Sec C - pricing Flashcards
1
Q
Price:
A
the amount of money expected, required, or given in payment for something.
2
Q
- High Price: Risks
A
low sales volume and insufficient contribution to cover fixed costs. Low Price: Risks high sales volume but insufficient revenue to cover all costs.
3
Q
Low Price: Risks
A
high sales volume but insufficient revenue to cover all costs.
4
Q
- Core Principle: Price is determined by
A
the interaction of supply and demand.
5
Q
The “Three Cs” Impact Pricing:
A
Customer Demand: ,
Competitors’ Prices:
Costs
6
Q
- The Law of Demand
A
- Relation between Price and Demand (Inversely related - customers perspective)
7
Q
- Demand Graph:
A
Vertical Axis: Price. Horizontal Axis: Quantity Demanded. Shape: Downward sloping curve, showing the inverse relationship.
8
Q
Why Demand is Also Average Revenue (AR) In any market structure:
A
Demand represents the price consumers are willing to pay at each level of quantity.
* Average Revenue (AR) is the revenue per unit sold, which is simply the price when there is only one price at each quantity level.
9
Q
other factors affecting demand
A
- Income of the buyer (superior goods demand will increase- inferior good will decrease)- direct- against the law of demand
- Tasete and preferance of the consumer - direct relation against the law of demand
- Price of Substitue goods - direct
- Price of complenetary good - (petrol,and petrol cars) inverse
- Market Price anticipation of buyer - direct
10
Q
Price Elasticity of Demand Definition:
A
Measures how quantity demanded changes in response to price changes.
11
Q
PriceElasticityofDemand =
A
%ChangeinQuantityDemanded / %ChangeinPrice
12
Q
- **Relatively Elastic:
A
Price Elastic Demand: Elasticity > 1. * Price ↑ → Total revenue ↓ —— Price ↓ → Total revenue ↑
13
Q
A
14
Q
- **Relatively Inelastic:
A
Price Inelastic Demand: Elasticity < 1. * Price ↑ → Total revenue ↑ —— Price ↓ → Total revenue ↓
15
Q
Perfectly Elastic
A
Tiny price change → infinite demand change. theoretical scenario (perfect competition)
Horizontal line
E = ∞ (Infinite)
16
Q
Perfectly Inelastic
A
Demand constant, no matter the price change. theoretical concept
Vertical line
E = 0
17
Q
Relatively Elastic
A
Small price change → large demand change. quantity demanded is relatively greater
Flat, downward slope
E = >1
18
Q
Relatively Inelastic
A
Large price change → small demand change. quantity demanded is relatively less
Steep, downward slope
E = <1 and >0
19
Q
Unitary Elastic
A
Price change → proportional demand change.
Standard downward slope
rectangular hypebola E = 1
20
Q
Calculation of Elasticity of Demand
1. Percentage Change Method
A
PriceElasticityofDemand(PED) = %ChangeinQuantityDemanded / %ChangeinPrice
21
Q
Calculation of Elasticity of Demand
- Mid Point Elasticity Method (Arc Method)
A
PED = ΔQ / ΔP * Avg P / Avg Q
Less accurate than the percentage method but provides consistent results regardless of the direction of price change.
22
Q
Shift in Demand
A
A shift in the demand curve occurs when factors other than price, such as consumer income or preferences, change. This results in a new quantity demanded at every price level. An increase in demand shifts the curve rightward, while a decrease shifts it leftward.
23
Q
Income Elasticity of Demand
A
Income Elasticity of Demand (IED) =
ΔQ / ΔI * Avg I / Avg Q
24
Q
Cross Elasticity of Demand (CED) / Related Good’s Price Elasticity of Demand :
A
measures the responsiveness of the quantity demanded of one good to a change in the price of a related good.
- Substitute Goods:
- Positive Elasticity: An increase in the price of one good increases the demand for its substitute.
- Example: If the price of tea increases, the demand for coffee rises.
