Pricing Strategies: On Completion of This Chapter, You Will Be Able To: 1 2 3 4

10 Pricing Strategies
The price is what you pay;

the value is what you
receive. —Anonymous
On completion of this chapter, you will be able to:
1 Discuss the relationships among pricing, image, competition, and value.

2 Describe effective pricing techniques for introducing new products or
services and for existing ones.
3 Explain the pricing methods and strategies for (A) retailers,
(B) manufacturers, and (C) service firms.
4 Describe the impact of credit on pricing.
355
356 SECTION III • BUILDING THE BUSINESS PLAN: MARKETING AND FINANCIAL CONSIDERATIONS
Setting prices is a business decision governed by both art and science—with a measure
of instinct thrown in for good measure. Setting prices for their products and services
requires entrepreneurs to balance a multitude of complex forces, many of them working
in opposite directions. Entrepreneurs must determine prices for their goods and services
that will draw customers and produce a profit. Unfortunately, many small business
owners set prices without enough information about their cost of operations and the
nature of their customers. Price is an important factor in building long-term relation-
ships with customers, and haphazard pricing techniques can confuse and alienate cus-
tomers and endanger a small company’s profitability. Setting prices is not only one of
the toughest decisions small business owners face, but it also is one of the most impor-
tant. Research by the consulting firm McKinsey and Company shows that proper pric-
ing strategies have far greater impact on a company’s profits than corresponding reduc-
tions in fixed or variable costs.1 Improper pricing has destroyed countless businesses
whose owners mistakenly thought their prices were high enough to generate a profit
when, in fact, they were not.
After working with a consultant, Jeff Trott, founder of Timeless Message, a company that
sells bottles with greeting messages inside them, raised its prices from an average of
$30 per bottle to $60 per bottle. The company had underestimated both its costs and the
market value of its products. The price increase resulted in a brief sales dip, but, according
Timeless Message
to Trott, “We started making a profit for the first time in four years. It was like we had
been shipping a ten-dollar bill out the door with each order.”2
Pricing decisions cut across every aspect of a small company, influencing everything
from its marketing and sales efforts to its operations and strategy. Price is the monetary
value of a product or service in the marketplace; it is a measure of what the customer must
give up to obtain various goods and services. Price also is a signal of a product’s or ser-
vice’s value to an individual, and different customers assign different values to the same
goods and services. From an entrepreneur’s viewpoint, price must be compatible with cus-
tomers’ perceptions of value. “Pricing is not just a math problem,” says one business
writer. “It’s a psychology test.”3 The psychology of pricing is an art much more than it is a
science. It focuses on creating value in the customer’s mind but recognizes that value is
what the customer perceives it to be. In many cases, customers look to a product’s or ser-
vice’s price for clues about value. Consider the following examples, which illustrate the
sometimes puzzling connection between price and perceived value:
r In the ultra-premium segment of the watch industry, Rolex, Cartier, Patek Philippe,
Chopard, Toric, Blancpain, and Corum are legendary brands of handmade watches
that sell at prices ranging from $10,000 to $50,000. To some people, owning one of
these watches is a hallmark of financial success, even though they are less accurate at
keeping time than a $10 quartz-driven Timex.4
r To establish a niche in the beer market, microbrewers in the United States began pro-
ducing small batches of high-quality beer in the European style, focusing on ales,
porters, and stouts rather than the lagers the giant brewers were selling. Moving even
farther upscale in the beer market (which has seen relatively flat sales compared to a
63 percent increase in wine sales since 1991), small brewers are marketing premium
craft beers with all of the cachet of wine—at premium prices, of course. In addition to
its 18.5 percent alcohol content and $16 per bottle price, Dogfish Head Brewery’s Fort
Beer has a raspberry flavor, and the company suggests that connoisseurs drink it from
a champagne flute. Microbrewer Samuel Adams makes the world’s most expensive
beer. Its Utopia, made from special malts and yeast, sells for $100 per bottle. Because
the company produces just 8,000 bottles a year, some bottles of Utopia have fetched as
much as $200 on eBay!5
r The Renaissance Pen Company markets fountain pens made from gold and platinum
and encrusted with diamonds selling for as much as $230,000. It also sells a pen that
contains the crystallized DNA of Abraham Lincoln for only $1,650.6
CHAPTER 10 • PRICING STRATEGIES 357
As you can see, setting higher prices sometimes can increase appeal of a product or service (“If
you charge more, you must be worth it”). Value for these products is not found in their superior
technical performance but in their scarcity and uniqueness and the resulting image they create
for the buyer. Although an entrepreneur must recognize the shallow depth of the market for
such ultra-luxury items, the ego-satisfying ownership of limited-edition watches, pens, cars,
jewelry, and other items is the psychological force supporting the premium price strategy.
Three Potent Forces: Image, Competition, and Value LEARNING OBJECTIVES

1. Discuss the relationships
Price Conveys Image among pricing, image,
A company’s pricing policies communicate important information about its overall image to competition, and value.
customers. For example, the prices charged by a posh men’s clothing store reflect a com-
pletely different image from those charged by a factory outlet. Customers look at prices to
determine what type of store they are dealing with. High prices frequently convey the idea of
quality, prestige, and uniqueness to customers. “People bring a whole set of equations with
them when they make a purchase, and one of the values for most people is that high price
equals quality,” says Rob Docters, a pricing expert.7 Accordingly, when developing a mar-
keting approach to pricing, entrepreneurs must establish prices that are compatible with what
customers expect and are willing to pay. Too often, small business owners underprice their
goods and services, believing that low prices are the only way they can achieve a competitive
advantage. A study by the Copernicus consulting firm found that only 15 to 35 percent of
customers consider price to be the chief criterion when selecting a product or service.8
A common pricing mistake small business owners make is failing to recognize the
extra value, convenience, service, and quality they give their customers—all things many
customers are willing to pay for. These companies fall into the trap of trying to compete
solely on the basis of price when they lack the sales volume—and, hence, the lower cost
structures—of their larger rivals. It is a recipe for failure. “People want quality,” says one
merchant selling upscale goods at upscale prices. “They want value. But if you lower
prices, they think that you are lowering the value and lowering the quality.”9 Lowering
prices may be a dangerous cycle that can destroy a business. A study of businesses in multiple
industries by Rafi Mohammed, author of The Art of Pricing, found that those companies
that raised prices by 1 percent saw their profits increase 11 percent. Those that raised their
prices by 10 percent realized profit increases of 100 percent!10 The study does not imply
that businesses have free rein to raise prices to any level, but it does suggest that many
companies could raise their prices enough to improve their financial results significantly if
they can convince customers that their products offer superior value.
In the crowded soft drink market, the battle for market share often boils down to price
competition among the industry giants Coca-Cola and Pepsi. However, some small com-
panies have managed to carve out niches in the soft drink market with higher-priced spe-
cialty products that are made with all-natural ingredients, offer exotic flavors, or provide
some other appealing twist.
In 2002, Eric Schnell and Steven Kessler introduced

the Steaz Green Tea Soda line as part of their new
business, the Healthy Beverage Company, as a
nutritious alternative to regular carbonated soft
drinks. Their lightly carbonated beverage contains Healthy Beverage
Company
green tea (touted by many health care profession-
als for its antioxidant properties) and sugar cane By emphasizing the
juice and is certified as “organic” by the U.S. uniqueness of their organic
Department of Agriculture. Marketing their tea-soda green tea-soda combination
combination as a healthy beverage alternative to drink, Eric Schnell and Steven
Kessler, co-founders of Steaz
conventional soft drinks allows the company to
Green Tea Soda, are able to
charge $1.50 for a 12-ounce bottle, a healthy price premium over standard carbon-
charge a premium price over
ated drinks.11 regular carbonated drinks.
One key to setting prices properly is based on understanding a company’s target mar-
ket, the customer groups at which the small company is aiming its goods or services.
Target market, business image, and pricing strategy are closely related.
When Tamara Donaghy-Bates launched Sway & Cake, a Seattle, Washington, retail store
selling women’s clothing, her target audience was young professional women in their late
20s to late 30s who are looking for something other than traditional styles. Donaghy-
Bates describes the clothing she sells in Sway & Cake as “funky” and “flirty”—trendy,
sSway and Cake and TBC
fashion-forward styles that are common in metropolitan areas such as New York or Los
Angeles but are hard to find in conservative towns such as Seattle. Her upscale pricing
strategy is geared toward her target audience, and it works; her company’s first-year sales
exceeded $800,000. Working with customers every day in the shop provided Donaghy-
Bates with clear insight into her customers’ fashion preferences, and she soon saw an
opportunity to tap into another target audience with a different pricing strategy: students
and young women in their early to mid 20s. To reach this group of customers, Donaghy-
Bates opened TBC (To Be Continued) in Seattle as a lower-cost outlet for similar styles of
clothing that she sells in Sway & Cake. In fact, nearly half of the merchandise sold in TBC
is clothing that did not sell in Sway & Cake and has been marked down at a significant
discount, sometimes as much as 50 or 60 percent off the normal retail price. TBC’s
remaining merchandise is new, lower priced, and aimed at a younger audience.
Customers have responded to both stores’ pricing strategies and merchandise mix, and
combined sales for the two stores have grown well beyond the $1 million mark.12
Competition and Pricing

