Marketing Management, Millenium Edition - epiheirimatikotita.gr

Setting the Price 219Price elasticity depends on the magnitude and direction of the contemplatedprice change. It may be negligible with a small price change and substantial with alarge price change; it may differ for a price cut versus a price increase. Finally, longrunprice elasticity may differ from short-run elasticity. Buyers may continue to buyfrom their current supplier after a price increase because they do not notice theincrease, or the increase is small, or they are distracted by other concerns, or they findthat choosing a new supplier takes time. But they may eventually switch suppliers. Thedistinction between short-run and long-run elasticity means that sellers will not knowthe total effect of a price change until time passes.Step 3: Estimating CostsWhile demand sets a ceiling on the price the company can charge for its product, costsset the floor. Every company should charge a price that covers its cost of producing,distributing, and selling the product and provides a fair return for its effort and risk.Types of Costs and Levels of ProductionA company’s costs take two forms—fixed and variable. Fixed costs (also known as overhead)are costs that do not vary with production or sales revenue, such as payments forrent, heat, interest, salaries, and other bills that must be paid regardless of output.In contrast, variable costs vary directly with the level of production. For example,each calculator produced by Texas Instruments (TI) involves a cost of plastic, microprocessingchips, packaging, and the like. These costs tend to be constant per unitproduced, but they are called variable because their total varies with the number ofunits produced.Total costs consist of the sum of the fixed and variable costs for any given level ofproduction. Average cost is the cost per unit at that level of production; it is equal tototal costs divided by production. Management wants to charge a price that will at leastcover the total production costs at a given level of production.To price intelligently, management needs to know how its costs vary with differentlevels of production. A firm’s cost per unit is high if only a few units are producedevery day, but as production increases, fixed costs are spread over a higher level of productionresults in each unit, bringing the average cost down. At some point, however,higher production will lead to higher average cost because the plant becomes inefficient(due to problems such as machines breaking down more often). By calculatingcosts for different-sized plants, a company can identify the optimal plant size and productionlevel to achieve economies of scale and bring down the average cost.Accumulated ProductionSuppose TI runs a plant that produces 3,000 calculators per day. As TI gains experienceproducing calculators, its methods improve. Workers learn shortcuts, materialsflow more smoothly, and procurement costs fall. The result, as Figure 4-10 shows, isthat average cost falls with accumulated production experience. Thus, the average costof producing the first 100,000 hand calculators is $10 per calculator. When the companyhas produced the first 200,000 calculators, the average cost has fallen to $9. Afterits accumulated production experience doubles again to 400,000, the average cost is$8. This decline in the average cost with accumulated production experience is calledthe experience curve or learning curve.Now suppose TI competes against two other firms (A and B) in this industry. TI isthe lowest-cost producer at $8, having produced 400,000 units in the past. If all threefirms sell the calculator for $10, TI makes $2 profit per unit, A makes $1 per unit, andB breaks even. The smart move for TI would be to lower its price to $9 to drive B out of