STUDY GUIDE

Topic 6:

BMSB5103

Small Business Management

Pricing and Credit Strategies

Learning Outcomes
By the end of this topic, you should be able to:
1.

Discuss the role of cost and demand factors in setting a price;

2.

Apply break-even analysis and markup pricing;

3.

Identify specific pricing strategies;

4.

Explain the benefits of credit, factors that affect credit extension, and types
of credit; and

5.

Describe the activities involved in managing credit.

Topic Overview
Pricing and credit strategies are essential to small business. Setting a price is not
an easy task. Setting a high price may not bring a sufficient sale volume to a
small business, while setting a low price may lead to a high sale volume but not
enough profit. Thus, price and credit directly influence the relationship between a
small business and its customers, as well as directly affecting both revenue and
sale of the small business. Customers do not like a high price or a price increase,
so much so restrictive credit policies. As a value must be placed on a product
and service by a producer or provider before it can be sold, undoubtedly pricing
strategies are a critical issue in small business. It is always common that a seller
provides credit to buyers or customer to make the exchange happen. An
agreement between buyer and seller that payment for a product or service will be
paid at some later date is known as credit. Giving too many credits to customers
may loosen the cash flow and reduce the capacity of a small business to expand.
Not providing a single credit facility may result in less revenue as customers may
not like the products or services. Similar to pricing, credit represents another
critical issue for small businesses.

47

STUDY GUIDE

BMSB5103

Small Business Management

Focus Areas and Assigned Readings

Focus Areas

Assigned Readings

6.1 Define what is price and credit

Discuss the role of cost and demand
factors in setting a price.

Moore et al. (2010), Chapter 16, p 419

Extra Readings:
Scarborough (2012), Chapter 11, p 361.

6.2 Setting a Price

Apply break-even
markup pricing.

analysis

and

6.3 Applying a Pricing System

Identify specific pricing strategies.

Moore et al. (2010), Chapter 16, pp 419420

Extra Readings:
Scarborough (2012), Chapter 11, pp 362365.
Moore et al. (2010), Chapter 16, pp 420423
Extra Readings:
Scarborough (2012), Chapter 11, pp 365370.

6.4 Selecting a Pricing Strategy

Explain the benefits of credit, factors
that affect credit extension and types
of credit.

Moore et al. (2010), Chapter 16, pp 423426

Extra Readings:
Scarborough (2012), Chapter 11, pp 370382.

6.5 Offering Credit

Describe the Credit Process.

Moore et al. (2010), Chapter 16, pp 426428

Extra Readings:
Scarborough (2012), Chapter 11, pp 382383-384.

6.6 Managing the Credit process

6.6.1 Evaluation of Credit Applicants
6.6.2 Sources of Credit Information
6.6.3 Aging of Accounts Receivable
6.6.4 Billing
and
Collection
Procedures
6.6.5 Credit Regulation
6.6.6 Pricing and credit decisions

Moore et al. (2010), Chapter 16, pp 426432

Extra Readings:
Scarborough (2012), Chapter 11, pp 382384.

Moore et al. (2010), Chapter 16, pp 432-436

Extra Readings:
Scarborough (2012), Chapter 11, pp 382386.

48

STUDY GUIDE

BMSB5103

Small Business Management

Other Sources
1. Small Business School video; company
website: Glidden Point Oysters http://www.oysterfarm.com
2. A.G.A Correa & Son
http://www.agacorrea.com/aga/cgi
bin/aga.pl

3. Hardy Boat Cruises

http://www.hardyboat.com.
Maine Gold http://www.mainegold.com
4. Gulf of Maine Visionary Awards
http://www.gulfofmaine.org/mediaroom/
documents/2006Visionaryawards.pdf

Content Summary
6.1

Setting a Price

Cost Determination for Pricing

(a)

Cost of goods offered for sale

(b)

Selling cost

(c)