When setting prices, entrepreneurs should take into account their competitors’ prices, but
they should not automatically match or beat them. Although price is an important factor in
the purchase decision, it is not the only consideration for shoppers. Two factors are vital to
studying the effects of competition on the small company’s pricing policies: the location of
the competitors and the nature of the competing goods and services. In most cases, unless
a company can differentiate the quality and the quantity of extras it provides, it must match
the prices charged by nearby competitors for identical items. For example, if a self-service
station charges a nickel more per gallon for gasoline than does another self-service station
across the street, customers will simply go across the street to buy. Without the advantage
of a unique business image—quality of goods sold, value of services provided, convenient
location, favorable credit terms—a small company must match local competitors’ prices or
lose sales. Although the prices that distant competitors charge are not nearly as critical to
the small business as are those of local competitors, it can be helpful to know them and to
use them as reference points. Before matching any competitor’s prices, however, small
business owners should consider the rival’s motives. The competition may be establishing
its price structure based on a unique set of criteria and a totally different strategy. Blindly
matching competitors’ prices can lead a company to financial ruin, and companies that set
their prices this way typically do so because they perceive themselves in a position of
strategic weakness.
The nature of the competitors’ goods and services also influences a company’s pricing
policies. Entrepreneurs must monitor competitors’ prices on products that are identical to
or are close substitutes for those they sell and then strive to keep their prices in line with
them. For example, the local sandwich shop should consider the hamburger restaurant, the
taco shop, and the roast beef shop as competitors because they all serve fast foods.
Although none of them offers the identical menu of the sandwich shop, they are all com-
peting for the same quick-meal dollar. Of course, if a small business can differentiate its
products by creating a distinctive image in customers’ minds or by offering superior ser-
vice, quality, convenience, or speed, it can charge prices higher than those of its competi-
tors. Because competitors’ prices can have a dramatic impact on a small company’s prices,
entrepreneurs should make it a habit to monitor their rivals’ prices, especially on identical
items.
When Anthony Shurman launched Yosha Enterprises in 2002, a company that markets
liquid breath mints, he established a price of $1.99 for a 36-mint package. Later, in
response to competitors’ prices, he lowered the price to $1.79 and then to $1.69 per
pack. Momints contained more mints than any of the competing brands, but customers
Yosha Enterprises
failed to recognize that benefit, and based their purchase decisions on the package price.
When Shurman recently rolled out Momints at a regional chain of grocery stores, he cut
the size of the pack to the industry standard 28 mints and set a price of 99 cents. “Our
sales went up 350 percent,” he says. Yosha generates $3 million in annual revenue, and
Shurman believes that he can sell even more mints at the lower 99-cent price.13
Generally, entrepreneurs should avoid head-to-head price competition with other

firms that can more easily achieve lower prices through lower cost structures. For instance,
most locally owned drugstores cannot compete with the prices of large national drug
chains. However, many local drugstores operate successfully by using nonprice competi-
tion; these stores offer more personalized service, free delivery, credit sales, and other
extras that the chains have eliminated. Nonprice competition can be an effective strategy
for a small business in the face of larger, more powerful enterprises, especially because
there are many dangers in experimenting with price changes. Price shifts cause fluctua-
tions in sales volume that a small company may not be able to tolerate. In addition, fre-
quent price changes may damage a company’s image and its customer relations.
Attempting to undercut competitors’ prices may lead to a price war, one of the most
deadly games a small business can play. Price wars can eradicate companies’ profit margins
and scar an entire industry for years. “Many entrepreneurs cut prices to the point of unprof-
itablility just to compete,” says one business writer. “In doing so, they open the door to cata-
strophe. Less revenue often translates into lower quality, poorer service, sloppier salesman-
ship, weaker customer loyalty, and financial disaster.”14 Price wars usually begin when one
competitor thinks he or she can achieve higher volume instantaneously by lowering prices.
Rather than sticking to their strategic guns, competitors believe they must follow suit.
Entrepreneurs usually overestimate the power of price cuts, however. Sales volume
rarely increases enough to offset the lower profit margins of a lower price. A business with
a 25 percent gross profit margin that cuts its price by 10 percent would have to triple its
sales volume just to break even. In a price war, a company may cut its prices so severely
that it is impossible to achieve the volume necessary to offset the lower profit margins.
Even when price cuts work, their effects often are temporary. Customers lured by the low-
est price usually have almost no loyalty to a business. The lesson: The best way to survive
a price war is to stay out of it by emphasizing the unique features, benefits, and value your
company offers its customers.
Focus on Value
Ultimately, the “right” price for a product or service depends on one factor: the value that
it provides for a customer. There are two aspects of value, however. Entrepreneurs may
recognize the objective value of their products and services, which is the price customers
would be willing to pay if they understood perfectly the benefits that a product or service
delivers for them. Unfortunately, few, if any, customers can see a product’s or a service’s
true objective value; instead, they see only its perceived value, which determines the price
they are willing to pay for it. Research into purchasing decisions has revealed a fundamen-
tal problem that adds to the complexity of a business owner’s pricing decision: People
faced with pricing decisions often act irrationally. In one classic study, researchers asked
shoppers if they would travel an additional 20 minutes to save $5 on a calculator that costs
$15; most said they would. When asked the same question about a $125 jacket, most of the
shoppers said no, even though they would be saving the exact same amount of money!
“People make [purchasing] decisions piecemeal, influenced by the context of the choice,”
says Richard Thaler, who won a Nobel Prize for his work in behavioral economics.15
Note that value does not necessarily correspond to low price, however. Businesses that
underprice their products and services or run special discount price promotions may be
short-circuiting the value proposition they are trying to build and communicate to their
customers. Customers may respond to price cuts, but companies that rely on them to boost
sales risk undermine the perceived value of their products and services. In addition, once
customers grow accustomed to buying products and services during special promotions,
the habit can be difficult to break. They simply wait for the next sale. Some companies in
the auto industry have faced this problem as customers accustomed to buying autos with
large rebates postpone buying new cars until automakers offer them special incentives. The
result has been fluctuating sales and a diminished value of those automotive brands.
One of the most important determinants of customers’ response to a price is whether
they perceive the price to be a fair exchange for the value they receive from the product or
service. The good news is that companies can influence through marketing and other
efforts customers’ perception of value. “The price you get for a product is a function of
what it’s truly worth—and how good a job you do communicating that value to the end
user,” says one entrepreneur.16 Indeed, setting a product’s or a service’s price is another
way a company can communicate value to its customers. For most shoppers, three refer-
ence points define a fair price: the price they have paid for the product or service in the
past, the prices competitors charge for the same or similar product or service, and the costs
a company incurs to provide the product or service. The price that customers have paid in
the past for an item serves as a baseline reference point, but people often forget that infla-
tion causes a company’s costs to rise from year to year. Therefore, it is important for busi-
ness owners to remind customers periodically that they must raise prices to offset the
increased cost of doing business. “Over time, costs always go up,” says Norm Brodsky,
owner of a successful document storage company. “I’d rather raise prices a little every year
or with every new contract than be forced to demand a big increase down the road.”17
As we have seen already, companies often find it necessary to match competitors’
prices on the same or similar items unless they can establish a distinctive image in cus-
tomers’ minds. One of the most successful strategies for companies facing direct competi-
tion is to differentiate their products or services by adding value for customers and then
charging for it. For instance, a company might offer faster delivery, a longer product war-
ranty, extra service, or something else that adds value to an item for its customers and
allows the business to charge a higher price.
Perhaps the least understood of the three reference points is a company’s cost struc-
ture. Customers often underestimate the costs businesses incur to provide products and ser-
vices, whether it is a simple cotton T-shirt on a shelf in a beach-front shop or a life-saving
drug that may have cost hundreds of millions of dollars and many years to develop. They
forget that business owners must make or buy the products they sell, market them, pay
their employees, and cover a host of other operating expenses, ranging from health care to
legal fees. Entrepreneurs facing rapidly rising costs in their businesses should consider the
following strategies:
r Communicate with customers. Rather than hide bad news from customers, let them
know what is happening. When the owner of a wholesale coffee business saw coffee
bean prices escalate because of bad weather in key coffee-producing countries, he
included copies of news articles in a letter he sent to customers explaining his com-
pany’s price increases.
r Focus on improving efficiency in the company. One way to lessen the impact of
rising costs in one area of a business is to look for ways to cut costs in other areas.
Improving operating efficiency may not offset totally the increased costs of doing
business, but it will help dampen their effects.
r Consider absorbing the cost increases. When Norm Brodsky, owner of the docu-
ment storage company mentioned earlier, saw his competitors add a fuel surcharge to
their customers’ bills to offset steep increases in gas prices, he decided not to add a
fuel surcharge. Then, he used the pricing decision to attract new accounts, telling
them, “We have found other ways besides a surcharge to deal with the problem.
When we say the price [of our contract] is fixed for five years, we mean it, and you
can count on it.” Brodsky also used the fuel surcharge issue to build loyalty among
his existing customers, something he is certain will pay off in the future.18
Price Ceiling FIGURE 10.1

(“What will the market bear?”)
Pocket Price
? ? ? ? ? Waterfall
?
? ?
?
?
?
? ? ?
? ? ?
Acceptable ? ?
Final Price
Price
(“What is the company’s desired image?”)
Range ?
? ?
?
?
? ? ? ?
? ?
?
?
? ? ? ? ?
?
Price Floor
(“What are the company’s costs?”)
r Emphasize the value your company’s product or service delivers to customers.

