Business Pricing Methods : Free Business Administration Training : Lean Business Club, Inc.

FINANCIAL MANAGEMENT
CHECK POINT 58: PRICING METHODS

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1.	what is price?
2.	objectives of pricing methods
3.	factors in a price-setting process
4.	external price-setting factors
5.	internal price-setting factors
6.	pricing strategies
7.	the profit margin pricing method
8.	small business example price setting in a service company
9.	materials and spare parts markups
10.	small business example price setting in a merchandising company
11.	small business example price setting in a manufacturing company
12.	price discount structure
13.	financial and marketing managerial responsibilities
14.	for serious business owners only
15.	the latest information online

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FINANCIAL MANAGEMENT
CHECK POINT 58: PRICING METHODS

Please Select Any Topic In Check Point 58 Below And Click.

1.	what is price?
2.	objectives of pricing methods
3.	factors in a price-setting process
4.	external price-setting factors
5.	internal price-setting factors
6.	pricing strategies
7.	the profit margin pricing method
8.	small business example price setting in a service company
9.	materials and spare parts markups
10.	small business example price setting in a merchandising company
11.	small business example price setting in a manufacturing company
12.	price discount structure
13.	financial and marketing managerial responsibilities
14.	for serious business owners only
15.	the latest information online

DO I NEED TO KNOW THIS CHECK POINT?

Management Level	Yes	Optional
Level 1: I Am An MBA Student.	V
Level 2: I Am A Professional Manager In A Company.		V
Level 3: I Plan To Start A One-Person Business.	V
Level 4: We Plan To Start A Small Business Without Employees.	V
Level 5: I/We Plan To Start A Small Business With Employees.	V
Level 6: I Am A One-Person Business Owner.	V
Level 7: I Am A Small Business Owner With Employees.	V
Level 8: We Are Small Business Owners Without Employees.	V
Level 9: We Are Small Business Owners With Employees.	V
Level 10: I Am A Management Consultant Or A CPA.	V

WELCOME TO CHECK POINT 58

TUTORIAL 1 General Management				TUTORIAL 2 Human Resources Management				TUTORIAL 3 Financial Management				TUTORIAL 4 Operations Management				TUTORIAL 5 Marketing And Sales Management
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2	7	12	17	22	27	32	37	42	47	52	57	62	67	72	77	82	87	92	97
3	8	13	18	23	28	33	38	43	48	53	58	63	68	73	78	83	88	93	98
4	9	14	19	24	29	34	39	44	49	54	59	64	69	74	79	84	89	94	99
5	10	15	20	25	30	35	40	45	50	55	60	65	70	75	80	85	90	95	100

HOW CAN YOU BENEFIT FROM CHECK POINT 58?

The main purpose of this check point is to provide you and your management team with detailed information about Pricing Methods and how to apply this information to maximize your company's performance.

In this check point you will learn:

• About the objectives of pricing methods.
• About external and internal factors in a price-setting process.
• About four specific price-setting strategies.
• About the profit-margin pricing method.
• About price-setting in a service company.
• About price-setting in a merchandising company.
• About price-setting in a manufacturing company.
• About trade, quantity, cash, and promotional discounts.
• About various price discount structures.
• About financial and marketing managerial responsibilities... and much more.

LEAN MANAGEMENT GUIDELINES FOR CHECK POINT 58

You and your management team should become familiar with the basic Lean Management principles, guidelines, and tools provided in this program and apply them appropriately to the content of this check point.

You and your team should adhere to basic lean management guidelines on a continuous basis:

•	Treat your customers as the most important part of your business.
•	Provide your customers with the best possible value of products and services.
•	Meet your customers' requirements with a positive energy on a timely basis.
•	Provide your customers with consistent and reliable after-sales service.
•	Treat your customers, employees, suppliers, and business associates with genuine respect.
•	Identify your company's operational weaknesses, non-value-added activities, and waste.
•	Implement the process of continuous improvements on organization-wide basis.
•	Eliminate or minimize your company's non-value-added activities and waste.
•	Streamline your company's operational processes and maximize overall flow efficiency.
•	Reduce your company's operational costs in all areas of business activities.
•	Maximize the quality at the source of all operational processes and activities.
•	Ensure regular evaluation of your employees' performance and required level of knowledge.
•	Implement fair compensation of your employees based on their overall performance.
•	Motivate your partners and employees to adhere to high ethical standards of behavior.
•	Maximize safety for your customers, employees, suppliers, and business associates.
•	Provide opportunities for a continuous professional growth of partners and employees.
•	Pay attention to "how" positive results are achieved and constantly try to improve them.
•	Cultivate long-term relationships with your customers, suppliers, employees, and business associates.

