elastic demand if an increase in its price raises total revenue or a decrease in its price lowers total revenue.
In some markets, the demand for products or services is very elastic. With a lower price, the amount purchased increases sharply, thus providing higher revenue. For example, in the personal computer industry, a decrease in price will frequently produce a more than proportionate increase in quantity sold, resulting in higher total revenues. For products such as salt, however, the demand is highly inelastic. Regardless of price, the quantity purchased will not change significantly, because consumers use a fixed amount of salt.
The concept of elasticity of demand is important because the degree of elasticity sets limits on or provides opportunities for higher pricing. A small firm should seek to distinguish its product or service in such a way that small price increases will incur little resistance from customers and thereby yield increasing total revenue. Manny Apolonio. Founder of At Chore Service. A concierge service in San Francisco that runs errands for clients, charged between $20 and $40 an hour when he started the company. He was immediately flooded with referrals. It did not take Apolonio long to realize that there was opportunity to raise price to between $40 and $60 an hour. He tested the higher rates with a few clients and found them receptive. At Chore Service became profitable and stayed busy. From Apolonio’s experience. We can conclude that demand for his firm’s services is inelastic.
Pricing and a firm’s Competitive Advantage
Several factors affect the attractiveness of a product or service to customers. One factor is the firm’s competitive advantage a concept discussed in Chapter 3. If consumers perceive the product or service as an important solution to their unsatisfied needs. They are likely to demand more.
Only rarely will competing firms offer identical products. In most cases, products differ in some way. Even if two products are physically similar, the accompanying services typically differ. Speed of service, credit terms offered, delivery arrangements, personal attention from a salesperson, and warranties are but a few of the factors that can be used to distinguish one product from another. A unique and attractive combination of products and services may well justify a higher price.
A pricing tacit that often reflects a competitive advantage is prestige pricing setting a high price to convey an image of high quality or uniqueness. Its influence varies from market to market and product to product. Because higher-income buyers are usually less sensitive to price variations than those with lower incomes, prestige pricing typically works better in high-income markets.
Jeremy Hitchcock, introduced as the CEO of Dyn in this chapter’s In the Spotlight, found that value-based pricing was difficult to explain to his customers. However, he discovered that if Dyn could gain a customer through one product, the quality of the software offered would enable the company to engage in platform pricing, moving the customer through a funnel of products and services, upgrading at each platform level. The team at Dyn also discovered that being seen as a quality provider increased their ability to renew customers, thereby lowering costs.
Applying Pricing System
Atypical entrepreneur is unprepared to evaluate a pricing system until he or she understands potential costs, revenue, and product demand for the venture. To better comprehend these factors and to determine the acceptability of various prices, the entrepreneur can use break-even analysis. An understanding of markup pricing is also valuable, as it provides the entrepreneur with an awareness of the pricing practices of intermediaries-wholesaler and retailers.
BREAK-EVEN ANALYSIS
Break-even analysis allows the entrepreneur to compare alternative cost and revenue estimates in order to determine the acceptability of each price. A comprehensive break-even analysis has two phases: (1) examining cost-revenue relationships and (2) incorporating sales forecasts into the analysis. Break-even analysis can be presented by means of formulas and graphs
Examining Cost and Revenue Relationships
The objective of the first phase of break-even analysis is to determine the sales volume level at which the product, at an assumed price, will generate enough revenue to start earning a profit. Exhibit 16.4 (a) presents a simple break-even chart reflecting this comparison. Fixed costs and expenses, as represented by a horizontal line in the bottom half of the graph, are $300,000. The section for variable costs and expenses is a triangle that slants upward, depicting the direct relationship of variable costs and expenses to output. In this example, variable costs and expenses are $5 per unit. The entire area below the upward-slanting total cost line represents the combination of fixed and variable costs and expenses. The distance between the sales and total cost lines reveals the profit or loss position of the company at any level of sales. The point of intersection of these two lines is called the break-even point, because sales revenue equals total costs and expenses at this sales volume. As shown in Exhibit 16.4 (a), the break-even point is approximately 43,000 units sold, which means that the break-even point in dollar revenue is roughly $514,000.
We can now see that the exact break-even point in units sold is 42,857. And given the $12 sales price, the dollar break-even point is $514,284($12 sales price per unit × 42,857 break-even units sold).
This example shows that the break-even point is a function of (1) the firm’s fixed operating costs and expenses (numerator) and (2) the unit selling price less the unit variable costs and expenses (denominator). The higher the fixed costs, the more units we must sell to break even; the greater the difference between the unit selling price and the unit variable costs and expenses, the fewer units we must sell to break even. The difference between the unit selling price and the unit variable costs and expenses is the contribution margin; that is, for each unit sold, a contribution is made toward covering the company’s fixed costs.