Customers have a tendency to forget the benefits and value a business provides
unless an entrepreneur periodically reminds them.
r Anticipate rising costs and try to lock in prices early. By tracking coffee and tea
prices on commodities exchanges every day, the owner of a small coffee and tea shop
was able to anticipate price increases for her raw materials and committed early on to
purchase 125,000 pounds of coffee at a fixed price for one year. When coffee prices
doubled, she saved more than $80,000.
Setting prices with an emphasis on value is more important than trying to choose the
ideal price for a product. In fact, for most products there is an acceptable price range, not a
single ideal price. This price range is the area between the price ceiling defined by cus-
tomers in the market and the price floor established by the company’s cost structure. An
entrepreneur’s goal is to position the company’s prices within this acceptable price range.
The final price that business owners set depends on the desired image they want to create
for the business in their customers’ minds—discount, middle-of-the-road, or prestige (see
Figure 10.1).
Setting appropriate prices requires more than just choosing a number based solely on
intuition. Rather, proper pricing policies require information, facts, and analysis. The fac-
tors that small business owners must consider when determining the final price for goods
and services include the following:
r Product or service costs
r Market factors—supply and demand
r Sales volume
r Competitors’ prices
r A company’s competitive advantage
r Economic conditions
r Business location
r Seasonal fluctuations
r Psychological factors
r Credit terms and purchase discounts
r Customers’ price sensitivity
r Desired image
Although business owners may not be able to charge the ideal price for a product or
service, they should set the price high enough to cover their costs and earn a reasonable
profit but low enough to attract customers and generate an adequate sales volume.
After the terrorist attacks in 2001

dampened attendance at
Broadway, theaters cut their prices.
As audiences returned, theaters
were able to raise their ticket
prices. Even though they charge
more than $100 per ticket, popular
shows such as Wicked (featuring
here Idina Menzel (l) as Elpheba
and Kristin Chenoweth (r) as
Glinda) play to sold out houses
almost every night.
Furthermore, the right price today may be completely inappropriate tomorrow because of
changing market and competitive conditions. Broadway shows, which had suffered steep
sales declines in the wake of the terrorist attacks in 2001, recently pushed ticket prices
above the $100 level as audiences returned and shows began selling out once again. Monty
Python’s Spamalot was the first hit show to push through the psychological $100 price
ceiling, but long-running Mamma Mia! and Wicked quickly followed suit. The decisions
were based on the fact that all three shows were playing to sold-out houses almost every
night of the week, but theater managers were quick to point out that customers could still
buy standing-room-only tickets for as little as $20.19
For many businesses, the pricing decision has become more challenging because the
World Wide Web gives customers access to incredible amounts of information about the
prices of items ranging from cars to computers. Increasingly, customers are using the Web
to find the lowest prices available. To maintain their profitability, companies have
customized or dynamic responded with customized or dynamic pricing, in which they set different prices on the
pricing same products and services for different customers using the information they have col-
a pricing technique that sets lected about their customers. For instance, a first-time customer making a purchase at an
different prices on the same online store may pay a higher price for an item than a regular customer who shops there
products and services for different
frequently pays for that same item. AllState Insurance Company relies on a huge database
customers using the information
of statistical research that includes information ranging from customers’ driving records
that a company collects about its
customers.
and their age to their credit scores and whether they pay their bills on time to determine the
prices it charges for insurance coverage. AllState’s credit-derived premiums have enabled
the company to go from a system that established prices using three broad-based categories
to one that divides customers into nearly 400 categories, each with its own price point.
Since implementing the dynamic pricing strategy, AllState’s sales and profitability have
climbed significantly.20
Pricing Strategies and Tactics LEARNING OBJECTIVES

2. Describe effective pricing
There is no limit to the number of variations in pricing strategies and tactics. This wide techniques for introducing new
variety of options is exactly what allows the small business manager to be so creative. This products or services and for
section examines some of the more commonly used tactics under a variety of conditions. existing ones.
Pricing always plays a critical role in a firm’s overall strategy; pricing policies must be
compatible with a company’s total marketing plan and the image it plans to create in the
marketplace.
Introducing a New Product

Entrepreneurs are often apprehensive to set the price of a new product when they have no
precedent on which to base their decisions. If the new product’s price is excessively high,
it is in danger of failing because of low sales volume. However, if its price is too low, the
product’s sales revenue might not cover costs. In addition, the company runs the risk of
establishing the product’s perceived value at a low level. The management consulting firm
McKinsey and Company claims that 80 to 90 percent of the pricing problems on new
products are the result of companies setting prices that are too low.21 When pricing any
new product, the owner should try to satisfy three objectives:
1. Getting the product accepted. No matter how unusual a product is, its price must be
acceptable to a company’s potential customers. The acceptable price range for a new
product depends, in part, on the product’s position:
• Revolutionary products are so new and unique that they transform existing mar-
kets. The acceptable price range for revolutionary products tends to be rather
wide, but the businesses introducing them must be prepared to make an invest-
ment in educating customers about them.
• Evolutionary products offer upgrades and enhancements to existing products.
The acceptable price range for evolutionary products is not a wide as it is for rev-
olutionary products. Companies that introduce evolutionary products with many
new features at prices that are too low may initiate a price war.
• Me-too products, as the name suggests, offer the same basic features as
existing products on the market. The acceptable price range for these products
is quite narrow, and many companies introducing them find themselves left
with me-too pricing strategies that are the same or similar to those of their
competitors.
2. Maintaining market share as competition grows. If a new product is successful,
competitors will enter the market, and the small company must work to expand or at
least maintain its market share. Continuously reappraising the product’s price in con-
junction with special advertising and promotion techniques helps to retain a satisfac-
tory market share.
3. Earning a profit. Obviously, a small firm must establish a price for the new product
higher than its cost. Entrepreneurs should not introduce a new product at a price
below cost because it is much easier to lower a price than to increase it once the
product is on the market. Pricing their products too low is a common and often fatal
mistake for new businesses; entrepreneurs are tempted to underprice their products
and services when they enter a new market to ensure their acceptance or to gain
market share quickly. Doing so, however, sets customers’ value expectations at low
levels as well, and that can be a difficult perception to overcome.
Linda Calder, owner of Calder & Calder Promotions, a company that produces trade
shows, knows how difficult it can be to raise prices. When she launched her company,
Calder decided to set her price below the average price of competing trade show pro-
duction companies because she thought that would give her a competitive edge. “My
Calder & Calder
fee was so low . . . I sold out but did not make a profit,” she says. Realizing her mistake,
Promotions
Calder raised prices in her second year, but her customers balked. Her sales fell by
50 percent.22
Entrepreneurs have three basic strategies to choose from when establishing a new
product’s price: a penetration pricing strategy; a skimming pricing strategy; and a sliding-
down-the-demand-curve strategy.
Market Penetration If a small business introduces a product into a highly competitive

market in which a large number of similar products are competing for acceptance, the
product must penetrate the market to be successful. To gain quick acceptance and
extensive distribution in the mass market, entrepreneurs should consider introducing the
product at a low price. In other words, it should set the price just above total unit cost to
develop a wedge in the market and quickly achieve a high volume of sales. The resulting
low profit margins tend to discourage competitors from entering the market with similar
products.
In most cases, a penetration pricing strategy is used to introduce relatively low-priced
goods into a market where no elite segment and little opportunity for differentiation exists.
The introduction is usually accompanied by heavy advertising and promotional tech-
niques, special sales, and discounts. Entrepreneurs must recognize that penetration pricing
is a long-range strategy; until customers accept the product, profits are likely to be small. If
the strategy works and the product achieves mass market penetration, sales volume will
increase, and the company will earn adequate profits. The objectives of the penetration
strategy are to break into the market quickly, generate a high sales volume as soon as pos-
sible, and build market share. Many consumer products, such as soap, shampoo, and light
bulbs, are introduced through penetration pricing strategies.
Majesco, a small company that competes against many industry giants in the video game
business, uses a penetration pricing strategy for most of the games it sells. The company
releases 5 to 10 new games each year, and 80 percent of them are “bargain titles,” tar-
geted for sale in retailers’ discount bins, where they are priced from $9.99 to $19.99.
Majesco
“There’s not much competition in the value-game market,” explains company co-founder
Jesse Sutton. Because the average cost of producing budget games is far below that of
creating premium games with sophisticated graphics, Majesco can break even on sales of
just 15,000 to 50,000 units for its budget games compared to 200,000 to 1 million units
for premium games. One of the company’s most popular titles, Hypersonic Extreme, has
sold more than 170,000 units, earning the company a solid profit.23
Skimming A skimming pricing strategy often is used when a company introduces a new
product into a market with little or no competition. Sometimes the firm employs this tactic
when introducing a product into a competitive market that contains an elite group that is
able to pay a higher price. Here a firm uses a higher-than-normal price in an effort to
quickly recover the initial developmental and promotional costs of the product. Start-up
costs usually are substantial due to intensive promotional expenses and high initial
production costs. The idea is to set a price well above the total unit cost and to promote the
product heavily to appeal to the segment of the market that is not sensitive to price. Such a
pricing tactic often reinforces the unique, prestigious image of a store and projects a
quality image of the product. Another advantage of this technique is that the manager can
correct pricing mistakes quickly and easily. If the firm sets a price that is too low under a
penetration strategy, raising the price can be very difficult. If a firm using a skimming
strategy sets a price too high to generate sufficient volume, it can always lower the price.
Successful skimming strategies require a company to differentiate its products or services
from those of the competition, justifying the above-average price.
Sliding Down the Demand Curve One variation of the skimming price strategy is
called sliding down the demand curve. Using this tactic, the small company introduces a
product at a high price. Then, technological advances enable the firm to lower its costs
quickly and to reduce the product’s price before its competition can. By beating other
businesses in a price decline, the small company discourages competitors and gradually,
over time, becomes a high-volume producer. High-definition television sets are a prime
example of a product introduced at a high price that quickly cascaded downward as

companies forged important technological advances and took advantage of economies of
scale. When they were first introduced in 1999, high-definition TVs sold for $19,000;
today, they are priced at $1,000 or less.
Sliding is a short-term pricing strategy that assumes that competition will eventually
emerge. Even if no competition arises, however, the small business almost always lowers
the product’s price to attract a larger segment of the market. Nonetheless, the initial high
price contributes to a rapid return of start-up costs and generates a pool of funds to finance
expansion and technological advances.
Pricing Established Goods and Services