- Changes in substitute price and demand:
- Substitute Price ↓ → Demand ↓ —— Value will be positive
- Substitute Price ↑ → Demand ↑ —— Value will be positive
- Positive Elasticity: An increase in the price of one good increases the demand for its substitute.
- Complementary Goods: Negative Elasticity: An increase in the price of one good decreases the demand for its complement. Eg: If the price of petrol increases, the demand for cars decreases.
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1. Substitute Goods:
* Positive Elasticity: An increase in the price of one good increases the demand for its substitute.
* Example: If the price of tea increases, the demand for coffee rises.
* Changes in substitute price and demand:
* Substitute Price ↓ → Demand ↓ —— Value will be positive
* Substitute Price ↑ → Demand ↑ —— Value will be positive
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Cross Elasticity of Demand =
ΔQ / ΔRG’s Pric * Avg RG’s Price/ Avg Q
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2. Complementary Goods:
Negative Elasticity: An increase in the price of one good decreases the demand for its complement. Eg: If the price of petrol increases, the demand for cars decreases.
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Law of Supply (relation with Price and Supply- supplier's (or producer's) perspective
Positively correlated. (price elasticity is inelastic in short run, Elastic in the long run.
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Other Factors Affecting Supply
1. Resource Prices
* Increase in resource prices → Higher production costs → Supply decreases.
* Decrease in resource prices → Lower production costs → Supply increases.
2. Taxes and Subsidies
* Higher taxes → Increased costs → Supply decreases.
* Subsidies → Lower costs → Supply increases.
3. Technological Changes
* Technological advancements improve efficiency → Supply increases.
4. Seller's Expectations
* Future price increase expectation → Current supply decreases (stockpiling).
* Future price decrease expectation → Current supply increases (selling before prices drop).
5. Substitute of substitute Goods (seller perspective )
* Price of substitute product (coffee)Increase → Decrease in Qty Supplied for our product (pepper)- Inverse Relation
* Sellers may shift their resources to produce substitute goods of substitutes, depending on profitability and market demand.
Example: If the price of tea (a substitute for coffee) rises, sellers might focus on tea, reducing supply for coffee
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Market Equilibrium
The point where market demand equals market supply, It occurs where the demand curve intersects with the supply curve.
31
Equilibrium Price (Pᴇ):
Price where demand equals supply.
Equilibrium Quantity (Qᴇ): Quantity exchanged at equilibrium price.
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Efficient Resource Allocation:
Supply and demand balance production and consumption.
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Balanced Market:
All goods produced are purchased, meeting demand.
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Market Conditions & Price Adjustments
1. Excess Demand (Shortage): .
: Quantity Demanded > Quantity Supplied -
Effect: Price rises as consumers compete for limited goods
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2. Excess Supply (Surplus)::
Quantity Supplied > Quantity Demanded -
Effect: Price falls as producers reduce prices to sell surplus.
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3. Equilibrium:
: Quantity Supplied = Quantity Demanded -
Effect: Prices stabilize.
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Other factors influencing price include:
* Market Structure: Competitive, monopolistic, oligopolistic, or monopolistic competition.
* Product Differentiation: Features that make a product unique compared to competitors.
* Customer Perceptions: Value perceived by customers in the product/service.
* Competitor Actions: Pricing or promotional strategies of competitors.
* Elasticity of Demand: Sensitivity of consumers to price changes.
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market equilibrium in the short run
Quantity supplied equals quantity demanded at a given price, influenced by fixed factors.
Prices may fluctuate due to immediate supply and demand shocks.
Limited adjustments; can lead to temporary shortages or surpluses.
Rapid changes due to market forces; equilibrium can shift quickly.
Variable profit margins depending on immediate conditions.
Firms may experience losses or gains; varying market participation.
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market equilibrium in the long run:
Quantity supplied equals quantity demanded after all adjustments, leading to stable prices.
Prices are more stable as firms adjust capacity to meet demand.
Full adjustments; fewer shortages or surpluses as firms expand or contract.
Longer adjustments allow for new firms to enter or exit the market.
