Question

Chapter 18: Pricing and Profitability Analysis

1. Discuss factors that a company might look at when determining prices for its products.

2. What are the advantages and disadvantages of target pricing versus cost-based pricing?

3. Why might a company price goods below costs?

Answer 1

Ans

1) The factors that a company might look at when determining prices for its products are :

COST OF PRODUCT

  Before setting up your prices, work out the costs involved with running your business. These include your fixed costs and your direct costs (variable costs).

CUSTOMER OF THE PRODUCT

The price will often vary for different clients. Some clients require more effort, some are riskier, some are repeat clients, some have jobs you are dying to do, some you wouldn't want to go near with a stick. You should vary your price to account for these factors.

COMPETITORS

The price of the competitors have to be taken into account while deciding the prices of own product.

PROFIT MARGIN

The most important questions business owners neglect to ask themselves is, “How much profit do I want to make?” They tend to look at what others charge and then pull a figure out of the air to be competitive without giving consideration to how much profit the want and need.

2) The advantages and disadvantages of target pricing versus cost-based pricing are:

MARKETING STRATEGIES

Cost-based pricing considers your price relative to that of your competitors. You may choose to offer a lower price, than using other options to attract cost-conscious customers, or you may opt to charge an amount in the same ballpark so your offerings won't seem overpriced. Either way, you're looking at your prices in comparison to those of your competitors, and making a choice based on what you believe your customers will accept. Value-based pricing uses retail cost as a way to send a message about quality.

PRACTICAL CONSIDERATIONS

Cost-based pricing sets a price between a floor amount, which is the least you can charge and still earn a living, and a ceiling amount, which is the most the market will bear. The floor price offers the advantage of providing a competitive edge, with customers looking to pay as little as possible. But you'll need to sell more products with a lower profit margin than you would at a higher price to earn the same net profit. Value-based pricing enables you to earn an even higher net profit, but you need to earn the respect and trust of your customers to get them to pay more.

PRODUCTS VS SERVICES

Because physical products are made from materials that must be purchased and labor that must be paid for at a specific rate, they are more likely to fall under a cost-based pricing strategy, rather than under services, which are more subjectively valued. If you're buying laundry soap, a broad range of products exist that can get your clothes clean, and the price of any of them must cover the materials and labor that went into producing them.

3) A company price goods below costs because :

1. CREATE A LOSS LEADER

Under many circumstances, selling one product at a loss may drive significant value for other products. The classic example of this is inkjet printers, which for a long time have been sold at or below cost to attract customers, who inevitably purchase high-margin ink cartridges from the manufacturer, driving significant value to the bottom line.

2.       PENETRATE THE MARKET

With many new emerging technologies, a product may be offered at a loss initially to increase customer uptake. In such a market, a new technology might be offered at a loss to encourage trial and drive acceptance among consumers.

3.       PINPOINT COST SAVINGS

There may be ways to reverse the fortunes of an unprofitable product by reducing costs or streamlining overhead. Before eliminating a product from your portfolio, determine what specific costs are driving the value destruction.An unprofitable product can often serve as an indicator of operational inefficiencies that can impact the profitability of multiple products in the portfolio.

4.       IDENTIFY YOUR ABILITY TO SELECTIVELY RAISE PRICE

For some products, the cost structure is sound, but the revenues are still insufficient to achieve a profit. This is largely the strategy behind many premium products, which have a higher cost structure but provide significantly more value to the customer, warranting a higher price.

5. PROMOTION OF THE PRODUCT

For promotion or advertisement, the product is often sold at a price lower than its cost. Sometimes they are also sold for free termed as sales promotion.