Each of the following pricing tactics or techniques can become part of the toolbox of pric-
ing tactics entrepreneurs can use to set prices of established goods and services.
Odd Pricing Although studies of consumer reactions to prices are mixed and generally
inconclusive, many small business managers use the technique known as odd pricing. odd pricing
These managers prefer to establish prices that end in odd numbers such as 5, 7, or 9 a pricing technique that sets prices
because they believe that merchandise selling for $12.69 appears to be much cheaper than that end in odd numbers to create
the item priced at $13.00. Psychological techniques such as odd pricing are designed to the psychological impression of
appeal to certain customer interests, but research on their effectiveness is mixed. Some low prices.
studies show no benefits from using odd pricing, but others have concluded that the
technique can produce significant increases in sales.
price lining
Price Lining Price lining is a technique that greatly simplifies the pricing function by
a technique that greatly simplifies
pricing different products in a product line at different price points, depending on their the pricing function by pricing
quality, features, and cost. Under this system, entrepreneurs stock merchandise in several different products in a product line
different price ranges, or price lines. Each category of merchandise contains items that are at different price points,
similar in appearance but that differ in quality, cost, performance, or other features. For depending on their quality,
example, most music and video stores use price lines for their CDs and DVDs to make it features, and cost.
easier for customers to select items and to simplify inventory planning. Many lined
products appear in sets of three—good, better, and best—at prices designed to satisfy
different market segment needs and incomes. Price lining can boost a store’s sales because
it makes goods available to a wide range of shoppers, simplifies the purchase decision for
customers, and allows them to keep their purchases within their budgets.
leader pricing Leader Pricing Leader pricing is a technique in which a retailer marks down the
a technique that involves marking customary price (i.e., the price consumers are accustomed to paying) of a popular item in an
down the normal price of a attempt to attract more customers. The company earns a much smaller profit on each unit
popular item in an attempt to because the markup is lower, but purchases of other merchandise by customers seeking the
attract more customers who make leader item often boost sales and profits. In other words, the incidental purchases that
incidental purchases of other items
consumers make when shopping for the leader item boost sales revenue enough to offset a
at regular prices.
lower profit margin on the leader. Grocery stores frequently use leader pricing. For instance,
during the holiday season, stores often use turkeys as a price leader, knowing that they will
earn higher margins on the other items shoppers purchase with their turkeys.
Geographic Pricing Small businesses whose pricing decisions are greatly affected by
the costs of shipping merchandise to customers across a wide range of geographic regions
frequently employ one of the geographic pricing techniques. For these companies, freight
expenses comprise a substantial portion of the cost of doing business and may cut deeply
zone pricing into already narrow profit margins. One type of geographic pricing is zone pricing, in
a technique that involves setting which a small company sells its merchandise at different prices to customers located in
different prices for customers different territories. For example, a manufacturer might sell at one price to customers east
located in different territories of the Mississippi and at another to those west of the Mississippi. The U.S. Postal Service’s
because of different varying parcel post charges offer a good example of zone pricing. The company must be
transportation costs.
able to show a legitimate basis (e.g., differences in selling or transporting costs) for the
price discrimination or risk violating Section 2 of the Clayton Act.
delivered pricing Another variation of geographic pricing is uniform delivered pricing, a technique in
a technique in which a firm which a firm charges all of its customers the same price regardless of their location, even
charges all of its customers the though the cost of selling or transporting merchandise varies. The firm calculates the
same price regardless of their proper freight charges for each region and combines them into a uniform fee. The result is
location.
that local customers subsidize the company’s charges for shipping merchandise to distant
customers.
FOB-Factory A final variation of geographic pricing is FOB-Factory, in which a company sells its
a pricing method in which a merchandise to customers on the condition that they pay all shipping costs. In this way, the
company sells merchandise to company can set a uniform price for its product and let each customer cover the freight
customers on the condition that costs.
they pay all shipping costs.
Opportunistic Pricing When products or services are in short supply, customers are
willing to pay more for products they need. Some businesses use such circumstances to
maximize short-term profits by engaging in price gouging. Many customers have little
opportunistic pricing choice but to pay the higher prices. Opportunistic pricing may backfire, however,
a pricing method that involves because customers know that unreasonably high prices mean that a company is exploiting
charging customers unreasonably them. For example, after a devastating Los Angeles earthquake, one convenience store
high prices when goods or services jacked up prices on virtually every item, selling small bottles of water for $8 each.
are in short supply. Neighborhood residents had no choice but to pay the higher prices. After the incident,
many customers remembered the store’s unfair prices and began to shop elsewhere. The
convenience store’s sales slipped and never recovered.
discounts or markdowns Discounts Many small business managers use discounts or markdowns—reductions
reductions from normal list prices. from normal list prices—to move stale, outdated, damaged, or slow-moving merchandise.
A seasonal discount is a price reduction designed to encourage shoppers to purchase
merchandise before an upcoming season. For instance, many retail clothiers offer special
sales on winter coats in midsummer. Some firms grant purchase discounts to special
groups of customers, such as senior citizens or students, to establish a faithful clientele and
to generate repeat business. For example, one small drugstore located near a state
One of the most common tactics

for selling slow-moving
merchandise is the markdown.
university offered a 10 percent student discount on all purchases and was quite successful
in developing a large volume of student business.
Multiple-unit pricing is a promotional technique that offers customers discounts if multiple-unit pricing
they purchase in quantity. Many products, especially those with relatively low unit value, a technique offering customers
are sold using multiple pricing. For example, instead of selling an item for 50 cents, a small discounts if they purchase in
company might offer five for $2. quantity.
Bundling Many small businesses have discovered the marketing benefits of bundling, bundling
grouping together several products or services, or both, into a package that offers a pricing method that involves
customers extra value at a special price. For instance, many software manufacturers bundle grouping together several products
several computer programs (such as a word processor, spreadsheet, database, presentation or services, or both, into a package
graphics, and Web browser) into “suites” that offer customers a discount over purchasing that offers customers extra value
at a special price.
the same packages separately. Fast food outlets often bundle items into “meal deals” that
customers can purchase at lower prices than if they bought the items separately.
Recognizing that each fall the 15 million students who set out for college spend more
than $210 million to furnish and decorate their dormitory rooms and apartments, one retailer
began offering a line of bundled products aimed squarely at this target audience. The com-
pany’s Dorm Room line includes Kitchen in a Box, a set of between 46 and 80 starter pieces
that are suitable for equipping an empty kitchen. One set that is priced at $80 includes pieces
that would cost $140 if purchased separately. The company’s Bath in a Box includes over-
sized towels that are convenient for dorm life and a laundry bag with handy instructions for
washing clothes for students who have not yet mastered the art of sorting clothes.24 optional product pricing
Optional-product pricing involves selling the base product for one price but selling a technique that involves selling
the options or accessories for it at a much higher markup. Automobiles are often sold at a the base product for one price but
base price with each option priced separately. In some cases, the car is sold with some of selling the options or accessories
the options “bundled” together, as explained previously. for it at a much higher markup.
Kettler, a German company that makes upscale tricycles, uses an optional-product pricing
strategy that more closely mimics BMW than Babies “R” Us. A basic model of its most
popular tricycle, The Navigator, starts at $70, but a host of options ranging from a seat
belt ($15.99) to a little red bell ($5.99) quickly pushes the price to $150 or more, far
Kettler
above the price of an average tricycle. Despite Kettler’s premium prices, parents who want
only the best for their children are snapping up the company’s high-quality tricycles fast
enough that its sales are growing at nearly 20 percent a year.25
captive-product pricing Captive-product pricing is a pricing strategy in which the base product is not func-
a technique that involves selling a tional without the appropriate accessory. King Gillette, the founder of Gillette, taught the
product for a low price and business world that the real money is not in selling the razor (the product) but in selling the
charging a higher price for the blades (the accessory)! Most companies in the desktop printer business use this technique.
accessories that accompany it.
They introduce a printer at a low initial price and then price replacement cartridges so that
they earn high margins on them. Manufacturers of electronic games also rely on captive-
product pricing, earning lower margins on the game consoles and substantially higher mar-
gins on the game cartridges.
byproduct pricing Byproduct pricing is a technique in which the revenues from the sale of byproducts
a technique in which the revenues allow a company to be more competitive in its pricing of the main product. For years,
from the sale of byproducts allow sawmills thought that the bark from the trees they processed was a nuisance. Now it is pack-
a company to be more competitive aged and sold to gardeners who use the bark chips for ground cover. Zoos across the globe
in its pricing of the main product. offer one of the most creative examples of byproduct pricing, packaging once-worthless
exotic animal droppings and marketing it as fertilizer under the clever name “Zoo Doo.”
Suggested Retail Prices Many manufacturers print suggested retail prices on their
products or include them on invoices or in wholesale catalogs. Small business owners
frequently follow these suggested retail prices because this eliminates the need to make a
pricing decision. Nonetheless, following prices established by a distant manufacturer may
create problems for the small firm. For example, a haberdasher may try to create a high-
quality, exclusive image through a prestige pricing policy, but manufacturers may suggest
discount outlet prices that are incompatible with the small firm’s image. Another danger of
accepting the manufacturer’s suggested price is that it does not take into consideration a
small company’s cost structure or competitive situation. A manufacturer cannot force a
business to accept a suggested retail price or require a business to agree not to resell
merchandise below a stated price because this would be a violation of the Sherman
Antitrust Act and other legislation.
Pricing for Value
A fter spending 15 years as an executive in the textile

