1.
Section 3:
Launching the Business
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2.
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Essentials of Entrepreneurship and Small
Business Management
Ninth Edition
Chapter 11
Pricing and Credit Strategies

3.
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Learning Objectives
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 retailers,
manufacturers, and service firms.
4. Describe the impact of credit and
debit cards and mobile wallets on
pricing.

4.
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Introduction
• Pricing:
– Is governed by both art and science.
– Requires balancing a multitude of complex forces.
– Influences every aspect of a small company.
– Is an important signal of value to customers.
– Involves both math and psychology.
– Has a greater impact on profits than corresponding
increases in unit volume or reductions in costs.

5.
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Impact of Pricing and Cost Improvements
on Profitability
Figure 11.1 The Impact of Pricing and Cost Improvements
on Profitability
Source: Based on Richard
Hayes and Ranjit Singh, “CFO
Insights: Pricing for Profitability:
What’s in Your Pocket,”
Deloitte, 2013,
https://www2.deloitte.com/conte
nt/dam/Deloitte/us/Documents/fi
nance-transformation/uscfo-cfo-
insights-pricing-forprofitability-
080113.pdf.

6.
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Image, Competition, Value
• Companies that take a strategic approach to pricing and
monitor its results can raise their sales revenue between
1% and 8%
– Example: Duane Reade

7.
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Price Conveys Image
• Price sends important signals to customers: quality,
prestige, uniqueness, etc.
• Common small business mistake: charging prices that are
too low and failing to recognize extra value, service,
quality, and other benefits they offer.
• The key is to understand the target market and identify
how much customers are willing to pay rather than how
much to charge.

8.
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Competition and Pricing
• Must take into account competitors’ prices, but it is not
always necessary to match or beat them.
• Key is to differentiate a company’s products and services.
• Price wars often eradicate companies’ profits and scar an
industry for years.
• Best strategy: Stay out of a price war!

9.
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The Reality of Setting Prices
Figure 11.2 The Reality of Setting Prices
Source: Based on data from William C. Dunkelberg and Holly Wade, “NFIB Small Business Economic
Trends,” National Federation of Independent Businesses, July 2017, p. 8.

10.
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Focus on Value
• The “right” price for a product or service depends on the
value it provides for a customer.
• Two aspects of price:
– Objective value
– Perceived value: determines the price customers are
willing to pay.
• Value is not synonymous with low price.
– Fighter brand

11.
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Dealing with Rising Costs (1 of 2)
• Communicate with customers
• Add a surcharge
• Focus on improving efficiency
• Consider absorbing cost increases
• Eliminate discounts, coupons, and freebies
• Use cheaper raw materials
• Raise prices incrementally and consistently

12.
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Dealing with Rising Costs (2 of 2)
• Modify the product or service to lower its cost
• Offer products in smaller sizes or quantities
• Differentiate your company and its products and services
from the competition
• Anticipate rising costs and try to lock in prices of raw
materials early
• Emphasize the value of your company’s product or service
to customers

13.
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What Determines Price?
Figure 11.3 What Determines Price?

14.
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Introducing a New Product (1 of 2)
Three Goals:
1. Getting the product accepted
– Revolutionary products
– Evolutionary products
– Me-too products
2. Maintaining market share as competition grows
3. Earning a profit

15.
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Introducing a New Product (2 of 2)
Three basic pricing strategies:
1. Penetration
2. Skimming
3. Life cycle pricing

16.
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Pricing Established Goods (1 of 2)
• Odd pricing
• Price lining
• Price anchoring
• Freemium pricing
• Subscription pricing
• Dynamic pricing
• Leader pricing
• Discounts (markdowns)
• Geographic pricing
– Zone pricing
– Delivered pricing
• Discounts
– Earned discounts
– Limited time offers
– Steadily decreasing
discount (SDD)
– Multiple unit pricing

17.
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Pricing Established Goods (2 of 2)
• Bundling
• Optional-product pricing
• Captive-product pricing
• By-product pricing
• Suggested retail prices
• Follow-the-leader pricing

18.
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Pricing Strategies: Markup
Dollar Markup =Retail price Cost of the merchandise
Dollar markup
Percentage (of retail price) markup =
Retail price
Dollar markup
Percentage (of cost) markup =
Cost of unit

if a shirt costs $14, and a retailer plans to sell it for $30, the
markup would be as follows:
Dollar Markup = $30 $14 = $16
$16
Percentage (of retail price) markup = = 53.3%
$30
$16
Percentage (of cost)markup = = 114.3%
$14


19.
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Table 11.1 Costs and Markup Calculations for
Samsung’s Galaxy S6 Edge and Apple’s iPhone 7 (1 of 2)
Component Samsung Galaxy
S6 Edge
Apple iPhone 7
(32GB)
Display and touchscreen $85.00 $43.00
Processors $29.50 $26.90
Cameras $21.50 $19.90
User interface and sensors $14.75 $14.00
Memory $52.50 $16.40
Modules and processors $31.50 $43.20
Case and enclosure elements $12.00 $18.20
Power management device $5.40 $7.20
Lithium polymer battery $3.50 $2.50
Mechanical/Electromechanical components $23.00 $16.70

