SELF TEST #23: Using the Components of Price
Test #1:
In the following examples, determine which price component the company is using to manage its pricing policy: Performance Benefit, Optional Price Components, Discounts and Premiums, Basis of Charge, or Period of Price Agreement.
Example #1:
Mail-order shoppers usually are charged for shipping according to the total price of their order – not the weight or volume of the package being shipped. So, customers who order light products feel cheated.
(SIC 5961 – 1995)
Answer:
There are two possible Answers here. From the perspective of the shipping company, this is a Basis of Charge example. If we use the retailer as the company doing the pricing, this is an example of an Optional Price Component.
Example #2:
Software manufacturers offer discounted upgrade prices to customers who already use the old version.
(SIC 7372 -1995
)
Answer:
This is a Discount offer to an existing customer, a customer status discount.
Example #3:
At Mt. Reba, parents can get free lodging and skiing for children 12 and under when staying midweek in a Bear Valley hotel room, condo or home rental.
(SIC 7011 -1988)
Answer:
There are two price component examples here. First, is a multiple purchase Discount covering lodging and skiing. Second, this is an example of a Period of Price Effectiveness.
Example #4:
UPS is boosting the cost of ground shipping for packages at least 2.9%. UPS determines price by a combination of weight and distance.
(SIC 4513 – 1996)
Answer:
This is an example of a Basis of Charge. Here the basis is a price for a result achieved.
Example #5:
HLW has an incentive-based fee scale for a laboratory it's designing. 10% of the total fee is at risk. Various benchmarks must be hit for HLW to receive all its potential revenue.
(SIC 8900-1996)
Answer:
This is a example of an Optional Price Component, a bonus for the seller. The 10% fee on its own, is an example of a Basis of Charge where the basis is an event occurrence.
Example #6:
Because stainless-steel producers are living hand-to-mouth, they are reluctant to sign quarterly supply contracts. Instead, they are buying relatively small lots of nickel on the spot market.
(SIC 3300 -1985)
Answer:
This is an example of a Period of Price Agreement.
Example #7:
To avoid volatile commercial property and casualty rates, some firms try offering more three-year contracts, sharing some risk by locking in premiums for nervous clients. Johnson & Higgins offers a property policy that sets premiums for 10 years and puts a portion of the cost in a "premium reserve," which the insured keeps if claims don't surpass a set level. At worst, the insured forfeits the reserve. At best, it has stable premiums, despite any disaster, and it may share profits.
(SIC 6331 -1991)
Answer:
This pricing has two examples: a Period of Price Agreement and an Optional Price Component, which is a bonus for the customer.
Example #8:
Best Buy sells CDs near or even below cost to lure customers into stores.
Answer:
This is a pricing example of a Discount on a high visibility product.
Example #9:
Marriott's pricing structure includes a seven-day advance purchase price with up to 25% savings. Availability may be limited. The company has a 50% penalty for changes or cancellation.
(SIC 7011 – 1992)
Answer:
This pricing has two examples of components. The company has changed the Performance Benefits of the product to reduce the support features. This creates the ability to offer a Discount based on limited availability. The 50% penalty for changes or cancellation is an example of an Optional Price Component.
Example #10:
American Express continues to charge $10 for reissuing a ticket, $10 for overnight priority mail, $75 for planning a complicated domestic itinerary and $150 for planning a complicated international itinerary.
(SIC 4724 – 1995)
Answer:
This pricing structure offers several examples of pricing components. The ticket re-issue charge is an example of an Optional Price Component, a penalty for the customer. The charge for overnight mail is a change in Performance Benefits creating a charge for the support features upgrade. The charges for the complicated domestic and international itineraries are Optional Price Components, a fee over the variable charge.
Test #2:
What are the major components of price?
Answer:
The major components of price are Performance Benefits, Optional Price Components, Discounts and Premiums, the Basis of Charge and the Period of Price Agreement.
Test #3:
How can a company change its Performance Benefits in order to change its price?
Answer:
There are four types of Performance Benefits that the company might change. First, you can change the primary features of the product, which fulfill the major needs of the customer in using the product. Second, you can change support features of the product. These features include many of the Convenience and Reliability benefits, including delivery times, minimum order quantity, warranties, cancellation policies and so forth. Third, you can change the optional components of the price. You can change the optional-related features of the product. These features are not a part of the standard set of primary or support benefits of the product. Rather, they include product options that encompass more of the customer's needs than does the standard product. Fourth, and finally, you may change the optional unrelated features of the product. These performance features have no impact on the customer's use of the current standard product. They become part of the product package to make it more attractive to the customer and to distinguish it from competition.
Test #4:
Are there other components that might be added to the variable price of the product?
Answer:
Every price has a basic unit of charge. This is the variable portion of a price. In some cases, companies and industries may add additional components to this unit price of the product. These optional price components are added over and above the variable component of the price. There are three potential optional components of price, including an additional fee, a penalty or bonus and extended payment terms.
Test #5:
Why would a company use Discounts or Premiums beyond those that are traditional for size of purchase and timing of payment?
Answer:
There are many Discounts or Premiums that the Company might add to its product price. Each of these reflects a difference in cost that the Company incurs in one customer segment compared to the average customer. These Discounts and Premiums provide the opportunity for the Company to reflect these cost differences in its pricing.
Test #6:
How does the Company use the Basis of Charge in its pricing?
Answer:
For the most part, the Basis of Charge for the variable part of the product price reflects the major cost driver that the Company has in serving the customer. As the Company's costs change, the Basis may change as well. For example, some time ago the air express industry changed its base pricing from distance-based to weight based pricing to reflect changes in its cost structure. The Basis of Charge may also be helpful as the Company uses other components in the price. It is likely that the Basis of Charge for these other components will be different than the Basis for the variable price of the product.
Test #7:
What does the period of price agreement do to pricing?
Answer:
The period of price agreement changes the price for the customer by giving the customer either a longer or a shorter period of time during which he knows exactly what the price for the product will be. In a rising price environment, the customer locks in a product price for the period. In a falling price environment, the Company locks in the customer for the period. Usually, periods of price agreement are important to companies and customers only when prices are volatile.
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