost breakdownis as follows:

Raw MaterialsNew machinery

Owner's salaryNew hire's salaries

Shop RentElectricityOld machinery

$300 per guitar$200 per month

(leased)$3,000 per month$25,000 per annum

each$1,400 per month$200 per month$400 per month

John figures he can sell the new guitars for$3,500 each to guitar shops, who will addtheir own margins and sell them to thepublic.

1. What are the fixed costs per month?

2. What are the variable costs per guitar?

3. What is the profit margin per guitar if the company can produce 30 guitars per month?

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ASSESSMENT

Read the following questions to check your knowledge of the topics presented in this unit.When you feel prepared, ask your instructor to assess your competency on them.

1. What are the factors that affect pricing decisions? What is pricing power?

2. What is the product Life cycle? What are its four stages'?

3. What is profit margin and how is it computed?

4. What are the most common forms of pricing incentives?

5. What are the fundamental pricing strategy choices?

REFERENCES

Britt, S., et al. Marketing Management and Admi:astrative Action. New York, NY: McGraw-

Hill, 1983.

Cook, K. AMA Complete Guide to Small Business Marketing. Lincolnwood, IL: NTC

Publishing, 1993.

Davidson, J. The Marketing Sourcebook for Small Business. New York, NY: John Wiley &Sons, 1989.

Monroe, K. Pricing; Making Profitable Decisions. New York, NY: McGraw-Hill, 1990.

Montgomery, S. Profitable Pricing Strategies. New York, NY: McGraw-Hill, 1988.

Morris, M., and Morris, C. Market Oriented Pricing. New York, NY: Quorum Books, 1990.

Rogers, L. Pricing for Profit. Cambridge, MA: Basil Blackwell, Ltd., 1990.

Level 2

PACE

Unit 1. Your Potential as An Entrepreneur

Unit 2. The Nature of the Small Business

Unit 3. Business Opportunities

Unit 4. Global Markets

Unit 5. The Business Plan

Unit 6. Help for the Entrepreneur

Unit 7. Types of Ownership

Unit 8. Marketing Analysis

Unit 9. Location

-> Unit 10. Pricing Strategy

Unit 11. Financing the Business

Unit 12. Legal Issues

Unit 13. Business Management

Unit 14. Human Resources

Unit 15. Promotion

Unit 16. Selling

Unit 17. Record Keeping

Unit 18. Financial Analysis

Unit 19. Customer Credit

Unit 20. Risk Management

Unit 21. Operations

Resource Guide

Instructor's Guide

Units on the above entrepreneurship topics are available at the following levels:

Level 1 helps you understand the creation and operation of a businessLevel 2 prepares you to plan for a business in your futureLevel 3 guides you in starting and managing your own business