1. WHAT IS PRICE?

PRICE

Business owners and financial managers must have a strong understanding about correct pricing procedures related to their company’s products or services in order to succeed in a competitive business environment.

There is a certain amount of confusion about the Costing and the Pricing of products or services among business owners and managers in various companies. It is essential, therefore, to understand the meaning of Cost and Price to ensure effective implementation of the cost accounting system. These concepts are defined below.

Price = Cost + Profit

DEFINITION OF COST AND PRICE


Cost		Price
This is the sum of all operating and financing expenses incurred by a company in producing and supplying a product or a service to a customer.		This is the sum of the cost of a product or a service supplied to a customer plus a profit required by the company.

ADDITIONAL INFORMATION ONLINE

•	Pricing Structure By Foundry Administration.
•	9 Pricing Rules For Entrepreneurs By StartUpMe.
•	Pricing Your Product By Tom Rich, BrentCoppieters.
•	Pricing Strategies: One Dumb Pricing Mistake By Derek Halpern.
•	Pricing Objectives And Strategies By Matt Alanis, Alanis Business Academy.

2. OBJECTIVES OF PRICING METHODS

PRICING METHODS

One of the prime responsibilities of the financial manager is to develop and constantly use sound Pricing Methods.

Correct pricing of products and services is essential to any profit-oriented organization. Setting of appropriate prices, however, often represents a difficult task for managers. The prime purpose of effective pricing methods is to meet several important objectives outlined below.

OBJECTIVES OF PRICING METHODS

1.	To ensure that products and services are offered at competitive prices in the marketplace.
2.	To ensure that the price of products and services is acceptable to customers.
3.	To ensure that all costs incurred in the supply of products and services to customers are recovered by the company.
4.	To ensure that the company produces income in accordance with a predetermined level of profitability.
5.	To ensure that the company maintains its share in the marketplace while maximizing profits.
6.	To ensure that the company produces an acceptable level of return on investments to shareholders and outside investors.

Pricing tasks can be completed manually or by using a specific accounting software program.

POPULAR ACCOUNTING SOFTWARE PROGRAMS

There are several excellent Accounting Software Programs available to small business owners at present. Some of the most popular accounting software packages are presented below:

• Sage One

• QuickBooks Intuit

• FreshBooks

• Harvest Software Systems

• NetSuite

Various accounting software programs may include additional functions, depending on each specific package. This is discussed in detail in Integrated Financial Management in Tutorial 3.

3. FACTORS IN A PRICE-SETTING PROCESS

A PRICE-SETTING PROCESS

A Price-Setting Process is often described as "more of an art than a science."

Managers frequently price products and services on the basis of "what the market can bear" or "what they, the managers, can get away with". Many factors, however, may influence price-setting decisions. These factors are generally categorized into two categories illustrated below.

FACTORS IN A PRICE-SETTING PROCESS


External Price-Setting Factors		Internal Price-Setting Factors

ADDITIONAL INFORMATION ONLINE

•	Four Common Pricing Strategies By Victor Holman.
•	How To Develop A Powerful Pricing Strategy By Dorie Clark.
•	Developing A Pricing Strategy Part 1 By Ron Collier, KCSBDC.
•	Developing A Pricing Strategy Part 2 By Ron Collier, KCSBDC.
•	Developing A Pricing Strategy Part 3 By Ron Collier, KCSBDC.

4. EXTERNAL PRICE-SETTING FACTORS

PRICE-SETTING FACTORS

Some of the external External Price-Setting Factors influencing the pricing decisions are outlined below.

EXTERNAL PRICE-SETTING FACTORS

1.	Overall demand for a particular product or service in the marketplace.
2.	Variety, quality, and price of products and services offered by competitors.
3.	Specific preference by customers for quality versus price.
4.	Seasonal or continuous demand for a product or service.
5.	Stage of life cycle of the product or service.

5. INTERNAL PRICE-SETTING FACTORS

PRICE-SETTING FACTORS

Some of the Internal Price-Setting Factors influencing the pricing decisions are outlined below.

INTERNAL PRICE-SETTING FACTORS

1.	Actual cost of products or services.
2.	Required level of return on investment.
3.	Required level of quality of products or services.
4.	Plant utilization level for automated processes.
5.	Company's position in the marketplace.

6. PRICING STRATEGIES

PRICING STRATEGIES

Appropriate prices are usually set in accordance with specific Price-Setting or Pricing Strategies adopted by the company's marketing executive.

Several Pricing Strategies are discussed in detail in Tutorial 5. These strategies include four specific types outlined below.

FOUR SPECIFIC PRICING STRATEGIES

• Penetration Pricing Strategy.

This strategy prescribes entering into the market with new products or services at reasonably low prices. This enables the company to penetrate the existing market and to attract additional customers.