20.
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Table 11.1 Costs and Markup Calculations for
Samsung’s Galaxy S6 Edge and Apple’s iPhone 7 (2 of 2)
Component Samsung Galaxy
S6 Edge
Apple iPhone 7
(32GB)
Box contents $6.20 $11.80
Assembly and testing cost $5.60 $5.00
Total Cost $290.45 $224.80
Retail price (no contract) $799.99 $849.99
$ Markup = Price − Cost $509.54 $625.19
Percentage (of cost) markup = 175.4% 278.1%
Source: Based on “iPhone 7 Materials Cost Higher Than Previous Versions, HIS Markit Teardown Reveals,” Business
Wire, September 20, 2016, www.businesswire.com/news/home/20160920006782/en/iPhone-7-Materials-Costs-Higher-
Previous-Versions; “Samsung Galaxy S6 Edge Pricier to Build, Cheaper to Buy Than Comparable iPhone 6 Plus, IHS
Teardown Reveals,” IHS Markit, April 14, 2015, http://news.ihsmarkit.com/press-release/technology/samsung-galaxy-s6-
edge-pricier-build-cheaper-buy-comparable-apple-iphone-6-.

21.
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Initial Dollar Markup and Retail Price
Operating expenses +Reductions + profit
Initial dollar markup =
Net Sales +Reductions
Dollar cost
RetailPrice =
(1 Percentage of retail price markup)


22.
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Pricing for Manufacturers
• The most commonly used pricing technique for
manufacturers is cost-plus pricing:
– A manufacturer establishes a price that covers the cost
of direct materials, direct labor, factory overhead,
selling and administrative costs, and a desired profit
margin.

23.
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Cost-Plus Pricing Components
Figure 11.5 Cost-Plus Pricing Components

24.
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Direct Costing and Pricing (1 of 2)
• Absorption costing:
– Traditional method of product costing in which all
manufacturing and overhead costs are absorbed into
the product’s total cost.
• Variable or direct costing:
– Product costing method that includes in the product’s
costs only those costs that can vary directly with the
quantity produced.

25.
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Break-Even Pricing
Break - even sellingprice =
Profit + (Variable cost per unit Quantity produced) + Total fixed cost
Quantity produced


26.
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Direct Costing and Pricing (2 of 2)
• To establish a reasonable, profitable price for service,
small business owners must know the cost of materials,
direct labor, and overhead for each unit of service they
provide.
=
productive hour
Price Total cost per hour
(1 net profit as a % of sales)


27.
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Impact of Credit and Debit Cards and
Mobile Wallets on Pricing
• Customers expect to make purchases with credit cards.
– But, companies incur an additional cost to offer this
service.
• E-commerce and credit cards
• Debit cards
• Mobile wallets
• Installment credit
• Trade credit
• Layaway

28.
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Top Three Payment Preferences
Figure 11.6 Top Three Payment Preferences Among
Shoppers
Source: Based on 2016 U.S. Consumer Payment Study, Total Systems Services, 2016, p. 12.

29.
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Consumer Credit (1 of 2)
• Credit cards: typical consumer has 4 credit cards.
– Research: Customers who use credit cards make
purchases that are 12–18% higher than if they had
used cash.
– On a typical $100 credit card purchase, cost to
business = $1.85.
 Interchange fee

30.
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Typical Credit
Card Transaction
Figure 11.7 How a
Typical Credit Card
Transaction Works
Sources: Based on “Credit Card Processing,” Card Fellow, 2013, www.cardfellow.com/content/creditcard-processing-
guide.php#MoneyGo; “Credit Cards,” U.S. Government Accounting Office, September 2006, pp. 73–74.

31.
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E-Commerce and Credit Cards
• E-commerce companies reject about 2.8% of orders
because of suspicion of fraud.
• To minimize credit card fraud:
– Use an address verification system
– Require a CVV2 number
– Check customers IP addresses
– Pay close attention to international orders
– Monitor Web site activity with analytics
– Verify large orders
– Post notices on Web site that your company uses anti-fraud
technology
– Contact the credit card company or bank that issued the card

32.
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Consumer Credit (2 of 2)
• Debit cards
– Shoppers make almost 70 billion debit card transactions,
totaling $2.6 trillion each year.
• Mobile wallets:
– Applications that link a smart phone or tablet to a credit
or debit card, transforming the device into a digital wallet.
– Growing form of payment.
• Installment credit
• Trade credit
• Layaway

33.
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Conclusion
• Pricing techniques impact every aspect of a company
including:
– Image
– Customers
– Cash flow
– Profits

34.
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Copyright