financial position. Revenues have climbed to $1.25 mil-
lion, and profits are up.
industry and 3 years as an elementary school teacher, As they considered their pricing options, Doellgast
Jeannette Doellgast made a major career move. With and El Din spent time defining the image they wanted
her husband and business partner, Alam El Din, she pur- the inn to have and the target customers they wanted
chased the Plumbush Inn, a bed-and-breakfast (B&B) to attract. In the end, they defined the inn as a B&B
located in the scenic town of Cold Spring, New York. where couples could go for a romantic escape rather
Shortly after taking over the inn, which had been in than one where a family with children might stop for
business for 30 years, Doellgast and El Din realized inexpensive lodging on their way to some vacation des-
that they needed to raise the prices they charged for tination. Doellgast says that once they settled on the
both the rooms they rented and the meals they served image they wanted to create, the price increases were
in their dining area. “It was a risk,” says Doellgast. essential. “A richer experience costs more money to
Most of their customers were regulars, so the couple provide,” she explains. The meals in the Plumbush Inn
took the time to explain the new pricing policy with dining room are a perfect example. “We are a slow din-
each one. A few customers were displeased, but most ing experience,” says Doellgast. “We don’t buy anything
accepted the price increases without complaint. The frozen. Everything is fresh, which makes a difference in
increases have put the Plumbush Inn in a much stronger the price.” The chef also uses organic products, which
typically cost more, but diners appreciate the fine dining intense the competition, the more difficult it is to
experience they get at the inn. Even the customers who raise prices.
initially complained about the price increases have r If you need to raise prices shortly after launching
returned and are satisfied because they now receive a your business, try to soften the blow by bundling
higher level of service. “People bring with them a whole products and services to create more value for
set of equations when they make a purchase, and one of customers.
the values for most people is that high price equals qual- r Assign someone in your company to track com-
ity,” explains pricing expert Rob Docters. “Pricing is not petitors’ prices regularly (at least monthly) and to
just about cost,” he says. It’s about value.” present the results on a timely basis.
Before establishing their new pricing structure, r Do not blindly follow your competitors’ pricing
Doellgast and El Din researched their competitors’ prices. strategies.
Their competitors’ prices were a consideration in making r Base your pricing on the value that your product or
their own pricing decisions, but the primary factors were service offers customers. Remember that some-
the image they wanted to create for the Plumbush Inn times the most valuable components of a product
and the customers they were targeting. “Pricing is an or service are intangible.
art, but it’s not only about pricing,” says Deollgast. It’s r Define the image you want to create for your busi-
about differentiating yourself and deciding what your ness and use your pricing strategy to communicate
niche [is] and what the value of your niche [is]. If you that image to your customers and to position your
build your business around low price, somebody is going company in the market.
to come in next week and undercut you. [In that case],
1. Why do many entrepreneurs underprice their
you really haven’t established your market.”
goods and services, especially when they first get
What steps can entrepreneurs take when it comes
into business? Discuss the connection between
to setting prices the right way? The following tips will
the prices a company establishes for its goods
help:
and services and the image it creates for the
r Know your costs, including the direct and the indi- company.
rect costs, of providing your product or service. 2. What is the impact of these pricing errors on a
r Don’t set your price below your costs. “We lose small company? What steps can entrepreneurs
money on every unit we sell, but we make up for it take to avoid this problem?
in volume” is a business philosophy that never
works. Sources: Geoff Williams, “Name Your Price,” Entrepreneur,
September 2005, pp. 108–115; Bridget McCrea, “When Is the Price
r Price increases are easier to accomplish when a Right? Effective Pricing Is Crucial to Remain Competitive and Move
company faces fewer competitors. The more Product,” Black Enterprise, July 2004, pp. 78–79.
Pricing Strategies and Methods for Retailers LEARNING OBJECTIVES

3A. Explain the pricing methods
As customers have become more price-conscious, retailers have changed their pricing and strategies for retailers.
strategies to emphasize value. This value/price relationship allows for a wide variety of
highly creative pricing and marketing practices. As discussed previously, delivering high
levels of recognized value in products and services is one key to retail customer loyalty.
Markup
The basic premise of a successful business operation is selling a good or service for more
than it costs. The difference between the cost of a product or service and its selling price is
called markup (or markon). Markup can be expressed in dollars or as a percentage of markup (or markon)
either cost or selling price: the difference between the cost of
a product or service and its selling
Dollar markup & Retail price # Cost of the merchandise price.
Dollar markup
Percentage 1of retail price2 markup &
Retail price
Dollar markup
Percentage 1of cost2 markup &
Cost of unit
For example, if a man’s shirt costs $15 and a business owner plans to sell it for $25,
the markup would be as follows:
Dollar markup & $25 # $15 & $10
Percentage 1of retail price2 markup & $10 % $25 & 40%
Percentage 1of cost2 markup & $10 % $15 & 66.67%
Notice that the cost of merchandise used in computing markup includes not only the
wholesale price of the merchandise, but also any incidental costs (e.g., selling or trans-
portation charges) that the retailer incurs and a profit minus any discounts (quantity, cash)
that the wholesaler offers.
Once a business owner has a financial plan, including sales estimates and anticipated
expenses, he or she can compute the firm’s initial markup. The initial markup is the
average markup required on all merchandise to cover the cost of the items, all incidental
expenses, and a reasonable profit:
Operating expenses " Reductions " Profits
Initial dollar markup &
Net sales " Reductions
In this calculation, operating expenses include the cost of doing business, such as rent, util-
ities, and depreciation, and reductions include employee and customer discounts, mark-
downs, special sales, and the cost of stockouts.
For example, if a small retailer forecasts sales of $380,000, expenses of $140,000, and
$24,000 in reductions, and he or she expects a profit of $38,000, the initial markup per-
centage is calculated as follows
$140,000 " $24,000 " $38,000
Initial markup percentage & & 50%
$380,000 " $24,000
This retailer thus knows that an average markup of 50 percent is required to cover
costs and generate an adequate profit.
Some businesses employ a standard markup on all of their merchandise. This tech-
nique, which is usually used in retail stores carrying related products, applies a standard
percentage markup to all merchandise. Most stores find it much more practical to use a
flexible markup, which assigns various markup percentages to different types of products.
Because of the wide range of prices and types of merchandise they sell, department stores
frequently rely on a flexible markup. It would be impractical for them to use a standard
markup on all items because they have such a divergent cost and volume range. For
instance, the markup percentage for socks is not likely to be suitable as a markup for wash-
ing machines.
Once an owner determines the desired markup percentage, he or she can compute the
appropriate retail price. Knowing that the markup of a particular item represents 40 percent
of the retail price gives
Cost & retail price # markup
& 100% # 40%
& 60% of retail price
Assuming that the cost of the item is $18.00, the retailer can rearrange the percentage (of
retail price) markup formula:
Retail price & Dollar cost % Percentage of retail price
The retailer computes a price as follows:
Retail price & $18.00 % 0.60 & $30.00
Thus, the owner establishes a retail price of $30.00 for the item using a 40 percent markup.
Finally, retailers must verify that the retail price they have calculated is consistent with
their planned initial markup percentage. Will it cover costs and generate the desired profit?
FIGURE 10.2
Sample Pocket Price

The Sale Rack Shuffle Band
Have you ever purchased an item of clothing at a
significant discount from the sale rack and then
wondered if the store actually made any profit on
the item? Here is how the markdown process
typically works:
1. Clothing company makes dress at a cost of $50.

2. Sells dress to retailer at a wholesale cost of $80.
3. Retailer marks dress up to $200.
4. If unsold after eight to twelve weeks, dress is
marked down by 25 percent to $150.
5. If dress still does not sell, it is marked down
further until it does. Clothing company and
retailer negotiate on how to share the cost of
the markdown.
Is it congruent with the firm’s overall price image? Is the final price in line with the com-
pany’s strategy? Is it within an acceptable price range? How does it compare to the prices
charged by competitors? And, perhaps most important, are the customers willing and able
to pay this price? Figure 10.2 explains the mathematics of markups—and markdowns—at
the retail level.
Follow-the-Leader Pricing
Some small companies make no effort to be price leaders in their immediate geographic
areas and simply follow the prices that their competitors establish. Entrepreneurs wisely
monitor their competitors’ pricing policies and individual prices by reviewing their adver-
tisements or by hiring part-time or full-time comparison shoppers. However, some retailers
use this information to establish “me-too” pricing policies, which eradicate any opportu-
nity to create a special price image for their businesses. Although many retailers must
match competitors’ prices on identical items, maintaining a follow-the-leader pricing pol-
icy may not be healthy for a small business because it robs the company of the opportunity
to create a distinctive image in its customers’ eyes.
Below-Market Pricing
Some small businesses choose to create a discount image in the market by offering goods
at below-market prices. By setting prices below those of their competitors, these firms
hope to attract a sufficient level of volume to offset the lower profit margins. Many retail-
ers using a below-market pricing strategy eliminate most of the extra services that their
above-market-pricing competitors offer. For instance, these businesses trim operating costs
by cutting out services like delivery, installation, credit granting, and sales assistance.
Below-market pricing strategies can be risky for small companies because they require
them to constantly achieve high sales volume to remain competitive.
Pricing Concepts for Manufacturers LEARNING OBJECTIVES

3B. Explain the pricing methods
For manufacturers, the pricing decision requires the support of accurate, timely accounting
and strategies for manufacturers.
records. The most commonly used pricing technique for manufacturers is cost-plus pric-
ing. Using this method, a manufacturer establishes a price that is composed of direct mate-
rials, direct labor, factory overhead, selling and administrative costs, plus the desired profit
margin. Figure 10.3 illustrates the cost-plus pricing components.
FIGURE 10.3 Selling Price
Cost-Plus Pricing Profit Margin

Components Selling and
Administrative Costs
Direct Labor
Direct Materials
Factory Overhead
The main advantage of the cost-plus pricing method is its simplicity. Given the proper
cost accounting data, computing a product’s final selling price is relatively easy. In addi-
tion, because they add a profit onto the top of their companies’ costs, manufacturers are
guaranteed the desired profit margin. This process, however, does not encourage the man-
ufacturers to use their resources efficiently. Even if the company fails to employ its
resources in the most effective manner, it will still earn a reasonable profit, and thus there
is no motivation to conserve resources in the manufacturing process. Finally, because man-
ufacturers’ cost structures vary so greatly, cost-plus pricing fails to consider the competition
(and market forces) sufficiently. Despite its drawbacks, the cost-plus method of establishing
prices remains prominent in many industries such as construction and printing.
Direct Costing and Price Formulation

