Page 605 - Business Principles and Management

Unit 6

FIGURE 22-3 Businesses consider operating expenses such as these
when setting a product’s price.

Rent Taxes
Interest paid on borrowed money Repairs and maintenance
Salaries, wages, and benefits Supplies
Telephone service Inventory losses due to theft,
Depreciation expense spoilage, or breakage
Furniture, fixtures, and equipment Customer service expenses
Uncollected accounts and collection Advertising
expense Donations
Delivery costs Utilities
Insurance Cost of business services

CHECKPOINT

Explain how net profit is calculated.

Pricing Strategies

Because businesses operate for profit, they must set prices that will entice customers
to buy the products yet will make a profit after costs are deducted. Businesses can
use different strategies to achieve this goal. For example, a business can establish a
high price. Fewer customers will buy at a high price than a low price, but the com-
pany will make a greater gross profit per item sold. On the other hand, a business
can choose to set a low price. More customers will buy at a low price than a high
price, but the company will make less gross profit per item sold. In this case, the
company hopes to make a satisfactory profit by selling a large number of items.
No one strategy is best in all cases. Either of these strategies can result in a
satisfactory profit for the company. Consider the following example:
Business A buys a product for $500 and offers it for sale at $1,000. It sells
four of these in a month, making a gross profit of $2,000:

$1,000 4 items $4,000 revenue from sales
$500 4 items $2,000 cost of goods sold
$4,000 revenue $2,000 cost of goods sold $2,000 gross profit
Business B, selling the same product, thinks it can make a better profit by
setting a lower price and selling a greater quantity. It offers the item for $800.
In one month it sells six items, for a gross profit of $1,800:
$800 6 items $4,800 revenue from sales
$500 6 items $3,000 cost of goods sold
$4,800 $3,000 cost of goods sold $1,800 gross profit
In this case, Business A’s strategy made the higher profit. However, either
strategy could result in the higher profit. The challenge is to choose the strategy
that works best for the situation.

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