• Meet-The-Competition Strategy.

The name implies entering into the market with new products or services at an existing price level established by competitors. This may require that the company offers additional advantages, such as improved quality of the product or service, to stimulate additional business from customers.

• Price-Skimming Strategy.

The name suggests entering into the market with new products or services at reasonably high prices. This strategy is often used when brand new and unique products are introduced to customers.

• Special Discount Pricing Strategy.

This strategy prescribes entering into the market with new products or services at reasonably high prices to realistically reflect their perceived high value. Such high prices, however, may be offset by a range of discounts to specialized groups of customers to motivate them to take advantage of the company's offer. These discounts may also be based on the conditional purchase of goods or services during a specified limited period of time.

ADDITIONAL INFORMATION ONLINE

Please watch these excellent videos professionally narrated and produced by Susan Crosson and SFCC:

•	Pricing 1 - Overview By Susan Crosson.
•	Pricing 2 - Gross Margin Method By Susan Crosson.
•	Pricing 3 - Return On Assets Method By Susan Crosson.
•	Pricing 4 - Time & Material Method By Susan Crosson.
•	Pricing 5 - Target Costing Method By Susan Crosson.
•	Pricing 6 - Transfer Pricing By Susan Crosson.

7. THE PROFIT MARGIN PRICING METHOD

THE PROFIT MARGIN PRICING METHOD

The central question that relates to the Pricing Procedure is:

"At what price should the product or service be offered to the customer?"

There are several Pricing Methods used by business owners and managers for determining prices of products and services. One of the most popular methods is Profit Margin Pricing. This method is based on budget projections for a specific fiscal period and it entails computation of a profit margin markup percentage and determination of a profit margin-based price per product or service unit as follows:

Profit Margin Markup	=	Income From Operations Cost Of Goods Sold + Total Operating Expenses
Profit Margin Markup Percentage	=	Income From Operations x 100% Cost Of Goods Sold + Total Operating Expenses
Profit Margin-Based Price	=	Total Cost Per Unit x (1+ Profit Margin Markup)

The Profit Margin Pricing Method can be used by service, merchandising, and manufacturing companies alike as illustrated in the examples below.

ADDITIONAL INFORMATION ONLINE

•	Margin And Markup By George Krueger.
•	Cost Plus Margin Equals Selling Price By Intubeman1.
•	Profit Markup Vs. Margin Simple Formula By LMNVideo.
•	Introduction To Markup And Margin Math By Amanda Bickell.
•	Markups Vs. Profit Margin By Weldon Long, HVACSalesBuilder.

8. SMALL BUSINESS EXAMPLE
PRICE SETTING IN A SERVICE COMPANY

PRICE SETTING IN A SERVICE COMPANY

For price setting in a service company, consider ABC Service Company.

From the ABC Service Company's Budgeted Income Statement example, presented earlier, the profit margin markup percentage is determined as follows:

Profit Margin Markup Percentage = $78,000 x 100% = 35.2%
$222,000

If the Cost Per Unit Of Service is $38 per hour as determined in the previous example for ABC Service Company, then:

Profit-Margin Based Hourly Rate = $38 per hour x (1+ 0.352) = $52 per hour

Hence, ABC Service Company should charge its clients the following:

• Hourly Rate For Junior Consultant = $52 per hour.
• Hourly Rate For Senior Consultant = $52 x 1.5 = $78 per hour.

Note:

The above hourly rates are designed to recover all of the company's budgeted operating costs plus profit, based on the current number of consultants, estimated average number of regular working hours during one week (H), estimated average number of working weeks during one year (W), and estimated average level of capacity utilization during one year (C) - Refer to Overhead Rates Example.

It is essential that business owners and financial managers continuously monitor the company's actual performance to ensure that these budget assumptions are in line with corresponding budget estimates. If there is a variation between the actual and budgeted values, it is essential to adjust the hourly rates accordingly to ensure that the company's actual profitability will be in line with the budget projections, that all operating costs are recovered, and avoidance of potential losses during the budgeted fiscal period.

9. MATERIALS AND SPARE PARTS MARKUPS

MATERIALS AND SPARE PARTS MARKUPS

Most Service Companies price their services on a Time-Per-Hour Basis to recover all operating expenses and to produce a desired level of profitability. Sometimes, however, the service-rendering process entails supplying materials or spare parts to customers in conjunction with providing specialized labor.

Consider, for example, auto repair shops, plumbing, electrical, or general maintenance specialists. In each case, various Materials or Parts are used as an integral element of rendering service. In order to simplify the pricing procedure in this instance, the cost of all materials and parts should be marked up by 10% to 50% or more, depending on the item.

