P2 - 9. Pricing Flashcards
What are the two driving considerations when setting prices?
- Attractive to customers
2. Makes the business profitable over the long term
What is a market driven optimum pricing approach?
Consider the quantity of business products that are demanded by consumers at different price levels
What is perfect competition?
A business can sell as many items as it wishes at the prevailing market price but it cannot have any influence over that market price
What is the selling strategy under perfect competition?
Sell as much as possible
What is imperfect competition?
In order to sell more items the price has to be lowered - inverse relationship between price and quantity demanded
What is the selling strategy under imperfect competition?
There will be a specific price and demand contribution that leads to a profit maximizing position
What is the equation for the price/demand relationship under imperfect competition?
P = a - bX
Where a = price above which sales are zero and
b = change in price/ change in quantity
What is the point at which profit is maximised?
Marginal Revenue = Marginal Cost
What is the point at which revenue is maximised?
Marginal revenue = 0
What does price elasticity of demand measure?
How much the quantity of a good is affected by a change in price of that good
What is the equation for price elasticity of demand?
% Change in Quantity / % Change in Price
What does PED > 1 mean?
Price sensitive, elastic - change in price leads to bigger change in demand
What does PED < 1 mean?
Price insensitive, inelastic - change in price leads to smaller change in demand
What 4 things influence price sensitivity?
- Number of competitors
- Similarity of competitor products
- Amount of disposable income taken up
- Necessity or luxury item?
Why do many companies opt for cost as a basis for pricing?
It can be difficult to identify the price/demand relationship
What is the benefit of using marginal cost as a basis for pricing?
Useful as a minimum price where there is spare capacity
What is the risk of using marginal cost as a basis for pricing?
Fixed costs may be ignored, and these do need to be covered in the long term
What is the benefit of using relevant cost as a basis for pricing?
Useful as a minimum price where there are scarce resources, as it incorporates opportunity cost
What are the 2 benefit of full absorption cost as a basis for pricing?
Guarantees that costs are covered (assuming that budgeted demand is covered) and fairly quick and easy to set up
What is the risk of using full absorption cost as a basis for pricing?
Need to ensure that customers are happy to pay
What are the 2 benefits of using standard cost as a basis for pricing?
- Selling price is kept stable
2. Internal inefficiency is borne by the organisation
What are the 3 main benefits of using cost as a basis for setting prices?
- Simple and easy to implement
- Based on readily available data
- Easily understood by most staff
What are the 3 main considerations for what margin/markup to use?
- What is the target ROCE for the company
- What are competitors prices
- What margins are obtained on similar products
What 4 main reasons might lead to a change in pricing strategy?
- Stage in product life
- Entry of competitors
- Different geographical demands
- Changes in technology
What is market skimming?
Initially charging high prices to recover upfront costs, then lowering as it becomes more mature
When is market skimming most often used?
High technology products that get updated quickly
What is premium pricing?
Products marketed as higher quality to justify a permanently higher price
What is penetration pricing?
A low initial price is set to gain high volumes and market share
Why does penetration pricing create a barrier to entry for other companies? (2)
- Potential profits aren’t attractive
2. Can’t achieve economies of scale to achieve lower unit cost
What is loss leader pricing?
Products sold at very low prices with the intention that customers will buy other products to go with it that will generate profits
What is product bundling?
Selling a combination of products together in a package that is lower than the sum of each individual product
What is price discrimination?
A different price is charged in a different market segment due to different price/demand relationships in each segment
What are 4 possible options for price differentiation?
- Time
- Age of consumer
- Geographical market
- Type of consumer (wholesale/retail)