To evaluate other break-even points, the entrepreneur can plot additional sales lines for other prices on the chart. (Don’t be intimidated abound drawing a graph or crunching the number to get a break-even point. The key issue is that calculating the break-even point helps you to determine whether you have a chance to make a profit by selling your products at certain price.) On the flexible break-even chart shown in Exhibit 16.4 (b), the higher price of $20 yields a much more steeply sloped sales line, resulting in a break-even point of 20,000 units and a sales dollar break-even point of $400,000. Similarly, the lower price of $8 produces a flatter revenue line, delaying the break-even point until 100,000 units are sold and we have $800,000 in sales. Additional sales lines could be plotted to evaluate other proposed prices.
Because it shows the profit area growing larger and larger to the right, the break-even chart implies that quantity sold can increase continually. Obviously, this assumption is unrealistic and should be factored in by modifying the break-even analysis with information about the way in which demand is expected to change at different price levels. Additionally, as revenues increase significantly, it is very likely that fixed costs will go up.
Incorporating Sales Forecasts
The indirect impact of price on the quantity that can be sold complicates pricing decisions. Demand for a product typically decreases as price increases. However, in certain cases price may influence demand in the opposite direction, resulting in increased demand for a product when it is priced higher. Therefore, estimated demand for a product at various prices, as determined through marketing research (even if it is only an informed guess), should be incorporated into the break-even analysis.
An adjusted break-even chart that incorporates estimated demand can be developed by using the initial break-even data from Exhibit 16.4(b) and adding a demand curve, as done in Exhibit 16.5 This graph allows a more realistic profit area to be identified.
We see that the break-even point in Exhibit 16.5 for a unit price of $20 corresponds to a quantity sold that appears impossible to reach at the assumed price (the break-even point does not fall within the demand curve). No customers are willing to pay $20 sales line. So, at the low price of $8, we would never break even the more we sell, the greater the loss would be. Only at $12 does the revenue from the demand curve rise above the total cost line. The potential for profit at this price is indicated by the shaded area in the graph.
MARKUP PRICING
Up to this point, we have made no distinction between pricing by manufacturers and pricing by intermediaries such as wholesalers and retailers, since break-even concepts apply to all small businesses, regardless of their position in the distribution channel. Now, however, we briefly present some of the pricing formulas used by wholesalers and retailers in setting their prices. In the retailing industry, where businesses often carry many different products, markup pricing has emerged as a manageable pricing system. With this cost-plus approach to pricing, retailers are able to price hundreds of products much more quickly than they could by using individual break-even analyses. Manufacturers will often recommend a retail price for their products that retailers and wholesalers can use as guidelines. In calculating the selling price for a particular item, a retailer adds a markup percentage (sometimes referred to as a
elastic demand if an increase in its price raises total revenue or a decrease in its price lowers total revenue.
In some markets, the demand for products or services is very elastic. With a lower price, the amount purchased increases sharply, thus providing higher revenue. For example, in the personal computer industry, a decrease in price will frequently produce a more than proportionate increase in quantity sold, resulting in higher total revenues. For products such as salt, however, the demand is highly inelastic. Regardless of price, the quantity purchased will not change significantly, because consumers use a fixed amount of salt.
The concept of elasticity of demand is important because the degree of elasticity sets limits on or provides opportunities for higher pricing. A small firm should seek to distinguish its product or service in such a way that small price increases will incur little resistance from customers and thereby yield increasing total revenue. Manny Apolonio. Founder of At Chore Service. A concierge service in San Francisco that runs errands for clients, charged between $20 and $40 an hour when he started the company. He was immediately flooded with referrals. It did not take Apolonio long to realize that there was opportunity to raise price to between $40 and $60 an hour. He tested the higher rates with a few clients and found them receptive. At Chore Service became profitable and stayed busy. From Apolonio’s experience. We can conclude that demand for his firm’s services is inelastic.
Pricing and a firm’s Competitive Advantage
Several factors affect the attractiveness of a product or service to customers. One factor is the firm’s competitive advantage a concept discussed in Chapter 3. If consumers perceive the product or service as an important solution to their unsatisfied needs. They are likely to demand more.
Only rarely will competing firms offer identical products. In most cases, products differ in some way. Even if two products are physically similar, the accompanying services typically differ. Speed of service, credit terms offered, delivery arrangements, personal attention from a salesperson, and warranties are but a few of the factors that can be used to distinguish one product from another. A unique and attractive combination of products and services may well justify a higher price.
A pricing tacit that often reflects a competitive advantage is prestige pricing setting a high price to convey an image of high quality or uniqueness. Its influence varies from market to market and product to product. Because higher-income buyers are usually less sensitive to price variations than those with lower incomes, prestige pricing typically works better in high-income markets.
Jeremy Hitchcock, introduced as the CEO of Dyn in this chapter’s In the Spotlight, found that value-based pricing was difficult to explain to his customers. However, he discovered that if Dyn could gain a customer through one product, the quality of the software offered would enable the company to engage in platform pricing, moving the customer through a funnel of products and services, upgrading at each platform level. The team at Dyn also discovered that being seen as a quality provider increased their ability to renew customers, thereby lowering costs.
