WEEK 3|Firm level strategies and performance data:

Question 1

What is pricing?

Answer 1

Pricing is a market and cost consideration.

Question 2

What are the factors affecting pricing?

Answer 2

1. Orgnaizational and marketing objectives
2. pricing objectives
   3.costs
3. other marketing mix variables
4. Channel member expectations
5. customer interpretation and response
6. Competition
7. Legal and regulatory issues

Question 3

What are some of the pricing strategies?

Answer 3

Marketing
Skimming
* Value Pricing
* Loss Leader
* Psychological
Pricing
* Going Rate (Price
Leadership)
* Tender Pricing
* Price
Discrimination
* Penetration Pricing
Cost Plus Pricing
* Contribution Pricing
* Target Pricing
* Destroyer Pricing
* Marginal Cost Pricing
* Absorption Cost Pricing

Question 4

What is Market Skimming Pricing?

Answer 4

High Price low volume
* Skim the Profit from the Market
* Suitable for the products that have
short life cycle or Which will face
competition at some point in future.
* Examples; Play Station, Digital
Technology & DVD etc.

Question 5

What is value pricing?

Answer 5

Based on consumer Perception.
* Price charged according to the
Customers Perception.
* Price set by the company as per the perceived value.
* Example; Status Products/ Exclusive Products

Question 6

What is loss leader pricing?

Answer 6

Goods/services deliberately sold below cost to encourage sales elsewhere
* Typical in supermarkets, e.g. at Diwali, selling sweets at lower prices in the hope that people will be attracted to the store and buy other things
* Purchases of other items more than covers ‘loss’ on item sold
* e.g. ‘Free’ mobile phone when taking on contract package

Question 7

What is Psychological Pricing?

Answer 7

Used to play on consumer
perceptions
* Classic example – Rs. 9.99
instead of Rs.10.99!
* Links with value pricing – high
value goods priced according to
what consumers THINK should
be the price

Question 8

What is going rate pricing?

Answer 8

In case of price leader, rivals have difficulty in competing on price –
too high and they lose market share, too low and the price leader
would match price and force smaller rival out of market
* May follow pricing leads of rivals especially where those rivals
have a clear dominance of market share
* Where competition is limited, ‘going rate’ pricing may be applicable
– banks, petrol, supermarkets, electrical goods – find very similar
prices in all outlets

Question 9

What is tender pricing?

Answer 9

Many contracts awarded on a
tender basis
* Firm (or firms) submit their price
for carrying out the work
* Purchaser then chooses which
represents best value
* Mostly done in secret

Question 10

What is price discrimination?

Answer 10

Charging a different price for the
same good/service in different
markets
* Requires each market to be
impenetrable
* Requires different price elasticity of demand in each market
* Prices for air travel differ for the
same journey at different times of the day

Question 11

What is penetration pricing?

Answer 11

Price set to ‘penetrate the market’
* ‘Low’ price to secure high
volumes
* Typical in mass market products – chocolate bars, food stuffs,
household goods, etc.
* Suitable for products with long
anticipated life cycles
* May be useful if launching into a
new market

Question 12

What is cost-plus pricing?

Answer 12

Cost-plus pricing is a pricing
strategy that is used to maximize
the rates of return of companies.
* Cost-plus pricing is also known as
mark-up pricing where cost +
mark-up = selling price.
* In practice, most firms use either
value- based pricing or cost-plus
pricing.

Question 13

What is contribution pricing?

Answer 13

Contribution = Selling Price –
Variable (direct costs)
* Prices set to ensure coverage of
variable costs and a ‘contribution’
to the fixed costs
* Similar in principle to marginal
cost pricing
* Break-even analysis might be
useful in such circumstances

Question 14

What is target pricing?

Answer 14

Setting price to ‘target’ a specified profit
level
* Estimates of the cost and potential revenue at
different prices, and thus the break-even have
to be made, to determine the mark-up
* Mark-up = Profit/Cost x 100

Question 15

What is marginal cost pricing?

Answer 15

Marginal cost – the cost of producing ONE extra or ONE fewer item of production
* MC pricing – allows flexibility
* Particularly relevant in transport where fixed costs may be relatively high
* Allows variable pricing structure – e.g. on a flight from London to New York – providing the cost of the extra passenger is covered, the price could be varied a
good deal to attract customers and fill the aircraft

Question 16

What are absorption cost pricing?

Answer 16

Full Cost Pricing – attempting to set
price to cover both fixed and variable
costs
* Absorption Cost Pricing – Price set to ‘absorb’ some of the fixed costs of production

Question 17

What is destroyer pricing?

Answer 17

Deliberate price cutting or offer of ‘free gifts/products’ to force rivals (normally smaller and weaker) out of business or prevent new entrants
* Anti-competitive and illegal if it can be proved

Question 18

What is FInancial Analysis?

Answer 18

Assessment of the firm’s past, present and future financial
conditions
* Done to find firm’s financial strengths and weaknesses

Question 19

What are the primary tools for financial analysis?

Answer 19

• Financial Statements
• Comparison of financial ratios to past, industry, sector and
  all firms

Question 20

What are some of the financial statements?

Answer 20

*Balance Sheet
*Income Statement
*Cashflow Statement
* Statement of Retained Earnings

Question 21

What are the objectives of Ratio Analysis?

