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Essentials of Entrepreneurship and Small

Business Management

Eighth Edition

Section 3: Launching the Business

Chapter 10

Pricing and Credit

Strategies

Learning Objectives

10.1 Discuss the relationships among

pricing, image, competition, and

value.

10.2 Describe effective pricing

techniques for introducing new

products or services and for

existing ones.

10.3 Explain the pricing methods and

strategies for retailers,

manufacturers, and service firms.

10.4 Describe the impact of credit on

pricing.

Introduction

• Pricing:

– Is governed both by art and science.

– Requires balancing a multitude of complex forces.

– Influences every aspect of a small company.

– Is an important signal of value to customers.

– Involves both math and psychology.

– Has a greater impact on profits than corresponding

increases in unit volume or reductions in costs.

Figure 10.1 Impact of Pricing and

Cost Improvements on Profitability

Source: Based on Richard Hayes and Ranjit Singh, “CFO Insights: Pricing for Profitability:

What’s in Your Pocket?” Deloitte, 2013, http://www.marketingprofs.com/charts/2013/10839/62-

of-shoppers-use-mobile-devices-in-stores-to-compare-prices.

http://www.marketingprofs.com/charts/2013/10839/62-of-shoppers-use-mobile-devices-in-stores-to-compare-prices

Image, Competition, Value

• Companies that take a strategic approach to pricing and

monitor its results can raise their sales revenue between 1

and 8%

– Example: Duane Reade

Price Conveys Image

• Price sends important signals to customers: quality,

prestige, uniqueness, etc.

• Common small business mistake: charging prices that are

too low and failing to recognize extra value, service,

quality, and other benefits they offer.

• The key is to understand the target market and identify

how much customers are willing to pay rather than how

much to charge.

Competition and Pricing

• Must take into account competitors’ prices, but it is not

always necessary to match or beat them.

• Key is to differentiate a company’s products and services.

• Price wars often eradicate companies’ profits and scar an

industry for years.

• Best strategy: Stay out of a price war!

Figure 10.2 The Reality of Setting

Prices

Source: Based on data from William Dunkelberg and Holly Wade, “NFIB Small

Business Economic Trends,” National Federation of Independent Businesses,

October 2014, p. 8.

Focus on Value

• The “right” price for a product or service depends on the

value it provides for a customer.

• Two aspects of price:

– Objective value

– Perceived value: determines the price customers are

willing to pay.

• Value is not synonymous with low price.

– Fighter brand

Dealing with Rising Costs (1 of 2)

• Communicate with customers

• Add a surcharge

• Focus on improving efficiency

• Consider absorbing cost increases

• Eliminate discounts, coupons, and freebies

• Use cheaper raw materials

• Raise prices incrementally and consistently

Dealing with Rising Costs (2 of 2)

• Modify the product or service to lower its cost

• Offer products in smaller sizes or quantities

• Differentiate your company and its products and services

from the competition

• Anticipate rising costs and try to lock in prices of raw

materials early

• Emphasize the value of your company’s product or service

to customers

Figure 10.3 What Determines Price?

Introducing a New Product (1 of 2)

Three Goals:

1. Getting the product accepted

– Revolutionary products

– Evolutionary products

– Me-too products

2. Maintaining market share as competition grows

3. Earning a profit

Introducing a New Product (2 of 2)

Three basic pricing strategies:

1. Penetration

2. Skimming

3. Life cycle pricing

Pricing Established Goods (1 of 2)

• Odd pricing

• Price lining

• Freemium pricing

• Dynamic pricing

• Leader pricing

• Geographic pricing

• Discounts (markdowns)

Pricing Established Goods (2 of 2)

• Bundling

• Optional-product pricing

• Captive-product pricing

• By-product pricing

• Suggested retail prices

• Follow-the-leader pricing

Pricing Strategies: Markup

Dollar Markup = Retail price - Cost of the merchandise

Dollar markup Percentage (of retail price) markup =

Retail price

Dollar markup Percentage (of cost) markup =

Cost of unit

if a shirt costs $14, and a retailer plans to sell it for $30, the

markup would be as follows:

Dollar Markup = $30 $14 = $16

$16 Percentage (of retail price) markup = = 53.3%

$30

$16 Percentage (of cost) markup = = 114.3%

$14



Table 10.1 Costs and Markup Calculations

for I Pad and Surface Tablets Apple introduced the iPad years before Microsoft launched its Surface tablet and has a commanding

55 percent market share. Although both comparably equipped products sell for $599, Microsoft’s

Surface has a higher markup. The following table provides a cost breakdown for each device’s

components and its markup.