One requisite for a successful pricing policy in manufacturing is a reliable cost accounting
system that can generate timely reports to determine the costs of processing raw materials
absorption costing into finished goods. The traditional method of product costing is called absorption cost-
the traditional method of product ing because all manufacturing and overhead costs are absorbed into a finished product’s
costing in which all manufacturing total cost. Absorption costing includes direct materials, direct labor, plus a portion of fixed
and overhead costs are absorbed and variable factory overhead in each unit manufactured. Full absorption financial state-
into the product’s total cost. ments are used in published annual reports and in tax reports and are very useful in per-
forming financial analysis. However, full absorption statements are of little help to manu-
facturers when determining prices or the impact of price changes.
variable (or direct) costing A more useful technique for managerial decision making is variable (or direct) cost-
a method of product costing that ing, in which the cost of the products manufactured includes only those costs that vary
includes in the product’s cost only directly with the quantity produced. In other words, variable costing encompasses direct
those costs that vary directly with materials, direct labor, and factory overhead costs that vary with the level of the firm’s out-
the quantity produced.
put of finished goods. Those factory overhead costs that are fixed (rent, depreciation,
insurance) are not included in the costs of finished items. Instead, they are considered to be
expenses of the period.
A manufacturer’s goal when establishing prices is to discover the combination of selling
price and sales volume that covers the variable costs of producing a product and contributes
toward covering fixed costs and earning a profit. The problem with using full-absorption
costing for this is that it clouds the true relationships among price, volume, and costs by
including fixed expenses in unit cost. Using a direct costing basis yields a constant unit
cost for the product no matter what volume of production. The result is a clearer picture of
the price/volume/costs relationship.
The starting point for establishing product prices is the direct cost income statement.
As Table 10.1 indicates, the direct cost statement yields the same net income as does the
full-absorption income statement. The only difference between the two statements is the
format. The full-absorption statement allocates costs such as advertising, rent, and utilities
according to the activity that caused them, but the direct cost income statement separates
expenses into their fixed and variable components. Fixed expenses remain constant regard-
less of the production level, but variable expenses fluctuate according to production volume.
When variable costs are subtracted from total revenues, the result is the manufac-
turer’s contribution margin—the amount remaining that contributes to covering fixed
expenses and earning a profit. Expressing this contribution margin as a percentage of total
TABLE 10.1 Full-Absorption versus Direct-Cost Income Statement

Full-Absorption Income Statement
Sales revenue $ 790,000
Cost of goods sold
Materials 250,500
Direct labor 190,200
Factory overhead 120,200 560,900
Gross profit $ 229,100
Operating expenses
General and administrative 66,100
Selling 112,000
Other 11,000
Total operating expenses 189,100
Net income (before taxes) $ 40,000
Direct-Cost Income Statement
Sales revenue (100%) $ 790,000
Variable costs
Materials 250,500
Direct labor 190,200
Variable factory overhead 13,200
Variable selling expenses 48,100
Total variable costs (63.54%) 502,000
Contribution margin (36.46%) 288,000

Fixed costs
Fixed factory overhead 107,000
Fixed selling expenses 63,900
General and administrative 66,100
Other fixed expenses 11,000
Total fixed expenses (31.39%) 248,000
Net income (before taxes) (5.06%) $ 40,000
revenue yields the company’s contribution margin. Computing the contribution per-
centage is a critical step in establishing prices through the direct costing method. This
manufacturer’s contribution percentage is 36.5 percent.
Computing the Break-Even Selling Price

The manufacturer’s contribution percentage tells what portion of total revenues remains
after covering variable costs to contribute toward meeting fixed expenses and earning a
profit. This manufacturer’s contribution margin is 36.5 percent, which means that vari-
able costs absorb 63.5 percent of total revenues. In other words, variable costs make up
63.5 percent (1.00 # 0.365 & 0.635) of the product’s selling price. Suppose that this man-
ufacturer’s variable costs include the following:
Material $2.08/unit
Direct labor $4.12/unit
Variable factory overhead $0.78/unit
Total variable cost $6.98/unit
The minimum price at which the manufacturer would sell the item for is $6.98. Any
price below this would not cover variable costs. To compute the break-even selling price
for this product, we find the selling price using the following equation:
Selling price
Profit " 1Variable cost per unit $ Quantity produced2 " Total fixed cost
&
Quantity produced
To break even, the manufacturer assumes $0 profit. Suppose that his plans are to produce
50,000 units of the product and that fixed costs will be $110,000. The break-even selling
price is as follows:
Break-even selling price
$0 " 1$6.98 per unit $ 50,000 units2 " $110,000
&
50,000 units
$459,000
&
50,000 units
& $9.18 per unit
Thus, $2.20 ($9.18/unit # $6.98/unit) of the $9.18 break-even price contributes to meeting
fixed production costs. But suppose the manufacturer wants to earn a $50,000 profit. Then
the selling price is calculated as follows:
Selling price
$50,000 " 1$6.98 per unit $ 50,000 units2 " $110,000
&
50,000 units
$509,000
&
50,000 units
& $10.18 per unit
Now the manufacturer must decide whether customers will purchase 50,000 units at
$10.18. If not, he or she must decide either to produce a different, more profitable product
or to lower the selling price. Any price above $9.18 will generate some profit, although
less than that desired. In the short run, the manufacturer could sell the product for less than
$9.18 if competitive factors so dictated, but not below $6.98 because this would not cover
the variable cost of production.
Because the manufacturer’s capacity in the short run is fixed, pricing decisions should
be aimed at employing these resources most efficiently. The fixed costs of operating the
plant cannot be avoided, and the variable costs can be eliminated only if the firm ceases
offering the product. Therefore, the selling price must be at least equal to the variable costs
(per unit) of making the product. Any price above this amount contributes to covering
fixed costs and providing a reasonable profit.
Of course, over the long run, the manufacturer cannot sell below total costs and con-
tinue to survive. So, selling price must cover total product cost—both fixed and variable—
and generate a reasonable profit.
Calculate Your Company’s charge. Doing so, however, may be misleading if the
company offers significant “off-invoice” discounts such
Pocket Price Band as cash discounts for paying early, quantity discounts for
W
large purchases, special promotional discounts, and
hen entrepreneurs make pricing decisions, they others. These invoice leakages mean that a business is
usually look at the retail price or the invoice price they getting less, sometimes far less, than the retail or
100% 2% 3.5%
100
4.4%
10.8%
90
80 2.1%
77.2%
Percentage of Invoice Price

70
60
50
40
30
20
10
0
Invoice Cash Volume Coop Promotional Other Average
price discount discount advertising discount discounts pocket price
FIGURE 1
What Determines Price?
invoice price listed. In some cases, a company’s pocket estimate the width of the company’s pocket price band,
price, the price it receives for a product or a service after which shows the percentage of sales accounted for by
deducting all discounts and purchase incentives, is far each pocket price (shown as a percentage of the listed
below the listed retail or invoice price. The impact of invoice or retail price) (see Figure 2). In this example,
these discounts can be significant. Research by the con- pocket prices that are 90 percent or more of the com-
sulting firm McKinsey and Company shows that a pany’s invoice price account for just 28.3 percent of its
decrease of one percent in a typical company’s average total revenue. Conversely, pocket prices that are 80 per-
prices will reduce its operating profits by eight percent if cent or less of its invoice price make up 46.2 percent of
all other factors remain constant. its total revenue. The final step in the process is to iden-
How are discounts affecting your business? To find tify the individual customers that make up each seg-
out, you need to estimate your company’s pocket price ment of the company’s pocket price band.
waterfall and its pocket price band (see Figure 1). The A wide pocket price band is not necessarily bad. It
pocket price waterfall starts with a company’s invoice or simply shows that some customers generate much
retail price on the far left of the diagram and then shows higher pocket prices than others. When a band is wide,
how much every discount or incentive the company small changes in its shape can produce big results for a
offers its customers reduces that price. In the example in company. If an entrepreneur can increase sales at the
Figure 1, this small manufacturer offers a cash discount upper end of the band while reducing or even dropping
for early payment that shaves 2.0 percent off of the retail those at the lower end of the band, both the company’s
price, a 3.5 percent discount for companies whose pur- revenues and profits will climb. If a company’s price band
chases exceed a particular volume, a cooperative adver- is narrow, an entrepreneur has less room to maneuver
tising program (in which it splits the cost of advertising prices, changing the shape of the band is more difficult,
its products with retailers) that amounts to 4.4 percent, and any changes the entrepreneur can make tend to
and periodic promotional discounts to move products have less impact on the company’s sales and revenues.
that average 10.8 percent. Other discounts the company When one lighting company calculated its pocket
offered customers further reduced its pocket price. In price band, managers were surprised at its width. Once
the end, the company’s average pocket price is 77.2 per- managers realized how big a dent discounts were
cent of the listed invoice price. putting in its revenues and profits, they worked with
Not every customer qualifies for every discount, the sales force to realign the company’s discount struc-
however. The type and the amount of the discount vary ture. Some of the company’s smallest accounts had
from one customer to another; the pocket prices they been getting the largest discounts, despite their small
pay can vary a good deal. Therefore, it is important to volume of purchases. Managers also focused on boosting
30%
25.5%
25%
Percentage of Total Sales Volume
20% 19.5%
16.8%
15% 14.3%
12.4%
10%
8.3%
5%
3.2%
0%
70% 75% 80% 85% 90% 95% 100%
Pocket Price as Percentage of Invoice Price
FIGURE 2
The Mathematics of Markups and Markdowns
sales to those accounts that were producing the highest discounts, and, as a result, few companies realize the
pocket prices. These changes resulted in the company’s impact that discounts have on their profitability. By mon-
average pocket price rising by 3.8 percent and its profits itoring their companies’ pocket price waterfall and the
climbing 51 percent. resulting pocket price band, entrepreneurs can improve
Discounts tend to work their way into a company’s significantly the revenue and the profits they generate.
pricing structure gradually over time, often one transac-
tion at a time, especially if an entrepreneur gives sales
Sources: Michael V. Marn, Eric V. Roegner, and Craig C. Zawada,
representatives latitude to negotiate prices with cus- “The Power of Pricing,” The McKinsey Quarterly, Number 1, 2003,
tomers. Few companies make the effort to track these www.mckinseyquarterly.com.
LEARNING OBJECTIVES Pricing Strategies and Methods for Service Firms