Stabilized profit margins as firms reach normal profit levels.
Efficient resource allocation as firms exit if costs are not covered.
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The shutdown price is the
price at which a firm’s total revenue just covers its average variable cost (AVC) only, but does not contribute to fixed costs.
* Price ≥ AVC: The firm continues production to cover some fixed costs. Price < AVC: The firm shuts down to minimize losses, as variable costs cannot be covered.
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1. Perfect Competitive
Market (Myth) Large number of sellers and buyers,
price taker,
perfect information, homogeneous products,
free entry/exit
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2. Monopoly
Single seller,
unique products,
high barriers to entry,
price maker
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3. Oligopoly
Few sellers,
large number of buyers, homogeneous or slightly differentiated products, interdependence between sellers
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4. Monopolistic Competition
Large number of sellers, differentiated products, branded products,
free entry/exit,
some control over price, brand monopoly
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Demand Curve
Perfect Competition Monopolistic Competition Oligopoly
Monopoly
Perfectly elastic horizontal line), meaning AR = MR = P.
Downward-sloping, relatively elastic
Kinked (if price rigidity) or downward-sloping
Downward-sloping, inelastic
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Profit Maximization:
Perfect Competition Monopolistic Competition Oligopoly
Monopoly
Firms maximize profit where MC = MR (price equals marginal cost in the long run).
Firms maximize profit where MR = MC, but price will be above marginal cost due to differentiation.
Firms maximize profit where MR = MC, but often in a kinked demand curve environment (price rigidity).
Monopolist maximizes profit by producing at the quantity where MR = MC, then setting the price using the demand curve.
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Law of Diminishing Marginal Product (Law of Diminishing Returns)
adding more units of a variable input (e.g., labor) to a fixed input (e.g., machinery) will initially increase output, but after a certain point, the additional output will decrease. Negative Returns: Too many inputs can overcrowd, reducing total output.
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Marginal Cost (MC)
Initially decreases, then rises as each additional input adds less output, increasing cost per unit.
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Average Cost (AC)
Forms a U-shape: falls at first, then rises as efficiency declines and per-unit costs increase.
50
Price
Likely to increase as rising production costs are passed to consumers.
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Demand
May decrease if higher prices reduce consumer willingness to buy.
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Marginal Revenue Curve
* Perfect Competition: MR = Price; firms sell any quantity at market price.
* Monopoly: MR < Price; selling more requires lowering the price.
53
Why MR < Price in Monopoly:
1. Selling extra units needs a price drop.
2. Price drop reduces revenue on all units sold.
3. MR curve lies below the demand curve due to this revenue loss.
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1. Profit Maximizing Point:
MR = MC. : Producing beyond this point reduces profit since costs exceed revenue for extra units.
* MR > MC: Produce more to increase profit.
* MR < MC: Reduce production to avoid losses.
MR = MC: Optimal production level for maximum profit.
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Short-Run Equilibrium Price:
The price at which quantity demanded equals quantity supplied in the short run, determined by market demand and supply.
* In perfect competition, MR = Price, so MC = Price is the optimal production point.
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1. Outcomes Based on Price:
* Profit: Price > Average Total Cost (ATC).
* Break-Even: Price = ATC (zero economic profit).
* Loss: ATC > Price ≥ Average Variable Cost (AVC).
* Shut-Down Point: Price < AVC, firms stop production to avoid greater losses.
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Equilibrium Pricing in Perfect Competition
* Horizontal Demand Curve: Firms face perfectly elastic demand at the market price.
* Profit Maximization Rule: Firms produce where MC = MR to maximize profit.
* Short-Run Economic Profit: Firms can earn positive economic profit if Price > ATC.
* Long-Run Normal Profit: Free market forces ensure that Price = ATC, leading to zero economic profit.
* Economic Profit: In the short run, firms can achieve positive profit if Price > ATC.
Short run. : P = AR = MR = MC
Short Run:
* Condition: P=AR= MR not equal to ATC
* Profit Maximization Rule: Produce where MC=MR.
