P2C.3 Pricing Flashcards
Cost Based Method
- Cost driven
2. Focuses on product and costs
Basic Cost Based Approach Formula
Price = (Total fixed costs + total variable costs + desired profit) / Number of units produced
Cost Plus Markup Approach Formula
Price = Cost * (1 + markup percentage)
Market Based Method
- Competition driven
2. Focuses on consumer and the customer perceived value
Value Engineering
- Process of identifying and evaluating costs in value chain
- Goal is to reduce non-value added cost of a product to the level of acceptable (target) cost
Value Added Activity & Cost
Activity: activity that customers perceive increased quality, utility or value to a product of service
Cost: cost incurred to perform the value adding activity.
Market Penetration Pricing
Setting a low price to penetrate or introduce a product into a buyers market
Market Skimming Pricing
Setting a higher price to penetrate or introduce a product to a sellers market
Predatory Pricing
Setting the price at a very low price to control the market or discourage competition
Product Bundling Pricing
Packaging interrelated products at a reasonably low “all-in-on” price
Off Peak Pricing
Pricing the product at a lower price during periods of low sales or low season to attract customers
Peak Load Pricing
Pricing high when operating at full capacity and pricing low when operating with excess capacity
Price Discrimination
Pricing that only applies to certain segment of people.
Ex: providing % off price for students.
Pure Competition
Product: homogenous or identical
Ex: poultry or farm products
Competition: large number or sellers
Pricing: price takers
Marginal cost curve = supply curve
Individual firm’s demand curve is perfectly elastic.
Monopolistic Competition
Product: similar but not identical (differentiated)
Ex: toiletry products or beverages
Competition: several sellers
Pricing: limited control
- Entry is relatively easy with only a few obstacles.
- Monopolistic competition is characterized by interdependent firms, some (but not total) control over price, and heterogeneous products. Because products are heterogeneous, they are close but not perfect substitutes.
Monopoly
Product: unique
Ex: electricity, paid government services
Competition: single seller, no competition
Pricing: price makers
Will maximize profits if it produces an output where marginal costs is equal to marginal revenue.
Downward-sloping marginal cost curve.
Oligopoly
Product: standardized products
Ex: petroleum, telecom
Competition: few but large sellers. High degree of interdependence among firms. (High concentration ratio)
Pricing: competitor dependent / agreed upon cartel
Requires huge capital and technology requirements to enter.
Kinked demand curve: when an oligopolist lowers its price, the other firms in the oligopoly will match the price reduction, but if the oligopolist raises its price, the other firms will ignore the price change.
Cartel
- An agreement between competitors to set a fixed price on a good or service.
- Only legal with government intervention.
Target Cost per Unit
Difference between target price and target profit is allowable cost
Target Cost per Unit Formula
= Target price per unit - target profit per unit
= (1 - profit target rate) * Total sales in dollars / Number of units sold
Target Pricing
- Pricing strategy used to create competitive advantage.
- Target pricing involves selecting a price (the “target” price) for a product or service that will be very competitive in the market. Then, a process of “reverse engineering” is used to attempt to produce this product or service at a cost, lower than the target price, which will produce an acceptable profit margin.
- Target pricing identifies a market-based price for a new or proposed product. This target price is then reduced by the desired profit margin to arrive at the product’s target cost.
Price Elasticity of Demand
Measurement of how much changes in price will affect the supply demanded
Price Elasticity of Demand Formula
(Q2 − Q1)
(Q2 + Q1)
(P2 − P1)
(P2 + P1)
- Use absolute values
- Q/Q & P/P, then Q/P
= 1, perfectly elasticity
= 0, perfectly inelastic
>1, greater elasticity
Elastic Relationship to Demand & Price
Increase in price = Decrease in revenue
Decrease in price = Increase in revenue
Increase in demand = Increase in revenue
Decrease in demand = Decrease in revenue
Inelastic Relationship to Demand & Price
Increase in price = Increase in revenue
Decrease in price = Decrease in revenue
Increase in demand = Decrease in revenue
Decrease in demand = Increase in revenue
Coefficient of Elasticity
The coefficient of elasticity is multiplied by the change in price to determine the change in quantity demanded.
% change in quantity / % change in price