Overhead cost applicable to the given product

How Customer Demand Affects Pricing

Cost analysis can identify a level below which a price should not be
set under normal circumstances, but does not show how much the
final price might exceed that minimum figure and still be acceptable
to customers
Elasticity of Demand
(a)

Customer demand for a product is often sensitive to the price

level

(b)

Inelastic demand for a product means a lower total revenue

when the price is raised

(c)

Pricing and a firms competitive advantage

(d)

When customers perceive the product/service as an important

solution to their unsatisfied needs, they are likely to demand
more

49

STUDY GUIDE

6.2

BMSB5103

Small Business Management

(e)

If competing firms offer identical products and services, then the

services offered by the companies generally differ

(f)

Prestige pricing is setting a high price to convey an image of

high quality or uniqueness

Applying a Pricing System

Break-Even Analysis
(a)

Examining cost and revenue relationships

(b)

First phase of break-even analysis is to determine the sales

volume level at which the product, at an assumed price, will
generate enough revenue to start earning a profit

(c)

Contribution margin difference between the unit selling price and

the unit variable costs and expenses

(d)

Unrealistic to assume that quantity sold can increase continually

(e)

Incorporates sales forecasts

(f)

Indirect impact of price on the quantity that can be sold

complicates pricing decisions

Markup Pricing
(a)

Applying a percentage to a products cost to obtain its selling

price

(b)

Manageable pricing system that allows quick pricing of many

products

(c)

Must cover operating expenses, subsequent price reductions

(i.e. such things as markdowns and employee discounts) and
desired profit

50

STUDY GUIDE

6.3

BMSB5103

Small Business Management

Selecting a Pricing Strategy

Figure 6.1: Pricing strategies

Penetration Pricing
(a)

Prices a product or service at less than its normal, long-range

market price to gain more rapid market acceptance or to
increase existing market share

(b)

Strategy can sometimes discourage new competitors from

entering the market niche

Skimming Pricing
(a)

Sets prices for products/services at high levels for a limited

period before reducing prices to lower, more competitive levels

(b)

Assumes certain customers will pay the higher price due to

perception of the product as a prestige item

Follow-the-Leader Pricing
(a)

Uses a particular competitor as a model in setting a price for a

product/service

51

STUDY GUIDE

(b)
x

x
x

6.4

BMSB5103

Small Business Management

Price differential options may not work with different size

competitors

Variable Pricing
(a)

Offers price concessions to certain customers

(b)

Dynamic (personalised) pricing strategy charges more than the

standard price after gauging a customers financial means and
desire for the product

Price Lining
(a)

Establishes distinct price categories

(b)

Amount of inventory stocked at different quality levels depends

on the income levels and buying desires of a stores customers

Pricing at What the Market Will Bear

Uses when the seller has little or no competition
Final Notes on Pricing Strategies
(a)

Local, state, and federal laws may affect setting prices (Sherman
Antitrust Act prohibits price fixing)

(b)

Sometimes a line of products may have items which compete

with each other in which case the effects of a single product
must be considered when setting prices

(c)

Adjusting a price to meet changing marketing conditions

(d)

Can be costly to the seller and confusing to buyers

(e)

Alternative may be a system of discounting design to reflect a

variety of needs

(f)

Pricing errors can be corrected

Offering Credit
Explain the benefits of credit, factors that affect credit extension and types
of credit.
x

Benefits of Credit
(a)

Provides small firms with working capital, often allowing marginal

businesses to continue operations

(b)

Retail Customers (borrowers)

(i)

Ability to satisfy immediate needs and pay for them later

(ii)

Better records of purchases on credit billing statements

(iii)

Better service and greater convenience when exchanging

purchased items
52

STUDY GUIDE

BMSB5103

(iv)
(c)

Small Business Management

Establishment of a credit history

Suppliers
(i)

Facilitate increased sales volume

(ii)

Suppliers earn money on unpaid balances

(iii)

Closer association with customers because of implied trust

(iv)