* Outcome: Firms can earn economic profit if P>ATC.
Long Run:
* Condition: P=AR=MR=MC=ATC
* Profit Maximization Rule: Market adjustments ensure P=ATC.
* Outcome: Firms earn zero economic profit (normal profit)
At profit maximization point P = AR = MR = MC = ATC. Profit = 0
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Equilibrium Pricing in a Monopoly
1. Price Control:Monopolists face a downward-sloping demand curve and set prices accordingly.
* Marginal Revenue (MR) lies below the demand curve as price reductions apply to all units sold.
2. Profit Maximization:
* Output is set where MR = MC (Marginal Cost).
* Price is determined by extending this output line to the demand curve.
3. Outcomes Compared to Perfect Competition:
* Higher Prices: Monopolists charge more.
* Lower Output: Produces less than socially optimal levels.
* Limited Consumer Choice: Only one supplier.
4. Economic Profit:
* Formula: (Price - Average Total Cost) × Quantity. Includes explicit and implicit costs.
5. Long-Term Sustainability: Monopolists maintain profits due to high entry barriers.
6. Economic Inefficiency:
* Prices exceed marginal cost, leaving some demand unmet.
* Creates deadweight loss, reducing overall welfare.
7. Key Insights:
* Demand (AR) and MR Curves: Both slope downward; MR is below AR.
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Monopolistic market:
Short Run:
* Condition: Firms can earn economic profit if P > ATC.
* Profit Maximization where MR = MC.
Long Run:
* Condition: Free entry and exit drive firms toward normal profit.
* Profit Maximization Rule: Firms still produce where MR = MC, but new firms enter if profits exist, reducing demand for each firm.
* Outcome: In the long run, P = ATC, meaning firms earn zero economic profit (normal profit).
4. Economic Profit Calculation: Economic Profit=(P−ATC)×Q
* In the short run, firms can earn economic profit.
* In the long run, new firms enter, reducing individual demand, leading to zero economic profit.
5. Inefficiency in Monopolistic Competition:
* Excess Capacity: Firms do not produce at the lowest ATC, leading to inefficiency.
* Higher Prices: Prices are higher than in perfect competition due to differentiation and brand loyalty.
* Advertising Costs: Firms spend significantly on marketing, increasing costs.
* Product Variety vs. Inefficiency: While differentiation offers consumer choices, it also creates inefficiencies compared to perfect competition.
6. Summary:
✅ Many firms compete with differentiated products.
✅ Firms have some price control but face competition.
✅ Short run: Firms can earn economic profit if P > ATC.
✅ Long run: Entry of new firms leads to zero economic profit (normal profit).
✅ Firms do not produce at the lowest ATC, causing inefficiency but offering product variety.
* leading to less consumer and producer welfare compared to competitive markets.
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Oligopoly Market
* Few Sellers: A small number of firms dominate the market.
* Interdependence: Firms’ pricing and output depend on competitors’ actions.
* Product Types: Can be homogeneous (e.g., steel) or differentiated (e.g., cars).
* High Barriers to Entry: New firms face significant challenges entering the market.
Pricing Dynamics
* Kinked Demand Curve: Firms avoid price increases but may match price drops.
* Sticky Prices: Prices tend to remain stable to prevent price wars.
Competition Strategies
* Non-Price Competition: Focus on advertising and product differentiation.
* Collusion: Firms may attempt to form cartels or price-fixing agreements, though often illegal.
Profitability
* Short Run: Firms can earn or lose profits.
* Long Run: High barriers to entry protect long-term profits.
Oligopolies are dominated by few firms, with pricing based on competitors' actions and strategies to maintain stable prices and profits.
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Kinked Demand Curve in Oligopoly
* Above the Kink (Elastic): Price increases aren’t matched by competitors, leading to a significant loss of market share.
* Below the Kink (Inelastic): Price decreases are matched by competitors, resulting in only small gains in market share.