Component Surface I Pad

Memory 32 GB $34.00 $47.50

Display and touchscreen $101.00 $127.00

Processors $21.50 $23.00

Cameras $5.00 $12.35

User interface and sensors $20.00 $15.00

Power management device $8.00 $10.00

Lithium polymer battery $20.00 $32.00

Mechanical/Electromechanical components $36.00 $50.50

Box contents $25.00 $5.50

Box contents $13.00 $10.00

Total Cost $283.50 $332.85

Retail Price $599.00 $599.00

$ Markup = Price − Cost $315.50 $266.15

Percentage (of cost) markup = 111.3% 80.0%

Initial Dollar Markup and Retail Price

Operating expenses + Reductions + profit Initial dollar markup =

Net Sales + Reductions

Dollar cost Retail Price =

(1 Percentage of retail price markup)

Pricing for Manufacturers

• The most commonly used pricing technique for

manufacturers is cost-plus pricing:

– A manufacturer establishes a price that covers the cost

of direct materials, direct labor, factory overhead,

selling and administrative costs, and a desired profit

margin.

Figure 10.5 Cost-Plus Pricing

Components

Direct Costing and Pricing (1 of 2)

• Absorption costing:

– Traditional method of product costing in which all

manufacturing and overhead costs are absorbed into

the product’s total cost.

• Variable or direct costing:

– Product costing method that includes in the product’s

costs only those costs that can vary directly with the

quantity produced.

Break-Even Pricing

Break - even selling price =

Profit + (Variable cost per unit x Quantity produced) + Total fixed cost

Quantity produced

Direct Costing and Pricing (2 of 2)

• To establish a reasonable, profitable price for service,

small business owners must know the cost of materials,

direct labor, and overhead for each unit of service they

provide.

= productive hour

Price Total cost per hour (1 net profit as a % of sales)

Impact of Credit on Pricing

• 58% of small business owners say that their customers

expect them to accept credit cards.

– But, companies incur an additional cost to offer this

service.

• Three options for selling on credit:

– Credit (and debit cards)

– Installment credit

– Trade credit

Multiple Forms of Payment

Figure 10.6 Percentage of Customers Who Shop Only at Businesses

That Accept Multiple Forms of Payment

Source: Based on data from Small Business Payments Survey, WePay, June 23, 2013.

Consumer Credit (1 of 2)

• Credit cards: typical consumer has 3.75 credit cards.

– Research: Customers who use credit cards make

purchases that are 112% higher than if they had used

cash.

– On a typical $100 credit card purchase, cost to

business = $2.33.

▪ Interchange fee

Typical Credit Card Transaction Figure 10.7 How a Typical Credit Card Transaction Works

Source: Based on “Credit Card Processing,” Card Fellow, 2013, http://www.cardfellow.com/content/

credit-card-processing-guide.php#MoneyGo; “Credit Cards,” United States Government Accounting

Office, September 2006, pp. 73–74.

https://www.cardfellow.com/credit-card-processing-guide/#MoneyGo

E-Commerce and Credit Cards

• About 0.9% of online credit card transactions are fraudulent.

• To minimize credit card fraud:

– Use an address verification system

– Require a CVV2 number

– Check customers IP addresses

– Monitor Web site activity with analytics

– Verify large orders

– Post notices on Web site that your company uses anti-fraud

technology

– Contact the credit card company or bank that issued the

card

Consumer Credit (2 of 2)

• Debit cards

– Shoppers make almost 53 billion debit card transactions,

totaling $2.1 trillion each year.

• Mobile wallets:

– Applications that link a smart phone or tablet to a credit or

debit card, transforming the device into a digital wallet.

– Growing form of payment.

• Installment credit

• Trade credit

• Layaway

Conclusion

• Pricing techniques impact every aspect of a company

including:

– Image

– Customers

– Cash flow

– Profits