Price Setting Strategies Flashcards
Service Firms
A business that provides a service in return for a fee. The service is based on labour or expertise. Services are intangible (cannot be stored or physically touched).
Trading firm
A business that aims to generate a profit by selling a tangible (can be physically stored and touched) good rather than a service. The business buys a physical item at a cost price then sells the item at a higher price.
5 pricing methods
Recommended retail price Competitors price Market reaction Percentage mark up Cost volume profit analysis
Recommended retail price
A selling price that is suggested by the manufacturer or the wholesaler. These suggested prices are not mandatory, and it is up to the retailer to decide whether to use them.
Competitors prices
Prices charged by businesses competing in the same market. If prices are set too high, then sales will be lost to cheaper competitors and profit will suffer.
Market Reaction
The response of customers in a particular marketplace to price levels for a particular good or service. If demand is particularly high, then selling prices can be set higher, because customers are so keen to get their hands on the product that they are willing to pay a higher price.
Mark up
Determining selling prices by adding to the cost price a predetermined profit margin. Different percentage Mark up for different lines of stock. It may be dependant on the cost price of the stock: if the cost price is high then applying a large Mark up may make that item too expensive. It may not be practical to have one fixed Mark up as the business needs to be able to react to market conditions and competitors prices.
Formula to determine Mark up
Selling price = cost price X (1 + Mark-up/100)
REVISE QCS AND APS
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REVISE QCS AND APS
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Cost volume profit analysis
A tool that allows a business to determine a selling price or volume of sales that will let them achieve a specific profit goal.
Break even point
The level of sales where total revenue equals total expenses and the business makes neither a profit nor loss.
Variable costs
Costs that vary directly with the volume of sales. The amount is expressed as per unit.
Fixed costs
Costs that do not vary with the level of activity. These costs remain the same regardless of the number of sales. Common examples of fixed costs are rent, insurance, wages etc.
Cost-volume profit formula
Quantity to be sold = (total fixed costs + profit)/(selling price per unit - variable cost per unit)
This formula calculates how many products need to be sold to make a profit.
(selling price per unit - variable cost per unit) this calculates how much gross profit is generated from every item that is sold.
Contribution margin
The gross profit from each sale that goes towards covering fixed expenses and contributing to net profit, calculated by deducting variable costs from the selling price. (Bottom line of formula)
Minimum desired profit
a lowest acceptable profit figure, usually similar to previous income plus a return on the amount invested
Gross profit
the pro t earned purely from the purchase and sale of stock, measured by deducting Cost of Sales from Sales revenue
State two reasons why it may be necessary to apply a different percentage mark-up to each line of stock.
It may be dependent on the cost price of the stock: if the cost price is high then applying a large mark-up may make that item too expensive.
It may not be practical to have one fixed mark-up as the business needs to be able to react to market conditions and competitors’ prices.
Mark up formula
Mark-up = (SP/CP) – 1
Explain why not all businesses can use a percentage mark-up to set selling prices.
Some businesses are of a service nature and therefore have to take various costs into account before setting a price.
Where costs are not well defined it is difficult to calculate cost price, making the application a of a percentage mark-up impossible.
Some franchise agreements may dictate selling prices making the application of a mark-up a breach of the agreement.
Explain how an increase in selling price could lead to a decrease in pro t.
If the decrease in sales volume due to the increase in selling price is greater than the effect of the increase in contribution margin per sale then the business’s profit will decrease.
Desired monthly profit formula
Desired profit = previous wage plus return on savings
8400(previous wage)/12 + (6 000(savings)( x 10%(interest rate on savings)/12
Variable profit formula
(Variable profit) = (Contribution margin) = (Selling price – Variable cost)