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Internal Factors Affecting Pricing
1. Marketing Objectives: Goals like profit maximization or market leadership. Example: Premium pricing for high-end products.
2. Marketing Mix: Control costs (target costing) and balance price with quality.
3. Costs: Prices must cover fixed and variable costs.
4. Organizational Structure: Pricing authority depends on company hierarchy
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External Factors Affecting Pricing
1. Market and Demand: Market structure and consumer perception of value.
2. Competitors' Activities: Prices should remain competitive.
3. Other Factors: Economic conditions, regulations, and ethical pricing.
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Six Steps to Set Pricing Policy
1. Select Pricing Objective: Align with goals like profit maximization or survival.
2. Analyze Demand: Assess market needs and demand elasticity.
3. Estimate Costs: Calculate total costs to set a price baseline.
4. Study Competitors: Analyze competitor prices and strategies.
5. Determine Pricing Method: Choose between cost-based, value-based, or competition-based pricing.
6. Decide Final Price: Set price based on objectives, costs, and market feedback.
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General Pricing Approaches
* Profitability: Price must be above the cost floor.
* Demand: Price should stay below the ceiling (customer's perceived value).
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Three Pricing Approaches
1. Cost-based: Price determined by adding a markup to costs.
2. Value-based: Price based on customer perception of value.
3. Competition-based: Price influenced by competitors' pricing.
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1. Cost-Based Approaches
* Starts with: Product cost. Ends with: Customers' perceived value.
* Process: Design product → Calculate total costs → Add profit margin → Set price.
1. Convince customers that the product is worth the price.
* Challenges: If the price is too high, demand may drop, lowering profits. High price = Fewer sales; Low price = Lower margins.
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Methods Under Cost-Based Pricing:
Profit Margin: Percentage of Selling Price (SP).
Markup: Percentage of Cost.
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1. Cost-Plus Pricing:
Formula: Cost + Fixed Profit Margin = Price. Or % of selling price
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2. Markup Pricing (% of cost)
1. Markup on Cost: Formula
:Price = Item Cost × (1 + Markup Percentage)
Markup % = cost other than the item cost+ Profit / Item Cost for example : VC = 80, to
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2. Markup on Selling Price:
Formula: Price = Item Cost ÷ (1 – Markup Percentage)
* Used for promotional reasons, as the percentage markup appears smaller compared to markup on cost.
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3. Break-Even and Target Profit Pricing
* Break-Even Pricing: Sets a price where total revenue equals total costs (no profit).
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* Target Profit Pricing:
Sets a price to achieve a desired profit level based on revenue and cost forecasts.
* Limitation: These methods do not consider price-demand relationships, so changes in price can impact sales volumes unexpectedly.
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* Cost Plus Target Rate of Return :
Price = Total Cost + (Target Rate of Return × Investment)
The Cost-Plus Target Rate of Return pricing method adds a specific target rate of return to the total cost of a product.
It ensures that the price not only covers the costs but also achieves the desired return on investment (ROI).
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Advantages of Cost-Based Pricing Strategies
* Simple to use: Predetermined markup percentages save time.
* Fair pricing perception: Ensures sellers earn fair ROI without exploiting demand spikes.
* Confidence in costs: Relieves sellers from adjusting prices based on fluctuating demand.
* Industry consistency: Minimizes price competition if all firms use this method.
* Adaptable to changes: Cost-plus contracts allow price adjustments for changing inputs.
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Limitations of Cost-Based Pricing Strategies
* Ignores demand and competition: Prices may not align with customer demand or competitor prices.
* Limited flexibility: Break-even and target profit pricing overlook the relationship between price and demand.
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2. Value-Based Pricing
sets prices based on customer perceptions rather than costs, focusing on the value customers assign to the product.
* Pricing Process: Customer Value → Price → Cost → Product
* Examples: Discounted versions, Everyday Low Pricing (EDLP), and High-Low Pricing.
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2. Value-Based Pricing
Benefits and Limitations :
Benefits:
* Maximizes profits by capturing the highest price customers are willing to pay.