Easier selling through telephone, mail-order systems and

the Internet

(v)

Smoother sales peaks and valleys, since purchasing power

is always available

(vi)

Easy access to a tool with which to stay competitive

Factors That Affect Selling on Credit

(a)

Credit sales should increase profits but this is not a risk-free

practice

(b)

May shift or share credit risk by accepting credit cards

(c)

Cost of accepting credit cards includes fraud protection,

chargebacks

(d)

Variety of reasons why small businesses may decide not to sell

on credit including the type of business, credit policies of
competitors, customers income levels and the availability of
working capital

Type of Business
(a)

Retailers of durable goods typically grant credit more freely than

those that sell perishables or primarily serve local customers

(b)

Big ticket items often must be sold on an instalment basis

Types of Credit
(a)

Consumer credit including open charge accounts, instalment

accounts, revolving charge accounts

(b)

Credit cards including bank credit cards, entertainment credit

cards. retailer credit cards

(c)

Trade Credit (depends on product sold and circumstances of the

buyer and the seller)

53

STUDY GUIDE

BMSB5103

Small Business Management

Managing the Credit Process

(a)

Describe the credit process.

(b)

Evaluation of Credit Applicants with Four Credit Questions

(i)

Can the buyer pay as promised?

(ii)

Will the buyer pay?

(iii)

If so, when will the buyer pay?

(iv)

If not, can the buyer be forced to pay?

The traditional five Cs of credit (character, capital, capacity,

conditions, collateral) are relevant.
x

x
x

Sources of Credit Information

(a)

Customers previous credit history

(b)

Trade credit agencies collect credit information on businesses

(c)

Credit bureaus summarise a number of firms credit experiences

with particular individuals

Aging of Accounts Receivable

Aging schedule (see Exhibit 16-6 Hypothetical Aging Schedule for
Accounts Receivable)
Billing and Collection Procedures
(a)

Timely notification of customers indicating the status of their

accounts is the most effective method of keeping credit accounts
current

(b)

Overdue credit accounts time sellers working capital

(c)

Effective weapon in collecting past-due accounts is reminding

debtors that their credit standing may be impaired

(d)

Bad-debt ratio is the ratio of bad debts to credit sales

Credit Regulation
(a)

Variety of federal and state laws that vary from state to state

(b)

Federal legislation includes: The Fair Credit Billing; The Fair

Credit Reporting Act; The Equal Credit Opportunity Act; The Fair
Debt Collection Practices Act

Pricing and credit decisions have a direct impact on a firms financial health.
54

STUDY GUIDE

BMSB5103

Small Business Management

Study Questions
1.

How does the concept of elasticity of demand relate to prestige pricing?

Give an example.

2.

What is the difference between penetration pricing strategy and skimming

pricing strategy? Under what circumstances would each be used?

3.

What are the major benefits of credit to buyers? What are its major benefits
to sellers?

4.

What is the major purpose of aging accounts receivable? At what point in

credit management should this activity be performed? Why?

5.

Based on this case study, answer the questions that follow.

SUPPLIES TEMPORARY OFFICE HELP
Mat Junid is the 35-year-old owner of a highly competitive small
business that supplies temporary office help. Like most businesspeople,
he is always looking for ways to increase profit. However, the nature of
his competition makes it very difficult to raise prices for the temps
services, while reducing their wages makes recruiting difficult. Mat Junid
has, nevertheless, found an area bad debts in which improvement
should increase profits. A friend and business consultant met Mat Junid
to advise him on credit management policies. Mat Junid was pleased to
get his friends advice, as bad debts were costing him about two percent
of sales. Currently, Mat Junid has no system for managing credit.
Adapted from Moore et al. (2010)

(a)

What advice would you give Mat Junid regarding the screening of new
credit customers?

(b)

What action should Mat Junid take to encourage current credit

customers to pay their debts? Be specific.

(c)

Mat Junid has considered eliminating credit sales. What are the
possible consequences of this decision?

55