Price SettingNDFS Tree Promotion / NDCDEA Meeting – Mar. 19, 2014

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Price setting can be complicated.Seems to be guesswork.

Today, try to simplify

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Pricing Objectives• Cover Costs/Generate Profit• Market Positioning• Market Share• New Product• Branding

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Pricing Objectives• Cover Costs/Generate Profit• Market Positioning• Market Share• New Product• Branding

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Main Pricing Strategy• Cost-plus PricingCost/unit + Profit/unit = Price/unitProfit

1. Return on good decisions2. Use to expand, invest3. Financial cushion

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What is Profit?

Revenue/unit TR - Cost/unit or

- TC Profit /unitProfit

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Profit Margin in grocery stores is typically about 1 to 2 percent of sales(volume business)

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Profit Margin in restaurants is typically about 5-6 percent (Forbes, 2011)

Profit Margin in greenhouses, nurseries, is 5-10 percent

Costs of Selling Product(Cost of Production)

• Costs are broken up into two areas –

variable, operating, or direct costsand fixed, ownership, or indirect costs.

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Costs of Selling Product1. Fixed Costs

- Do not change directly with production/sales

2. Variable Costs- Do change directly with production/sales

Costs of Selling Product• Cost of Production varies

depending on how much produced

• As production increases, cost per unit goes down (to a point)

• Fixed costs are spread over more units• Assuming variable costs per unit are constant

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Costs of Selling Product1. Fixed Costs2. Materials/Supplies3. Labor4. Marketing (transportation, packaging,

advertising)

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Costs of Selling Product1. Fixed Costs

These are property and building costs, equipment costs, insurance, utilities, property taxes, office expenses, and interest

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Costs of Selling Product Fixed Costs – Segment

If selling trees is 25% of your “business” – estimate 25% of these costs and divide by # of plants

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Costs of Selling Product2. Materials/Supplies

This is your tree cost and any associated costs on a per tree basis (variable costs) (COGS)

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Costs of Selling Product Materials/Supplies

Or, cost of seedling, fert., soil, container, etc.

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Costs of Selling Product3. Labor

Labor can be a variable cost if time per unit can be determined (5

workers x 10 hours x $12.00/hr for 1,000 trees = $0.60 per tree)

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Costs of Selling Product Labor

Labor can be handled as a fixed cost if workers are paid a salary

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Relative importance of employer costs for employee compensation, June 2013Compensation Civilian Private State and local component workers industry government___________________________________________________________________Wages and salaries 69.2% 70.3% 64.5%Benefits 30.8 29.7 35.5 Paid leave 7.0 6.9 7.4 Supplemental pay 2.4 2.8 0.8 Insurance 9.0 8.2 12.2 Health benefits 8.5 7.7 11.8 Retirement and savings 4.7 3.7 9.0 Defined benefit 2.9 1.6 8.3 Defined contribution 1.8 2.1 0.8 Legally required 7.8 8.2 6.1

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Costs of Selling Product4. Marketing (fixed or variable cost)

- estimate cost per tree

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Costs of Owning Machinery1. Fixed Costs2. Repairs and Maintenance3. Labor4. Fuel

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Costs of Owning Machinery1. Fixed Costs

These are housing costs, depreciation, insurance, interest, and property taxes

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Costs of Leasing Machinery1. Lease Costs2. Labor3. Fuel

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Must at least cover VC!Grass seed is product - Fixed Cost is a Forklift

Volume Price/Unit ($)

VC/unit($)

FC/unit($)

TC/unit($)

Profit/Unit ($)

2,000 3.50 1.00 1.00 2.00 1.50

2,000 4.50 3.50 1.00 4.50 0

2,000 3.50 3.50 1.00 4.50 -1.00

2,000 2.50 3.50 1.00 4.50 -2.00

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Breakeven Volume• Number units at which Revenue equals

Total Cost• Minimum sale volume• Fixed costs of $5,000/month• Variable costs of $20/tree• Price set at $50/tree

Breakeven volume is 167 trees per month

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Breakeven Volume $

Trees

5kFC

100

Revenue

167

VC

TC

8,350

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Breakeven Price• Price at which Revenue equals Total Cost

• Minimum sale price• Everything constant except tree price• Fixed costs of $2,000/month• Variable costs of $20/tree• On average, sell 200 trees/month