* Appeals to customers seeking good quality at fair prices.
Limitations: Does not consider production costs, risking unsustainable pricing if costs are high.
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3. Competition-Based or Market-Based Approaches to Pricing
* Going-Rate Pricing: Set prices based on competitors' prices; often used in homogeneous industries.
* Provides price stability and consumer clarity., Going-Rate Pricing: Limits flexibility in responding to market changes.
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* Bidding: *
Open Bidding: Competitors submit visible bids, often lowering prices incrementally.
Sealed Bidding: Competitors submit hidden bids, balancing profitability and competitiveness.
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Bidding : Benefits and Limitations
Benefits: Bidding: Fair process for buyers, ensuring no collusion among bidders. Limitations:Bidding: Limited information for bidders can lead to suboptimal pricing.
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Target Pricing and Costing
1. Process: Set Target Price and Projected Sales → Define Target Operating Income → Calculate Target Cost per Unit → Calculate Current/Estimated Cost → Perform Value Engineering and Cost Reduction
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Target Pricing and Costing: Benefits:
Optimizes costs. Limitations: External factors can affect pricing.
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Value Engineering:
*
Goal: Reduce unnecessary costs while improving efficiency.
* Value-Added Costs: Essential, cannot be removed.
* Non-Value-Added Costs: Can be minimized.
The main goal of value engineering is to eliminate non-value-added costs and make value-added activities more efficient.
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Price Adjustment Strategies
* Cash Discounts: Incentives for early payment (e.g., 2/10, net 30).
* Volume Discounts: Lower unit costs for bulk purchases; must be equally offered.
* Seasonal Discounts: Off-season price reductions to stabilize sales.
* Trade Discounts: Price cuts for distributors performing tasks, uniformly applied within channels.
* Allowances: Incentives for trade-ins, upgrades, or promotional participation. Price reductions for specific buyer actions
* Trade-In Allowance: Discount for returning old items. (Exchange sales)
* Promotional Allowance: Incentives for retailers promoting the product.
Study Unit 16: C.3. New Product and Product Mix Pricing
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* Cash Discounts:
Incentives for early payment (e.g., 2/10, net 30).
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* Volume Discounts:
Lower unit costs for bulk purchases; must be equally offered.
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* Seasonal Discounts:
Off-season price reductions to stabilize sales.
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* Trade Discounts
: Price cuts for distributors performing tasks, uniformly applied within channels.
* Allowances: Incentives for trade-ins, upgrades, or promotional participation. Price reductions for specific buyer actions
* Trade-In Allowance: Discount for returning old items. (Exchange sales)
* Promotional Allowance: Incentives for retailers promoting the product
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1. Market Penetration Pricing:
Maximize market share quickly by setting a low initial price.
* Best When: Market is price-sensitive, demand is elastic, and low pricing is sustainable.
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2. Market Skimming:
Maximize profit from early adopters by setting a high initial price.
* Process: Start with high prices for tech-savvy or enthusiastic buyers., Gradually lower prices as demand decreases and competitors enter the market.
* Best When: Product is unique or innovative, and demand is less price-sensitive.
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1. Product-Line Pricing:
Set different price points within a product line based on features and quality. A product line is a range of products that are intended to meet similar needs of different target audiences. The products within the product line are related but may vary in style, colour and quality.
* Example: Soap priced at $10, $25, $50, and $100 based on quality.
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2. Optional-Product Pricing:
Offer optional features or add-ons at additional costs. Example: Basic computer with optional upgrades (e.g., memory, processors).
* Challenge: Deciding which features to include as standard and which as optional.
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3. Captive-Product Pricing:
Sell a primary product at a low price and charge premium prices for its essential consumables. Eg: Low-cost printers but expensive ink cartridges. Focus: Profit from captive products rather than the primary product.
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4. By-Product Pricing:
Sell production by-products to reduce costs.
* Example: Steel manufacturers selling by-products as raw materials. Key: Price above delivery costs and support environmental responsibility.
