Week 9 Everything

Question 1

Pricing decisions

Answer 1

How companies price a product or service ultimately depends on the demand and supply for it.

Question 2

Three influences on demand and supply:

Answer 2

Customers – influence price through their effect on the demand for a product or service, based on factors such as quality and product features

Competitors – influence price through their pricing schemes, product features, and production volume

Costs – influence prices, because they affect supply (the lower the cost, the greater the quantity a firm is willing to supply).

Question 3

Balancing customers, competitors and costs:

The three different markets

Answer 3

Competitive markets

Less-competitive markets

Non-competitive markets

Question 4

Competitive markets

Answer 4

Companies have no control over setting prices and must accept the price determined by a market

Question 5

Less-competitive markets

Answer 5

Can use either the market-based or cost-based approach

Question 6

Non-competitive markets

Answer 6

Use cost-based approaches

Question 7

Various objectives that a company may pursue through its pricing policy:

1/2

Answer 7

Profit maximisation

Revenue maximisation

To maximise unit sales [to keep their production facilities
operating near capacity]

To utilise spare capacity

To gain the largest market share

Question 8

Various objectives that a company may pursue through its pricing policy:

2/2

Answer 8

To discourage market entry by competitors [Prices that produce only modest profits will often discourage competitors]

Survival

To create a perception of brand quality or exclusiveness

To create store traffic by slashing the price of a staple item [“loss leader” strategy brings people through the door]

To encourage trial purchases [to boost newly introduced products and services]

Question 9

Price elasticity of demand

Answer 9

When a business proposes to change the price of a product or service, the key question is “To what extent will demand be affected?” Price elasticity of demand measures the change in demand (of a product or service) as a result of a change in its price. Since the demand goes up when the price falls, and demand goes down when the price rises, the elasticity has a negative value. However, it is usual to ignore the minus sign.

Question 10

Price elasticity of demand (PED) =

Answer 10

Change in quantity demanded (as a percentage of demand)

Divided by Change in price (as a percentage of price)

Question 11

Interpretation of PED

Elastic

Answer 11

If the percentage change in demand exceeds the percentage change in price, then demand is ‘elastic’ (i.e., very responsive to changes in price). Total revenue increases when price is reduced and vice versa.

Question 12

Interpretation of PED

Inelastic

Answer 12

If the percentage change in demand is less than the percentage change in price then demand is ‘inelastic’ (not very responsive to changes in price). Total revenue decreases when price is reduced and vice versa.

Question 13

Factors affecting price elasticity

Answer 13

Product or service pricing policies depend primarily on the circumstances of the firms and the markets in which they operate.

In particular, the following factors influence prices:

Question 14

In particular, the following factors influence prices:

Answer 14

Scope of the market

Availability of substitutes

Complementary products

Disposable income

Habitual items

Question 15

Scope of the market

Answer 15

larger the defined market, the more inelastic is the demand for the product

Question 16

Availability of substitutes

Answer 16

the less the differentiation between competing products, the greater the price elasticity of those products

Question 17

Complementary products

Answer 17

the inter-dependency of products results in price inelasticity, because the sales of the dependent goods rely on the sales of the primary goods.

Question 18

Disposable income

Answer 18

The relative wealth of the consumers over time affects the total demand in the economy. Luxury goods tend to have a high price elasticity. Necessities (such as milk, bread, toilet rolls, etc.) are usually relatively price inelastic.

Question 19

Habitual items

Answer 19

Items consumers buy out of habit such as cigarettes are usually relatively price inelastic.

Question 20

Pricing approaches

Answer 20

Market-based

Cost-based

Question 21

Market-based

Answer 21

price charged is based on what customers want and how competitors react.

Question 22

Cost-based

Answer 22

also called cost-plus) – price charged is based on what it cost to produce, coupled with the ability to recoup the costs and still achieve a required rate of return.

Question 23

Target pricing

Answer 23

target price – estimated price for a product or service that potential customers will pay

estimated on customers’ perceived value for a product or service, and how competitors will price competing products or services.

Question 24

Understanding customers’ perceived value

understanding customers and competitors is important because

Answer 24

competition from lower cost producers has meant that prices cannot be increased

products are on the market for shorter periods of time, leaving less time and opportunity to recover from pricing mistakes

customers have become more knowledgeable and demand quality products at reasonable prices.

Question 25

Competitor analysis:

Answer 25

Understanding competitors’ technologies, products or services, costs and financial conditions helps a company to evaluate how distinctive its own products or services will be in the market, and determine the prices it might be able to charge as a result of being distinctive.

Question 26

Market segmentation:

Answer 26

price differentiation – the practice of charging different customers different prices for the same product or service

peak-load pricing – the practice of charging a higher price for the same product or service when the demand for it approaches the physical limit of the capacity to produce that product or service.

Question 27

Cost-based (cost-plus) pricing

Answer 27

The general formula adds a markup component to the cost base to determine a prospective selling price. This is usually only a starting point in the price-setting process. Markup is somewhat flexible, based partially on customers and competitors.

