Ch 3

Ch 3 Outline
Pricing Strategy
Price and Gross Margin
Core Prices and Discounting
Pricing and Competition
3-1 Introduction
• The basic business process that underlies all
ventures, regardless of their industry or size, is:
– R – C = P (revenue minus cost equals profit).
• Understanding the business process is critical for
entrepreneurs and for people who practice the
skills of entrepreneurism.
– One of the last considerations that the entrepreneur
takes into account is the price that will be charged to
– Yet, setting price for products and services is a critical
factor in the success of a venture.
3-1 Introduction (cont.)
• Problem with cost-plus pricing: Customers
care about the price they have to pay for
products and services and the value they
receive for that price.
– If the entrepreneur uses the cost-plus pricing
• The price is set too high and the customer does not
• The price is set too low and each sale returns less
profit to the business than is possible.
How Customer Demand Affects
• The Elasticity of Demand
– The degree to which a change in price affects the
quantity demanded.
– Elastic Demand
• Demand that changes
significantly when there
is a change in the price
of the product.
– Inelastic Demand
• Demand that does not change
significantly when there is a
change in the price of the product.
3-2 Pricing Strategy
• Price strategy is an attempt to affect
demand through alteration of prices.
• An effective price strategy is responsive to the type
of demand present in the market.
3-3 Price and Gross Margin
• Entrepreneurs must also monitor the
effect of their pricing strategy on the
firm’s gross margin.
– Gross margin is the difference between the
selling price of a product or service and the
amount the entrepreneur had to pay for the raw
materials that make up that product or service.
– Gross margin is expressed as a percentage of
revenue, using the following equation:
3-3 Price and Gross Margin
A price reduction
usually results in a reduction in
gross margin.
– Increased sales volume can lead to a reduction in the
average cost of goods sold because suppliers will often
provide discounts to clients that buy in large volumes.
• A price increase that increases sales volume—or,
at least, does not reduce sales volume—is a
powerful tool for profit.
– Businesses that are able to raise prices without cost
increases and without sacrificing sales volume possess
is called pricing power.
3-4 Core Prices and Discounting
• One of the most important considerations in
any price strategy is to protect the core
prices of the business.
– The airline industry provides a good example
of the concept of core price protection.
– Another common method that companies use to
protect their core pricing is through product
3-4 Core Prices and Discounting
– Discounting is the most widely used price
• When the discounted prices are offered for a limited
time, the situation is usually referred to as a sale.
3-4a Pricing and Finance
The U.S. economy
has grown to its present
size in large part based on the use of credit.
– Because the use of credit has become so
pervasive, credit terms have become an
important part of price and volume strategy.
• The furniture and appliance industries offer
examples of the use of interest rate discounting.
• In 2000 the automotive industry instituted a novel
discounting strategy.
– When purchasing a car, the customer was not required to
make any payments for a period of one year.
– Payments toward the vehicle began in the second year
through what is known as a level payment plan.
3-4a Pricing and Finance
When Discounting
starting a new business,(cont.)
many entrepreneurs are
tempted to set their prices below the general market. The
intent of such a strategy is to attract customers by offering
them a price advantage.
– Price is often regarded to be the advantage that customers
will respond to most readily.
– Sometimes this price strategy will lead to the opposite
Customer perception is an important factor in the success
of any business.
Established competitors may also respond by offering
discounts, which could cause a price war the new entrant
will loose.
3-5 Pricing and Competition
• Pricing strategy should never be executed without
thought to the reaction of competitors.
– If a price strategy is effective and encroaches on the
competitor’s market share, there is likely to be a
vigorous reaction.
• In an elastic market, a price change may bring
new customers into the market.
– When a price reduction is based on lower costs and the
price move results in a larger number of buyers in the
market, the strategy is a great success.
• The airline industry is an example of the price reduction cycle
in an elastic market.
3-5 Pricing and Competition
• The reverse side
of the success of price
reductions based on lowered costs and
expanded market is also demonstrated in
the computer and consumer electronics
– Discounters look for markets in which
consumers are price sensitive.

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