3C. Explain the pricing methods
and strategies for service firms. A service firm must establish a price based on the materials used to provide the service,
the labor employed, an allowance for overhead, and a profit. As in the manufacturing
operation, a service business must have a reliable, accurate accounting system to keep a
tally of the total costs of providing the service. Most service firms base their prices on an
hourly rate, usually the actual number of hours required to perform the service. Some
companies, however, base their fees on a standard number of hours, determined by the
average number of hours needed to perform the service. For most firms, labor and materi-
als comprise the largest portion of the cost of the service. To establish a reasonable, prof-
itable price for service, the small business owner must know the cost of materials, direct
labor, and overhead for each unit of service. Using these basic cost data and a desired
profit margin, an owner of the small service firm can determine the appropriate price for
the service.
Consider a simple example for pricing a common service—television repair. Ned’s
T.V. Repair Shop uses the direct costing method to prepare an income statement for exer-
cising managerial control (see Table 10.2). Ned estimates that he and his employees spent
about 12,800 hours in the actual production of television service. Therefore, total cost per
productive hour for Ned’s T.V. Repair Shop comes to the following:
$172,000 % 12,800 hours & $13.44/hour
TABLE 10.2 Direct-Cost Income Statement, Ned’s T.V. Repair Shop

Sales revenue $199,000
Variable expenses
Labor 52,000
Materials 40,500
Variable factory overhead 11,500
Total variable expenses 104,000
Fixed expenses
Rent 2,500
Salaries 38,500
Fixed overhead 27,000
Total fixed expenses 68,000
Net income $ 27,000
Now Ned must add in an amount for his desired profit. He expects a net operating profit of
18 percent on sales. To compute the final price he uses the following equation:
Price per hour
1.00
& Total cost per productive hour $
1.00 # Net profit target as percentage of sales
& $13.44 $ 1.219
& $16.38 per hour
A price of $16.38 per hour will cover Ned’s costs and generate the desired profit. The wise
service shop owner computes his cost per production hour at regular intervals throughout
the year. Rapidly rising labor costs and material prices dictate that the service firm’s price
per hour be computed even more frequently. As in the case of the retailer and the manu-
facturer, Ned must evaluate the pricing policies of competitors, and decide whether his
price is consistent with his firm’s image.
Of course, the price of $16.38 per hour assumes that each job requires the same
amount of materials. If this is not a valid assumption, Ned must recalculate the price per
hour without including the cost of materials:
$172.000 # $40,500
Cost per productive hour &
12,800 hours
& $10.27 per hour
Adding in the desired 18 percent net operating profit on sales gives
$10.27 1.00
Price per hour & $
hour 1.00 # 0.18
$10.27
& $ 1.219
hour
& $12.52 per hour
Under these conditions, Ned would charge $12.52 per hour plus the actual cost of
materials used and any markup on the cost of material. A repair job that takes four hours to
complete would have the following price:
Cost of service (4 hours $ $12.52/hour) $50.08

Cost of materials $21.00
Markup on material (20%) $4.20
Total price $75.28
Finding the right price for his business and event planning service was a problem facing Joshua
Estrin, founder of Concepts in Success. Initially, Estrin established a reasonable annual salary
for himself and then set the price for each project as a percentage of that salary. Because that
system required him to spend excessive amounts of time documenting details of every
Concepts in Success
expense for his clients, Estrin soon switched to an hourly rate that exceeded $100 per hour.
Now that he has more experience, Estrin charges for the services that Concepts in Success
offers using set price points that depend on the services his clients choose. Estrin’s pricing pol-
icy is working. His company now generates $1 million in annual revenue and counts several
major corporations, including American Express, Hertz, and PepsiCo, among its clients.26
Pricing Web Services
K erry Pinella, a recent business graduate of a small

so they could get away, review their progress, and plan
for the future. As they reviewed their latest financial
private college, started her career working for a large statements, one of the questions that kept popping up
multinational computer software maker as a sales repre- dealt with pricing. Were Web Consultant’s pricing poli-
sentative. After two years in sales, Kerry applied for a cies appropriate? Its sales were growing twice as fast as
position on a development team that was working on the industry average, and the company’s bid-winning
software applications for the World Wide Web. Kerry ratio was well above that of practically all of its com-
thrived on the team atmosphere and learned the techni- petitors. For the current year, sales were up, but Web
cal aspects of the new assignment very quickly. Not only Consultants’ net profits were virtually the same as they
did her team bring their project in on budget, but it also had been in their first year.
completed it slightly ahead of schedule. Team members Pulling the records from a computer database for
give much of the credit for the project’s success to Kerry’s each job they had completed since founding the com-
unofficial role as team leader. Her work ethic and relent- pany, they found that the partners and their employees
less pursuit of quality inspired other team members. had spent 22,450 hours developing projects for their
After Kerry’s team completed their project, however, clients at a total cost of $951,207. “We were shooting
Kerry had a hard time recapturing the thrill and excite- for a net profit of 25 percent on sales,” Kerry reminded
ment of developing the World Wide Web software. her partners, “but we so far, our net profit margin is just
Subsequent projects simply could not measure up to the 7.7 percent, only one-third of our target.”
“magic” of that first assignment. After talking with sev- “Maybe we could increase our profits if we
eral of the members of that software team, Kerry dis- increased our sales,” offered one partner.
covered that they felt the same way. Before long, Kerry The partners began to wonder whether their price
and two of her former team members left the company of $45 per hour was appropriate. Admittedly, they had
to launch their own computer consulting company, been so busy completing projects for clients that they
Web Consultants. Having worked on the forefront of had not kept up with what their competitors were
the Web’s commercialization, Kerry and her partners charging. Nor had they been as diligent in analyzing
saw the potential it had for revolutionizing business. their financial statements as they should have been.
Their company would specialize in developing , design- As Kerry closed the cover on her laptop computer,
ing, and maintaining Web sites for clients. In their first she looked at her partners and asked, “What should
year of business, Web Consultants accepted jobs from Web Consultant’s hourly price be?”
virtually anybody who wanted a Web site. Although
they experienced some growing pains, Web Consultants 1. Help Kerry answer the question she posed.
quickly earned a reputation for producing quality work 2. What factors should Kerry and her partners consider
on time and became more selective in the jobs it bid on. when determining Web Consultant’s final price?
Halfway into their second year of operation, the 3. Is the company’s current price too low? If so, what
partners planned a weekend retreat at a nearby resort signals could have alerted Kerry and her partners?
The Impact of Credit on Pricing LEARNING OBJECTIVES