Applying Pricing System
Atypical entrepreneur is unprepared to evaluate a pricing system until he or she understands potential costs, revenue, and product demand for the venture. To better comprehend these factors and to determine the acceptability of various prices, the entrepreneur can use break-even analysis. An understanding of markup pricing is also valuable, as it provides the entrepreneur with an awareness of the pricing practices of intermediaries-wholesaler and retailers.
BREAK-EVEN ANALYSIS
Break-even analysis allows the entrepreneur to compare alternative cost and revenue estimates in order to determine the acceptability of each price. A comprehensive break-even analysis has two phases: (1) examining cost-revenue relationships and (2) incorporating sales forecasts into the analysis. Break-even analysis can be presented by means of formulas and graphs
Examining Cost and Revenue Relationships
The objective of the first phase of break-even analysis is to determine the sales volume level at which the product, at an assumed price, will generate enough revenue to start earning a profit. Exhibit 16.4 (a) presents a simple break-even chart reflecting this comparison. Fixed costs and expenses, as represented by a horizontal line in the bottom half of the graph, are $300,000. The section for variable costs and expenses is a triangle that slants upward, depicting the direct relationship of variable costs and expenses to output. In this example, variable costs and expenses are $5 per unit. The entire area below the upward-slanting total cost line represents the combination of fixed and variable costs and expenses. The distance between the sales and total cost lines reveals the profit or loss position of the company at any level of sales. The point of intersection of these two lines is called the break-even point, because sales revenue equals total costs and expenses at this sales volume. As shown in Exhibit 16.4 (a), the break-even point is approximately 43,000 units sold, which means that the break-even point in dollar revenue is roughly $514,000.
We can now see that the exact break-even point in units sold is 42,857. And given the $12 sales price, the dollar break-even point is $514,284($12 sales price per unit × 42,857 break-even units sold).
This example shows that the break-even point is a function of (1) the firm’s fixed operating costs and expenses (numerator) and (2) the unit selling price less the unit variable costs and expenses (denominator). The higher the fixed costs, the more units we must sell to break even; the greater the difference between the unit selling price and the unit variable costs and expenses, the fewer units we must sell to break even. The difference between the unit selling price and the unit variable costs and expenses is the contribution margin; that is, for each unit sold, a contribution is made toward covering the company’s fixed costs.
To evaluate other break-even points, the entrepreneur can plot additional sales lines for other prices on the chart. (Don’t be intimidated abound drawing a graph or crunching the number to get a break-even point. The key issue is that calculating the break-even point helps you to determine whether you have a chance to make a profit by selling your products at certain price.) On the flexible break-even chart shown in Exhibit 16.4 (b), the higher price of $20 yields a much more steeply sloped sales line, resulting in a break-even point of 20,000 units and a sales dollar break-even point of $400,000. Similarly, the lower price of $8 produces a flatter revenue line, delaying the break-even point until 100,000 units are sold and we have $800,000 in sales. Additional sales lines could be plotted to evaluate other proposed prices.
Because it shows the profit area growing larger and larger to the right, the break-even chart implies that quantity sold can increase continually. Obviously, this assumption is unrealistic and should be factored in by modifying the break-even analysis with information about the way in which demand is expected to change at different price levels. Additionally, as revenues increase significantly, it is very likely that fixed costs will go up.
Incorporating Sales Forecasts
The indirect impact of price on the quantity that can be sold complicates pricing decisions. Demand for a product typically decreases as price increases. However, in certain cases price may influence demand in the opposite direction, resulting in increased demand for a product when it is priced higher. Therefore, estimated demand for a product at various prices, as determined through marketing research (even if it is only an informed guess), should be incorporated into the break-even analysis.
An adjusted break-even chart that incorporates estimated demand can be developed by using the initial break-even data from Exhibit 16.4(b) and adding a demand curve, as done in Exhibit 16.5 This graph allows a more realistic profit area to be identified.
We see that the break-even point in Exhibit 16.5 for a unit price of $20 corresponds to a quantity sold that appears impossible to reach at the assumed price (the break-even point does not fall within the demand curve). No customers are willing to pay $20 sales line. So, at the low price of $8, we would never break even the more we sell, the greater the loss would be. Only at $12 does the revenue from the demand curve rise above the total cost line. The potential for profit at this price is indicated by the shaded area in the graph.
MARKUP PRICING
Up to this point, we have made no distinction between pricing by manufacturers and pricing by intermediaries such as wholesalers and retailers, since break-even concepts apply to all small businesses, regardless of their position in the distribution channel. Now, however, we briefly present some of the pricing formulas used by wholesalers and retailers in setting their prices. In the retailing industry, where businesses often carry many different products, markup pricing has emerged as a manageable pricing system. With this cost-plus approach to pricing, retailers are able to price hundreds of products much more quickly than they could by using individual break-even analyses. Manufacturers will often recommend a retail price for their products that retailers and wholesalers can use as guidelines. In calculating the selling price for a particular item, a retailer adds a markup percentage (sometimes referred to as a
การแปล กรุณารอสักครู่..