Ideally, service companies should recover the total service overhead exclusively through the labor input, i.e. hourly rates chargeable for the work of auto mechanics, plumbers, electricians, or general maintenance specialists. The markup on materials and parts should become, therefore, an additional profit for the company, which could provide a “financial cushion” to cover unexpected losses during the service-rendering process.

Note:

Please consult with your accountant or CPA to ensure accurate determination of overhead recovery rates for your company to avoid potential losses.

10. SMALL BUSINESS EXAMPLE
PRICE SETTING IN A MERCHANDISING COMPANY

PRICE SETTING IN A MERCHANDISING COMPANY

Price setting in a merchandising company can be determined in a similar manner to the one above. From the earlier example, ABC Merchandising Company's Budgeted Income Statement, the profit margin markup percentage is determined as follows:

Profit Margin Markup  = $331,200 x 100%      = 38.1%
Percentage                    $708,000 + $160,800

If the Total Cost Per Unit Of Merchandise, i.e. Original Purchase Price + Cost Markup Percentage, is 1.4 times higher than its Original Purchase Price (O.P.P.), as determined in the previous example for ABC Merchandising Company, then:

Profit Margin-Based Price =Original Purchase Price x 1.4 x (1+0.381)

or:

Profit Margin-Based Price = O.P.P x 1.9334

This means that if ABC Merchandising Company purchased a specific product for resale for $100.00, then:

• The Cost Markup required to recover all merchandising expenses is $40.00, i.e. the
product actually costs the company: $100 x 1.4 = $140.00

• Profit Margin-Markup required to recover all merchandising expenses and generate a
desired level of profit is $93.34, i.e. the product should be sold to a customer at:
$100 x 1.4 x (1 + 0.381) = $100 x 1.9334 = $193.34

11. SMALL BUSINESS EXAMPLE
PRICE SETTING IN A MANUFACTURING COMPANY

PRICE SETTING IN A MANUFACTURING COMPANY

Price setting in a manufacturing company can also be determined in a manner described above. From the ABC Manufacturing Company's Budgeted Income Statement, presented earlier, the profit margin markup percentage is determined as follows:

Profit Margin Markup = $457,200 x 100% = 61.6%
Percentage $615,600 + $127,200

Thus, for example, if the Cost Per Product Unit = $20, as illustrated in the
ABC Manufacturing Company's Job Cost Report, then:

Profit Margin-Based Price = $20 x (1 + 0.616) = $32.32 or $33.00

12. PRICE DISCOUNT STRUCTURE

IMPORTANT INFORMATION ABOUT DISCOUNTS

Once the selling price for products or services is determined, it is necessary to develop a suitable Price Discount Structure to accommodate various situations in a competitive business environment.

Business owners and managers should be aware that it is always easier to reduce the discount on a particular product or service at a later stage, than to increase the price on the same item. For this reason it may be helpful to set the promotional discount at a higher level in the beginning of the selling cycle and gradually reduce this discount, thereby, in essence, increasing the selling price of the product or service without a formal sales price increase.

There are several types of Discounts which are usually considered by the financial manager in collaboration with the marketing or sales executives. These discounts are described in detail in Tutorial 5 and may include four types outlined below.

PRICE DISCOUNT STRUCTURE

1.	Trade Discount. This is a reduction in the Nominal List Price offered to regular customers. A List Price, or Suggested Retail Price, is the final price attached to a particular product or service.
2.	Quantity Discount. This is a reduction in the purchase price based on the quantity of purchased products, expressed either in units or dollars. Quantity discounts can be applied on a cumulative or non-cumulative basis.
3.	Cash Discount. This is a reduction in the purchase price when a bill is paid on time. Cash discount is usually offered to customers in addition to trade or quantity discounts.
4.	Promotional Discount. This is an allowance offered to customers for promoting new products or services in the marketplace. This allowance can be offered in the form of a price reduction, free samples, or display materials.

13. FINANCIAL AND MARKETING MANAGERIAL RESPONSIBILITIES

FINANCIAL AND MARKETING MANAGERIAL RESPONSIBILITIES

Since Pricing Of Products And Services aims at recovering all costs incurred by the organization and at producing a desired level of profitability in a competitive market environment, it should remain the continuous responsibility of the Financial And Marketing Executives. Only by combining their efforts will both executives be in a position to secure the profitability of their organization and customer satisfaction at the same time.

14. FOR SERIOUS BUSINESS OWNERS ONLY

ARE YOU SERIOUS ABOUT YOUR BUSINESS TODAY?

Reprinted with permission.

15. THE LATEST INFORMATION ONLINE

LESSON FOR TODAY:
10% Is A Safe Profit Margin
If Your Cost Is $10 And You Sell It For $100!

Go To The Next Open Check Point In This Promotion Program Online.