Answer 21

Standardize financial information for comparisons
* Evaluate current operations
* Compare performance with past performance
* Compare performance against other firms or industry standards
* Study the efficiency of operations
* Study the risk of operations

Question 22

What is being measured in ratio analysis?

Answer 22

1. Liquidity – the ability of the firm to pay its way
2. Investment/shareholders – information to enable decisions
   to be made on the extent of the risk and the earning
   potential of a business investment
3. Gearing – information on the relationship between the
   exposure of the business to loans as opposed to share capital
4. Profitability – how effective the firm is at generating profits
   given sales and or its capital assets
5. Financial – the rate at which the company sells its stock and
   the efficiency with which it uses its assets

Question 23

What is Acid Test?

Answer 23

Also referred to as the ‘Quick ratio’
* (Current assets – stock) : liabilities
* 1:1 seen as ideal
* The omission of stock gives an indication of the cash the firm
has in relation to its liabilities (what it owes)
* A ratio of 3:1 therefore would suggest the firm has 3 times as
much cash as it owes – very healthy!
* A ratio of 0.5:1 would suggest the firm has twice as many
liabilities as it has cash to pay for those liabilities. This might put
the firm under pressure

Question 24

What is Current Ratio?

Answer 24

Looks at the ratio between Current Assets and Current
Liabilities
* Current Ratio = Current Assets : Current Liabilities
* Ideal level? – 1.5 : 1
* A ratio of 5 : 1 would imply the firm has Rs.5 of assets to
cover every Rs.1 in liabilities
* A ratio of 0.75 : 1 would suggest the firm has only 75p in
assets available to cover every Rs.1 it owes
* Too high – Might suggest that too much of its assets are
tied up in unproductive activities – too much stock, for
example?
* Too low - risk of not being able to pay your way

Question 25

What are some of the ratios for investment /shareholders?

Answer 25

Earnings per share – profit after tax / number of shares
* Price earnings ratio – market price / earnings per share – the
higher the better generally for company. Comparison with other
firms helps to identify value placed on the market of the business.
* EV / EBITDA Ratio - Enterprise Value / EBITDA ratio - the higher
the better generally for company . It measures the operational
performance of the firm.
* Dividend yield – ordinary share dividend / market price x 100 –
higher the better. Relates the return on the investment to the
share price.

Question 26

What is gearing ratio?

Answer 26

• Gearing Ratio = Long term loans / Capital employed x 100
• The higher the ratio the more the business is exposed to
  interest rate fluctuations and to having to pay back interest
  and loans before being able to re-invest earnings

Question 27

What are some of the profitability measures?

Answer 27

Profitability measures look at how much profit the
firm generates from sales or from its capital assets
*Different measures of profit – gross and net
* Gross profit – effectively total revenue (turnover) –
variable costs (cost of sales)
* Net Profit – effectively total revenue (turnover) – variable
costs and fixed costs (overheads)

Question 28

What is gross profit margin?

Answer 28

Gross Profit Margin = Gross profit / turnover x 100
* The higher the better
* Enables the firm to assess the impact of its sales and
how much it cost to generate (produce) those sales
*A gross profit margin of 45% means that for every £1
of sales, the firm makes 45p in gross profit

Question 29

What is net profit margin?

Answer 29

Net Profit Margin = Net Profit / Turnover x 100
* Net profit takes into account the fixed costs involved in
production – the overheads
* Keeping control over fixed costs is important – could be easy
to overlook for example the amount of waste - paper,
stationery, lighting, heating, water, etc.
* e.g. – leaving a photocopier on overnight uses enough electricity to make
5,300 A4 copies. (1,934,500 per year)
* 1 ream = 500 copies. 1 ream = Rs.5.00 (on average)
* Total cost therefore = Rs.19,345 per year – or 1 person’s salary

Question 30

What is Return on Capital Employed(ROCE)?

Answer 30

Return on Capital Employed (ROCE) = Profit / capital
employed x 100
* The higher the better
* Shows how effective the firm is in using its capital to
generate profit
* A ROCE of 25% means that it uses every £1 of capital to
generate 25p in profit
* Partly a measure of efficiency in organisation and use of
capital

Question 31

What is Asset Turnover ratio?

Answer 31

Asset Turnover = Sales turnover / assets employed
* Using assets to generate profit
* Asset turnover x net profit margin = ROCE

Question 32

What is stock turnover?

Answer 32

Stock turnover = Cost of goods sold / stock expressed as times
per year
* The rate at which a company’s stock is turned over
* A high stock turnover might mean increased efficiency?
* But: dependent on the type of business – supermarkets might
have high stock turnover ratios whereas a shop selling high
value musical instruments might have low stock turnover ratio
* Low stock turnover could mean poor customer satisfaction if
people are not buying the goods

Question 33

What is Debtor Days?

Answer 33

• Debtor Days = Debtors / sales turnover x 365
• Shorter the better
• Gives a measure of how long it takes the business to
  recover debts
• Can be skewed by the degree of credit facility a firm offers

Question 34

What are limitations of Ratio Analysis?

Answer 34

A firm’s industry category is often difficult to identify
* Published industry averages are only guidelines
* Accounting practices differ across firms
* Sometimes difficult to interpret deviations in ratios
*Industry ratios may not be desirable targets
* Seasonality affects ratios