4. Describe the impact of credit
Consumers crave convenience when they shop, and one of the most common conveniences on pricing.
they demand is the ability to purchase goods and services on credit. Small businesses that
fail to offer credit to their customers lose sales to competitors who do. However, compa-
nies that do sell on credit incur additional expenses for offering this convenience. Small
companies have three options for selling to customers on credit: credit cards, installment
credit, and trade credit.
Credit Cards
Credit cards have become a popular method of payment among customers, who now
make 30 percent of personal consumption expenditures with credit cards. Approximately
73 percent of the adult U.S. population uses credit cards to make purchases, and the aver-
age U.S. household has 17 credit cards carrying an average interest rate of 18.9 percent a
year.27 The number of credit cards in circulation in the United States exceeds 1.5 billion,
an average of more than 8.5 cards per person! Customers use credit cards to make pur-
chases of more than $2.2 trillion a year, an amount equal to about 20 percent of the total
U.S. gross domestic product. The average amount a household charges to credit cards in a
year now exceeds $15,000.28 Studies have found that accepting credit cards increases the
probability, speed, and magnitude of customer spending. In addition, surveys show that
customers rate businesses offering credit options higher on key performance measures
such as reputation, reliability, and service.29 In short, accepting credit cards broadens a
small company’s customer base and closes sales that it would normally lose if customers
had to pay in cash.
Increasingly, customers are using credit cards to pay for micropurchases, those cost-
ing less than $5. The research company Gartner Inc. predicts that by 2020, the average
American adult will make more than 20 micropurchases per month on either debit or
credit cards. To make sure that they capture their share of those small purchases, fast food
restaurants now accept credit and debit cards. As a result, quick-service restaurants have
seen sales climb rapidly and the average transaction time drop. For instance, average sales
have risen from $5 to $7 since McDonald’s began accepting debit and credit cards, and
the cashless transactions have shaved seven seconds off the average service time.
Customers now purchase more than $37 billion worth of fast food on their debit and
credit cards a year.30
The convenience of credit cards is not free to business owners, however. Companies
must pay to use the system, typically one to six percent of the total credit card charges,
which they must factor into the prices of their products or services. They also pay a trans-
action fee of 5 to 25 cents per charge. Given customer expectations, small businesses
cannot drop major cards, even when the big credit card companies raise the fees that
merchants must pay. Fees operate on a multistep process. On a typical $100 Visa or
MasterCard purchase, a processing bank buys the credit card slip from the retailer for
$98.25. Then, that bank sells the slip to the bank that issued the card for about $98.49. The
$1.75 discount from the purchase price is called the interchange fee, the fee that banks interchange fee
collect from retailers whenever customers use a credit or a debit card to pay for a purchase. the fee that banks collect from
A study by Morgan Stanley estimates that the average interchange fees for Visa and retailers whenever customers use a
MasterCard transactions will increase from 1.75 percent to 1.86 percent in 2010.31 Before credit or a debit card to pay for a
it can accept credit cards, a business must obtain merchant status from either a bank or an purchase.
independent sales organization (ISO).
In 2003, the first time in history, shoppers used credit and debit cards more often than
cash or checks to make retail purchases.32 As debit cards have become more widely used,
many small businesses are equipping their stores to handle debit card transactions, which
act as electronic checks, automatically deducting the purchase amount immediately from a
customer’s checking account. The equipment is easy to install and to set up, and the cost to
the company is negligible. The payoff can be big, however, in the form of increased sales
and decreased losses due to bad checks. “How can you possibly lose when you’re offering
customers another avenue for purchasing merchandise?” says Mark Knauff, who recently
installed a debit card terminal in his guitar shop.33
Online merchants face one major challenge when customers pay by credit card.
Because there is no actual signature captured during the transaction, some customers later
deny that they made the purchase and dispute the charge. These chargebacks represent a
significant threat to online merchants. First Data Corporation, the largest credit card
processor in the United States, says that 1.25% of all Internet transactions are charged
back, compared with just 0.33% of catalog transactions by telephone and mail and 0.14%
of storefront retail transactions.68 New computer software is attempting to reduce this
fraud by checking whether customers’ shipping addresses match their billing addresses.
Installment Credit
Small companies that sell big-ticket consumer durables, such as major appliances, cars,
and boats, frequently rely on installment credit to support their sales efforts. Because very
few customers can purchase such items in a single lump-sum payment, small businesses
finance them over an extended time. The time horizon may range from just a few months
to 30 or more years. Most companies require customers to make an initial down payment
for the merchandise and then finance the balance for the life of the loan. The customer
repays the loan principal plus interest on the loan. One advantage of installment loans for a
small business is that the owner retains a security interest as collateral on the loan. If a cus-
tomer defaults on the loan, the owner still holds the title to the merchandise. Because
installment credit absorbs a small company’s cash, many rely on financial institutions such
as banks and credit unions to provide installment credit. When a company has the financial
strength to “carry its own paper,” the interest income from the installment loan contract
often yields more than the initial profit on the sale of the product. For some businesses,
such as furniture stores, this traditionally has been a major source of income.
Trade Credit
Companies that sell small-ticket items frequently offer their customers trade credit, that is,
they create customer charge accounts. The typical small business bills its credit customers
each month. To speed collections, some offer cash discounts if customers pay their bal-
ances early; others impose penalties on late payers. Before deciding to use trade credit as a
competitive weapon, the small business owner must make sure that the firm’s cash position
is strong enough to support the additional pressure.
Chapter Summary by Learning Objective
1. Discuss the relationships among pricing, image, the competition grows; and earning a profit. Generally,
competition, and value. there are three major pricing strategies used to introduce
Setting prices for their products and services requires entre- new products into the market: penetration, skimming, and
preneurs to balance a multitude of complex forces. When it sliding down the demand curve.
comes to setting prices, three forces are particularly impor- Pricing techniques for existing products and services
tant: image, competition, and value. A company’s pricing include odd pricing, price lining, leader pricing, geographic
policies communicate important information about its over- pricing, opportunistic pricing, discounts, and suggested
all image to customers. A company’s prices must be consis- retail pricing.
tent with the image it projects to its customers. When setting
prices, entrepreneurs should take into account their competi- 3. Explain the pricing methods and strategies for
(A) retailers, (B) manufacturers, and (C) service firms.
tors’ prices, but they should not automatically match or beat
them. The “right” price for a product or service also depends Pricing for the retailer means pricing to move merchandise.
on the value that it provides for customers. Markup is the difference between the cost of a product or
service and its selling price. Most retailers compute their
2. Describe effective pricing techniques for introducing markup as a percentage of retail price, but some retailers
new goods or services and for existing ones. put a standard markup on all their merchandise; more fre-
Pricing a new product is often difficult for the small busi- quently, they use a flexible markup.
ness manager, but it should accomplish three objectives: A manufacturer’s pricing decision depends on the sup-
getting the product accepted; maintaining market share as port of accurate cost accounting records. The most common
technique is cost-plus pricing, in which the manufacturer involved, overhead, and a profit. The proper price reflects
charges a price that covers the cost of producing a product the total cost of providing a unit of service.
plus a reasonable profit. Every manufacturer should calcu-
4. Describe the impact of credit on pricing.
late a product’s break-even price, the price that produces
neither a profit nor a loss. Offering consumer credit enhances a small company’s rep-
Service firms often suffer from the effects of vague, utation and increases the probability, speed, and magnitude
unfounded pricing procedures, and frequently charge the of customers’ purchases. Small firms offer three types of
going rate without any idea of their costs. A service firm consumer credit: credit cards, installment credit, and trade
must set a price based on the cost of materials used, labor credit (charge accounts).
Discussion Questions
1. How does pricing affect a small firm’s image? 7. What is a standard markup? A flexible markup?
2. What competitive factors must the small firm con- 8. What is cost-plus pricing? Why do so many manu-
sider when establishing prices? facturers use it? What are the disadvantages of
3. Describe the strategies a small business could use using it?
in setting the price of a new product. What objec- 9. Explain the difference between full-absorption
tives should the strategy seek to achieve? costing and direct costing. How does absorption
4. Define the following pricing techniques: odd pric- costing help a manufacturer determine a reasonable
ing, price lining, leader pricing, geographic pricing, price?
and discounts. 10. Explain the technique for a small service firm set-
5. Why do many small businesses use the manufac- ting an hourly price.
turer’s suggested retail price? What are the disad- 11. What benefits does a small business get by offering
vantages of this technique? customers credit? What costs does it incur?
6. What is a markup? How is it used to determine
individual price?
Business Plan Pro

As the chapter describes, setting enter the information that will enable to you to determine
the price of your products and your break-even point. This will require you to have esti-
services and understanding your mated figures for your fixed costs, variable costs, and price.
break-even point are major elements of your business plan. Once you have entered that information, look at the break-
Resources and information are available within Business even point shown in units and revenue. Based on what you
Plan Pro that may help you to better understand the impact find, is this break-even point realistic? How long do you
that pricing will have on your business. expect it would take to reach your break-even point? Is this
timeframe acceptable? Now, increase your price by 10%.
Business Plan Exercises
What does this do to your break-even point? You may want
On the Web to experiment with your break-even point by entering dif-
Do some competitive pricing research on the Web. Search for ferent price points and costs to see the impact price will
products and services that are similar to what you are offering have on the break-even point when you will begin making a
and list their price points. Check to see that you are making profit.
parallel comparisons of these products. For example, are you
considering the entire price, which may include shipping, Building Your Business Plan
handling, complementary products, and other attributes that Go to the “Sales Forecast” table under the “Sales Strategy”
will influence the final price to the customer? Do you consider section. An optional wizard will appear that you may select
these businesses to be direct competitors? If not, why? What to help you through the process, or you can enter your
does this information tell you about your price point? Does information directly on the worksheet. If you have not done
your price point coincide with your stated business strategy? so yet, enter your price information in that section. Work
through the rest of the table as you estimate your direct unit
In the Software costs. The instructions and examples will assist you
Open your business plan and locate the “Break Even” sec- through that process.
tion under “Financial Plan.” Follow the instructions and
Beyond the Classroom . . .

1. Interview a successful small retailer and ask the How are discounts calculated? What markup per-
following questions: Do they seek a specific image centage does the firm use? How are prices derived?
through their prices? What type of outlet do you What are their cost structures?
consider the retailer to be? What role do their com- 2. Select an industry that has several competing small
petitors play in their pricing strategy? Do they use firms in your area. Contact these firms and com-
specific pricing techniques such as odd pricing, pare their approaches to determining prices. Do
price lining, leader pricing, or geographic pricing? prices on identical or similar items differ? Why?

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10 Pricing Strategies

The price is what you pay;

On completion of this chapter, you will be able to:

1 Discuss the relationships among pricing, image, competition, and value.

Three Potent Forces: Image, Competition, and Value LEARNING OBJECTIVES

In 2002, Eric Schnell and Steven Kessler introduced

Competition and Pricing

Generally, entrepreneurs should avoid head-to-head price competition with other

Price Ceiling FIGURE 10.1

r Emphasize the value your company’s product or service delivers to customers.

After the terrorist attacks in 2001

Pricing Strategies and Tactics LEARNING OBJECTIVES

Introducing a New Product

Market Penetration If a small business introduces a product into a highly competitive

example of a product introduced at a high price that quickly cascaded downward as

Pricing Established Goods and Services

One of the most common tactics

Pricing for Value

A fter spending 15 years as an executive in the textile

Pricing Strategies and Methods for Retailers LEARNING OBJECTIVES

Sample Pocket Price

1. Clothing company makes dress at a cost of $50.

Pricing Concepts for Manufacturers LEARNING OBJECTIVES

FIGURE 10.3 Selling Price

Cost-Plus Pricing Profit Margin

Direct Costing and Price Formulation

TABLE 10.1 Full-Absorption versus Direct-Cost Income Statement

Contribution margin (36.46%) 288,000

Computing the Break-Even Selling Price

Percentage of Invoice Price

What Determines Price?

The Mathematics of Markups and Markdowns

LEARNING OBJECTIVES Pricing Strategies and Methods for Service Firms

TABLE 10.2 Direct-Cost Income Statement, Ned’s T.V. Repair Shop

Cost of service (4 hours $ $12.52/hour) $50.08

Pricing Web Services

K erry Pinella, a recent business graduate of a small

The Impact of Credit on Pricing LEARNING OBJECTIVES

Chapter Summary by Learning Objective

Business Plan Pro

Beyond the Classroom . . .

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