Question 28

Cost-plus target rate of return on investment

Answer 28

Target rate of return on investment ‒ the target annual operating return that an organisation aims to achieve, divided by invested capital.

Question 29

Cost-plus methods

Answer 29

Selecting different cost bases for the ‘cost-plus’ calculation:

variable manufacturing cost

variable cost

manufacturing cost

full cost.

These cost bases give four prospective selling prices that are close to each other.

Question 30

Most firms use full cost for their cost-based pricing decisions because it:

Answer 30

allows for full recovery of all costs of the product

allows for price stability

is a simple approach.

Question 31

Comparison of cost-plus pricing and target pricing:

Answer 31

Cost-plus selling prices are prospective prices and are set after balancing the trade-offs among costs, mark-up and customer reactions. The target-pricing approach sets the target price after assessing customer preferences, expected competitor responses, and the target cost.

Question 32

Costing and pricing for the long run

Answer 32

Long-run pricing decisions have a time horizon of one year or longer, and include decisions such as: Pricing a product in a major market wherethere is some leeway in setting price. Costs that are often irrelevant for short-run policy decisions, such as fixed costs that cannot be changed, are generally relevant in the long run, because costs can be altered in the long run. Profit margins in long-run pricing decisions are often set to earn a reasonable return on investment – prices are decreased when demand is weak and increased when demand is strong.

Question 33

Costing and pricing for the short run

Answer 33

Short-run pricing decisions have a time horizon of less than one year and include decisions such as pricing a one-time-only special order with no long-run implications and pricing a one-time-only special order with no long-run implications.

Question 34

Relevant costs for short-run pricing decisions

Answer 34

direct materials

direct manufacturing labour

fixed costs of any additional capacity required

Question 35

Firms may use different pricing policies, including the following 4:

Answer 35

Price-skimming pricing policy

Penetration pricing policy

Bait and Hook pricing

Product life cycle pricing policy

Question 36

Price skimming 1/2

Answer 36

Firms use the price skimming policy to take advantages of price insensitive sections of the market. When demand is high for new products, initial prices may include high mark-ups. High initial prices safeguard against unexpected future increases in costs It also helps to recover high research and development costs.

Question 37

Price skimming 2/2

Answer 37

At the later stages of product growth cycle, progressively lower prices may be charged (to attract other segments of the market). Apple has added a twist to the skimming strategy. Apple stakes out a price and then maintains and defends that price by significantly increasing the value of their products in future iterations. On occasions, this approach is used to prolong the life of the old products.

Question 38

Penetration pricing

Answer 38

Under the penetration pricing policy firms initially charge low prices in order to introduce the product to the market and to build a customer base. Helps to compete with other producers or with close substitutes of the product. Low prices are also used to discourage potential competitors from entering the market. Low prices also enable a company to establish a large market share.

Question 39

Bait and Hook pricing

Answer 39

A bait and hook pricing strategy sets the initial purchase price low but charges aggressively for replacement parts or other materials con- sumed in the course of using the product.
Gillette has done well for its owners for more than a century, in part because of its success in selling replacement blades for its shaving devices. Makers of ink-jet printers appear to have adopted the same pricing strategy: sell the printer cheaply, but make up for it on ink cartridges.

Question 40

Product’s life cycle

Answer 40

Pricing policies may vary depending on the different stages of a product’s life cycle

Question 41

A product life cycle consists of four stages:

Answer 41

Introductory
Growth
Maturity
Decline

Question 42

Advantages of life cycle costing

Answer 42

A large proportion of a product ’s costs can be committed or “locked in” during the planning and design stage. Pricing can be most effectively set taking into consideration costs incurred during planning and design stages. Life cycle costing focuses on costs over the product’s entire life cycle. It determines whether profits earned during the manufacturing phase will cover the costs incurred during the pre-and post-manufacturing stages.

Question 43

Customer profitability analysis

Answer 43

Customer-profitability analysis is the reporting and analysis of revenues earned from customers and costs incurred to earn those revenues. An analysis of customer differences in revenues and costs can provide insight into why differences exist in the operating income earned from different customers.

Question 44

Customer-revenue analysis

Answer 44

A price discount is the reduction of selling prices to encourage increases in customer purchases. Lower sales price is a tradeoff for larger sales volumes. Discounts should be tracked by customer and salesperson to help improve profitability.

Question 45

Customer-cost analysis

Answer 45

Customer-cost hierarchy categorises costs related to customers into different cost pools on the basis of different:

types of drivers

cost-allocation bases

degrees of difficulty in determining cause-and-effect or benefits-received relationships.

Question 46

Categories of indirect costs in a customer-cost hierarchy:

Answer 46

customer output unit-level costs

customer batch-level costs

customer-sustaining costs

distribution-channel costs

organisation-sustaining costs.

Question 47

Factors to be considered in allocating resources among customers include:

Answer 47

likelihood of customer retention

potential for sales growth

long-run customer-profitability

increases in overall demand from having well-known customers

ability to learn from customers.