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5. Product-Bundle Pricing:
Combine products or services into a bundle at a discounted rate.
* Example: Software suites offered at a lower price than individual programs.
* Pure Bundling: Customer can only buy the bundle. Mixed Bundling: Customer can choose between the bundle or individual items (higher per-unit price).
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Short-Term Pricing
VS
Long-Term Pricing :
Pricing Objective
Pricing Objective Maximize contribution margin (price above variable costs).
Set profit margins to ensure return on investment.
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3. Calculate Target Cost per Unit:
Formula: Target Cost = Target Price - Target Operating Income per Unit
Includes all variable and fixed costs over the product's lifetime. Target pricing takes into consideration a product’s entire lifecycle.
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* Locked-In Costs:
Early-stage costs (e.g., material and design) that are difficult to change later.
Value Engineering: * Focus on reducing locked-in costs through design improvements and supplier negotiations.
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Key Concept: Cost-Plus Target Rate of Return Steps:
1. Determine Desired Return on Investment (ROI):
ROI = Annual Desired Operating Income ÷ Total Invested Capital (e.g., total assets).
2. Calculate Target Operating Income for Product: Target Operating Income = Capital Invested in Product × Desired ROI.
3. Determine Target Operating Income Per Unit: Target Operating Income Per Unit = Target Operating Income ÷ Expected Sales Units.
4. Set Price Per Unit: Price = Full Cost Per Unit + Target Operating Income Per Unit.
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Cost-Plus Target Rate of Return:
Key Considerations:
* Avoid Downward Demand Spiral: Do not include unused fixed asset costs in production cost to avoid inflated pricing that reduces demand.
* Simplified Practice: Companies often estimate a markup percentage instead of calculating ROI for individual products.
* Markup depends on market competition:High competition → Lower markups and profit margins.
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Cost-Based Pricing and Market-Based Pricing Together
1. Initial Pricing: Cost-based pricing sets a baseline (e.g., $950/unit).
2. Market Feedback: Adjust prices based on customer and competitor responses (e.g., reduce to $850/unit).
3. Profit Adjustments: Price cuts may reduce per-unit income (e.g., $50 instead of $150).
4. Adapt Strategies: Companies may:
* Reduce costs (e.g., value engineering).
* Redesign products to lower expenses.
* Accept lower profit margins if needed.
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Product Life Cycle Pricing
Brands, products, and technologies all have life cycles. Managers using target pricing and target costing often incorporate the product’s life cycle in estimating costs.
from research and development (R&D) to discontinuation. Life Cycle Costing (or "cradle-to-grave costing") tracks costs across all value chain phases.
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Stages of the Product Life Cycle:
1. Product Development: 2. Introduction: 3. Growth: 4.Maturity 5. Decline:
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Introduction
Slow sales growth.
- High costs for R&D, promotion, and distribution.
Revenues Low or negative.
Profitability Negative due to high initial expenses.
Cash Flow Negative due to high expenses and low sales.
Pricing - High prices to recover costs.
- Low prices for penetration strategy.
Competition Limited; few or no rivals.
Goal Build a foundation for growth and future profitability.
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Growth
- Rapid sales growth.
- Competitors enter with rival products.
- Positive publicity and word of mouth.
Revenues
Rapidly increasing.
Profitability
Increasing as sales volume grows.
Cash Flow
Low or negative due to growing production costs, inventory needs, and receivables.
PRICING:
- Maintain high prices for premium demand.
- Reduce prices strategically to capture market share.
Intensifying as new entrants introduce alternatives.
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Maturity
Sales peak; growth slows.
- Stable inventories and receivables.
- Decreasing product differentiation.
- Potential overcapacity.
REVENUE : Slowing rate of sales increase.
PROFITABILITY : High but declining due to competition and higher promotion costs.
CASH FLOW : Peak due to stable inventories and receivables.
PRICING : - Lower prices due to competition.
- Use price adjustments to remain competitive.
COMPETION : Intense; weaker competitors exit.
