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Chapter 12

Pricing
Determination

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McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All right
 Chapter Goals
• What is Price?
• Significance of price in the economy/consumer/firm
• Concept of value and relation to price
• Pricing objectives
• Factors influencing Price
• Types of Costs
• Approaches to determine price
• Break-even Analysis

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McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All right
 Price
• The amount of money charged for a product
or service, or the sum of the values that
customers Pay/exchange for the benefits of
having or using the product or service.
 Significance of price in the economy/consumer/firm

• Importance in Economy:

• If there’s too much product supply, prices go down,

and producers respond by making less. If there’s not
enough of a product to meet demand, prices rise.
• Accordingly, producers make more of the product
until there’s enough for everyone.
• Thus, price plays a critical role in establishing an
equilibrium between supply and demand.
 Significance of price in the economy/consumer/firm

• Importance in Consumer Mind:

• Price Perception: Refers to how consumers perceive the price of a

product or service.
• It involves their subjective evaluation of whether the price is high,
low, fair, or expensive based on their expectations, past
experiences, and value perception.
• Price-Quality Inference: Describes the tendency of consumers to
associate higher prices with higher quality.
• When consumers encounter a higher-priced product, they often
assume it offers better features, performance, or durability
compared to lower-priced alternatives.
 Significance of price in the economy/consumer/firm

• Importance in Consumer Mind:

• Price Fairness: Refers to consumers' perception of whether the
price they are paying for a product or service is fair in relation to its
perceived value. Fair pricing is important for building trust,
maintaining positive customer relationships, and enhancing brand
reputation.

• Price Promotions and Discounts: Involves temporary reductions

in the price of a product or service to stimulate demand and
encourage consumer purchases. Price promotions and discounts
can attract new customers, increase sales volume, and create a
sense of urgency to buy.
 Significance of price in the economy/consumer/firm

• Importance in Consumer Mind:

• Price Sensitivity: Represents the degree to which

consumers are responsive to changes in price. Price-sensitive
consumers are more likely to consider price as a key factor in
their purchase decisions and may switch brands or delay
purchases based on price fluctuations.
 Pricing Objectives
1: profit-oriented pricing objectives

A profit-oriented pricing objective means that a company

seeks to earn maximum profit with every sale or service
provided and achieve long-term business profitability.

2: Sales-oriented pricing objectives

• seek to boost volume or market share.

• A volume increase is measured against a company's

own sales across specific time periods.
• A company's market share measures its sales against
the sales of other companies in the industry.
 Pricing Objectives
3: Status quo—objectives
• seeks to keep your product prices in line with the same or
similar products offered by your competitors to avoid starting
a price war or to maintain a stable level of profit generated
from a particular product.
 Factors influencing Price Determination

The factors are:

1: Demand:
• The market demand of a product has an impact on the price of
the product, if the demand is inelastic then a higher price can be
fixed, if the demand is highly elastic then less price is to be
fixed.
• When the demand for the goods is more and the supply of the
goods is constant, the price of the goods can be increased and
if the demand for the goods decreases the price of the goods
should be decreased to survive in the market.
 Factors influencing Price Determination

The factors are:

2: Competition:
• The prices are required to be competitive without any
compromise on the quality of the product.
• While in a monopolistic market, the prices are fixed irrespective
of the competition.
• Thus, the manufacturer tries to estimate the price of his
competitor.
• When the price of the supplementary goods is high, the
customers will buy the manufacturer’s product. .
 Factors influencing Price Determination

The factors are:

3: Marketing Mix:
• Product

• Distribution Channels

• Promotion
 Factors influencing Price Determination

The factors are:

4: Cost of a Product:
• The costs of the product—its inputs—including the amount
spent on product development, testing, and packaging
required have to be taken into account when a pricing
decision is made.
• So do the costs related to promotion and distribution.
 Factors influencing Price Determination

• Total costs include both fixed costs and variable costs.

• Fixed costs, or overhead expenses, are costs that a

company must pay regardless of its level of production or
level of sales.
• A company’s fixed costs include items such as rent, leasing
fees for equipment, contracted advertising costs, and
insurance.
• Variable costs are costs that change with a company’s level
of production and sales. Raw materials, labor, and
commissions on units sold are examples of variable costs.
 Cost plus pricing

• Cost-plus pricing is a basic pricing strategy that involves

determining the cost of goods or services, and then adding a
fixed percentage (the margin) as the markup.
• For example, if your total costs are $100 and you want a 20%
profit margin, you would add $20 to arrive at a selling price of
$120.
• Also known as “markup pricing,” this approach is used by
many businesses because it is a straightforward way to
calculate prices.
 Marginal-cost pricing,
• Marginal-cost pricing,

• in economics, the practice of setting the price of a product to equal the

extra cost of producing an extra unit of output.
• By this policy, a producer charges, for each product unit sold, only the
addition to total cost resulting from materials and direct labour.
• Businesses often set prices close to marginal cost during periods of poor
sales.
• If, for example, an item has a marginal cost of $1.00 and a normal selling
price is $2.00, the firm selling the item might wish to lower the price to
$1.10 if demand has waned.
• The business would choose this approach because the incremental profit
of 10 cents from the transaction is better than no sale at all.
 Pricing by middlemen

• As goods exchange hands from one middleman to the other,

their prices inflate. A higher price is charged at each junction
to cover the cost of warehousing, insurance, transportation,
advertising, etc.
 Break-Even Analysis

• A break-even analysis is an economic tool that is used to

determine the cost structure of a company or the number of
units that need to be sold to cover the cost. Break-even is a
circumstance where a company neither makes a profit nor a
loss but recovers all the money spent.
• To calculate the break-even point in units use the formula:
Break-Even point (units) = Fixed Costs ÷ (Selling price –
Variable costs)
 Prices set in relation to market alone

• Pricing to meet competition:

• A simple definition of competitive pricing is when you create

product prices based on the prices being offered by your
competitors.
• Below the competition (loss leader pricing)

• Intentionally setting prices below competitor selling prices

(also known as loss leader pricing) can effectively grow
market share and revenue in the short term.
 Prices set in relation to market alone

• Pricing to meet competition: A simple definition of

competitive pricing is when you create product prices based
on the prices being offered by your competitors.
• Below the competition (loss leader pricing): Intentionally
setting prices below competitor selling prices (also known as
loss leader pricing) can effectively grow market share and
revenue in the short term.
• Pricing above the competition: Offering products or
services priced superior to your competitors. It is usually
done when you feel the products or services you offer are a
notch above your competitors.