Breakeven price per tree is $30$2,000 + $20(200) = x(200)

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Pricing Strategies• Penetration pricing

- very low margin, or at cost, or below total cost

- low price generally means large salesBenefit – get established, sell productDownside - later raising prices causes

backlash

Source: Setting Your Price, Ag Decision Maker, File C5-17, Iowa State University Extension

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Pricing Strategies• Penetration pricing

- works well when demand is elasticP

Q

Source: Setting Your Price, Ag Decision Maker, File C5-17, Iowa State University Extension

Demand

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Pricing Strategies• Penetration pricing

- works well with high (large) fixed costs

- fixed costs spread over large number of

sales (production)

Source: Setting Your Price, Ag Decision Maker, File C5-17, Iowa State University Extension

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Selling grass seedAssume FC = $10,000

Volume Price/Unit ($)

VC/unit($)

FC/unit($)

TC/unit($)

Profit/Unit ($)

500 2.25 1.00 20 21 -

1,000 2.25 1.00 10 11 -

5,000 2.25 1.00 2 3 -

10,000 2.25 1.00 1 2 0.25

20,000 2.25 1.00 0.50 1.50 0.75

50,000 2.25 1.00 0.20 1.20 1.05

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Pricing Strategies• Premium PricingSetting price relatively high

- works well whendemand is inelastic- works well whenno good substitutes

P

Q

Source: Setting Your Price, Ag Decision Maker, File C5-17, Iowa State University Extension

Demand

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Pricing Strategies• Premium pricing

very large margin,but don’t sell many units,or, don’t have to sell many units

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Pricing Strategies• Premium pricing

- new product- product without substitutes- segmented market (high end users)

- few buyers, so that dictates high price

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Pricing Strategies• Bundling

Bundling something desired, but expensive, with something less desirable, but profitable

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Pricing Strategies• Bundling

You buy a tree for $50, sell for $60 (profit of

$10), or offer to plant same tree for $80 (your planting cost is

$10, profit of $20)

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Pricing Strategies• Bundling

You buy a tree for $55, sell for $60 (profit of

$5), or have expenses, seedling, fert., container, soil, labor, fixed

costs, at $50, sell for $60 (profit of $10)

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Pricing Strategies• Value AddedAdding value such that additional revenue is greater than additional cost

You buy a seedling for $5 and sell for $10, or you buy seedling for $5, add $45 worth of stuff, and sell for $70Added cost = $45Added value = $65

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Pricing based on QualityConsumers evaluate on price and quality.Perceived quality (quality is subjective).Higher price may signal more value.More perceived value can garner higher price.

Value = Quality/Price

Source: Setting Your Price, Ag Decision Maker, File C5-17, Iowa State University Extension

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Value PricingDifferentiated Product

Product Price/unit Quality Value

1 10 8 0.8

2 12 9 0.75

3 15 15 1

4 20 23 1.15

Commodity

Product Price/unit Quality Value

1 10 20 2

2 12 20 1.6

3 15 20 1.3

4 20 20 1

Source: Setting Your Price, Ag Decision Maker, File C5-17, Iowa State University Extension

Economies of Scale• As scale increases, cost per unit

decreases• Renting a warehouse, thinking

about doubling the size• Revenue will double• Variable costs will double• Fixed costs increase, but if any do not double

Economies of Scale – Cost/unit

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Economies of Scale• Volume discounts are essentially

the passing along of savings from economies of scale (and specialization)

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Competitor’s PricesKnow what these are, if any.Can you undercut?Should you undercut?

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Prices ending in 9“Was $40, now only $29”“Was $40, now only $25”

Advertising Ideas

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Weber’s LawPrice increases of around 10% upper limit of acceptability

- consumer don’t notice or don’t care

Advertising Ideas

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AnchoringPlacing premium products and services close to standard items

- less expensive items may seem like a

bargain

Advertising Ideas

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Price Similar Products Differently

Avoids “action paralysis”- consumer defer decision

Advertising Ideas

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A lot of research done in advertising on context

“Experience” product or service provides

Advertising Ideas

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Kim Douglas DillivanCrops Business Mgmt Field Specialistkim.dillivan@sdstate.edu605-626-2870