- Prices stabilize among remaining firms.
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Decline
Sales decline sharply.
- Increased price competition.
- Alternative products dominate.Falling demand.
Sales peak; growth slows.
- Stable inventories and receivables.
- Decreasing product differentiation.
- Potential overcapacity.
REVENUE :Declining sharply.
PROFITABILITY : Low or negative as margins shrink.
.
CASH FLOW : Temporary positive cash flow from inventory liquidation.
PRICING : - - Reduce prices to liquidate inventory.
- Maintain steady pricing for niche markets.
COMPETION : Competitors exit or consolidate; remaining suppliers dominate niche markets.
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Customer Life Cycle Product Costs:
Evaluates the total ownership cost (purchase, usage, maintenance, disposal) from the customer’s perspective.
Key Points:
* Focuses on lifetime cost, not just purchase price.
* Justifies higher prices with long-term savings. Highlights the product's overall value over competitors.
Benefits: Builds loyalty by proving cost efficiency., Supports premium pricing for lower life cycle costs.
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Price Discrimination;
Charging different prices for the same product or service based on customer flexibility.
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Peak-Load Pricing / off-peak pricing :
Prices vary based on demand fluctuations., High prices during peak demand (e.g., travel, utilities).
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Dumping
Selling products in foreign markets at prices below production cost or domestic market price.
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Predatory Pricing
Pricing below production costs to drive competitors out of the market.
* Leads to monopoly pricing once competitors are eliminated. * Reduces competition and can harm market fairness.
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Anticompetitive Pricing
Discriminatory pricing across state lines, which is known as “interstate commerce.” (Robinson - Patman Act makes it illegal).
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Collusive Pricing
Companies agree to fix prices or limit output, creating artificial price levels.* Reduces competition and leads to higher prices for consumers.
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Cartels:
Groups of suppliers formally agreeing to control prices or output. Cartels are illegal in the U.S
* Example: Assigning exclusive territories or limiting supply to drive up prices.
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Secret Collusion:
Informal agreements without explicit contracts but still manipulating prices (e.g., coordinated bids for government contracts). creating a de facto cartel - illegal, - often aranged without an explicit contract
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Qualitative Factors in Business Decision Analysis
1. Employee Morale and Labor Relations
* Positive: Adding break rooms or benefits.
* Negative: Eliminating bonuses or benefits.
2. Scheduling and Internal Considerations
* Challenges in production scheduling for product-mix changes.
* Lack of employee skills for reassigned roles.
3. Supplier Relationships and Commitments
* Long-term supplier relationships may be affected by switching suppliers.
* Risks with new suppliers: lower quality or unreliable deliveries.
4. Customer Impact and Loyalty
* Negative: Diverting production could lead to loss of regular customers.
* Risks of discounted special orders damaging relationships with other customers.
5. Company Reputation
* Protecting consumer safety and maintaining a positive image.
* Addressing public perception issues.
6. Worker Safety: Prioritizing safety improvements, even if it temporarily reduces profitability.
7. Social Impact and Public Reaction: Factory closings, layoffs, or outsourcing may provoke public backlash, especially if jobs move abroad.
8. Creditor Perceptions : Opening or closing locations may affect creditors’ trust and credit decisions.
9. Quality Considerations : Lower-cost options might reduce quality or delay production, risking business losses.
10. Investor Reactions : Public perception changes could influence stock price and investor confidence.
11. Community Impact: Positive contributions like employee involvement in community projects.
12. Branding Importance: Investments in branding may lower short-term profits but prevent long-term damage.
13. Competitive Position: Raising prices might hurt competitiveness, but improved production speed or delivery times could enhance it.
14. Legal Constraints: Compliance with laws, such as pollution-control requirements.
15. Technological Investments : Reduced product development time from new equipment or software.
16. Customer Service Improvements: Adding customer support staff could enhance service quality.
17. Product and Service Quality Enhancements: Spending to improve quality may reduce short-term profits but increase long-term gains.
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