Pricing the Product
Read this chapter. Pricing is a difficult issue because most products will sell at some volume at just about any price level. Some customers are willing to pay almost any price for a specific product, but how many of those customers exist? Marketers could consider a value-priced model, but this may make the product's price so low that there is no way to profit. One common pricing strategy is known as "the loss leader", which involves selling one product below the cost to manufacture it to get it in customers' hands. They make up for this loss later with complementary goods. This is commonly seen in video game console sales. Console system manufacturers like Sony and Nintendo will price the system below the cost to manufacture it. Consumers adopt the systems due to the attractive price point, and the manufacturer makes up for the initial loss on the system with sales of proprietary accessories and video games.
ALTERNATIVE APPROACHES TO DETERMINING PRICE
Cost-Oriented Pricing: Cost-Plus and Mark-Ups
The cost-plus method, sometimes called gross margin pricing, is perhaps most widely used by marketers to set price. The manager selects as a goal a particular gross margin that will produce a desirable profit level. Gross margin is the difference between how much the goods cost and the actual price for which it sells. This gross margin is designated by a percent of net sales. The percent selected varies among types of merchandise. That means that one product may have a goal of 48% gross margin while another has a target of 33M % or 7.%.
A primary reason that the cost-plus method is attractive to marketers is that they do not have to forecast general business conditions or customer demand. I f sales volume projections are reasonably accurate, profits will be on target. Consumers may also view this method as fair, since the price they pay is related to the cost of producing the item. Likewise, the marketer is sure that costs are covered.
A major disadvantage of cost-plus pricing is its inherent inflexibility. For example, department stores have often found difficulty in meeting competition from discount stores, catalog retailers, or furniture warehouses because of their commitment to cost-plus pricing. Another disadvantage is that it does not take into account consumers' perceptions of a product's value. Finally, a company's costs may fluctuate so constant price changing is not a viable strategy.
When middlemen use the teon mark-Up, they are referring to the difference between the average cost and price of all merchandise in stock, for a particular department, or for an individual item. The difference may be expressed in dollars or as a percentage. For example, a man's tie costs $4.60 and is sold for $8. The dollar mark-up is $3.40. The mark-up may be designated as a percent of selling price 0; as a percent of cost of the merchandise.
There are several reasons why expressing mark-up as a percentage of selling price is preferred to expressing it as a percentage of cost. One is that many other ratios are expressed as a percentage of sales. For instance, selling expenses are expressed as a percentage of sales. If selling costs are 8%, this means that for each $100,000 in net sales, the cost of selling the merchandise is $8,000. Advertising expenses, operating expenses, and other types of expenses are quoted in the same way. Thus, there is a consistency when making comparisons in expressing all expenses and costs, including mark-up, as a percentage of sales (selling price).
Middlemen receive merchandise daily and make sales daily. As new shipments are received, the goods are marked and put into stock. Cumulative mark-up is the term applied to the difference between total dollar delivered cost of all merchandise and the total dollar price of the goods put into stock for a specified period of time. The original mark-up at which individual items are put into stock is referred to as the initial mark-up.
Maintained mark-up is another important concept. The maintained mark-up percentage is an essential figure in estimating operating profits. It also provides an indication of efficiency. Maintained mark-up, sometimes called gross cost of goods, is the difference between the actual price for which all of the merchandise is sold and the total dollar delivered cost of the goods exclusive of deductions. The maintained mark-up is typically less than the initial mark-up due to mark-downs and stock shrinkages from theft, breakage, and the like. Maintained mark-up is particularly important for seasonal merchandise that will likely be marked-down substantially at the end of the season.
Although this pricing approach may seem overly simplified, it has definite merit. The problem facing managers of certain types of businesses such as retail food stores is that they must price a very large number of items and change many of those prices frequently. The standard mark-up usually reflects historically profitable margins and provides a good guideline for pricing.
To illustrate this cost-based process of pricing, look at the case of Johnnie Walker Black Label Scotch Whiskey. This product sells for about $30 in most liquor stores. How was this price derived?
$5.00 production, distillation, maturation + $2.50 advertising + $3.11 distribution + $4.39 taxes + $7.50 mark-up (retailer) + $7.50 net margin (manufacturer)
Certainly costs are an important component of pricing. No firm can make a profit until it covers its costs. However, the process of determining costs and then setting a price based on costs does not take into consideration what the customer is willing to pay at the marketplace. As a result, many companies that have set out to develop a product have fallen victim to the desire to continuously add features to the product, thus adding cost. When the product is finished, these companies add some percentage to the cost and expect customers to pay the resulting price. These companies are often disappointed, as customers are not willing to pay this cost-based price.