advantages and disadvantages of different pricing methods

3 Business Studies – Cambridge IGCSE (0450) – Complete Lecture Notes

Section 1 – Understanding Business Activity

1.1 What is a Business?

• Purpose: Produce goods or services to satisfy needs and earn a profit (or achieve non‑profit objectives).
• Classification by sector

  Sector	Primary	Secondary	Tertiary
  Examples	Agriculture, mining	Manufacturing, construction	Retail, banking, education

• Classification by ownership

  Type	Private (profit)	Public (profit)	Non‑profit
  Typical examples	Sole trader, partnership, Ltd.	PLC listed on a stock exchange	Charity, NHS, schools

• Size of business – micro, small, medium, large (based on turnover, employees, assets).

1.2 Business Objectives

• Profit maximisation
• Growth (market share, sales, geographic expansion)
• Survival (especially for SMEs)
• Customer satisfaction
• Social and environmental responsibility

1.3 Stakeholders and Their Interests

Stakeholder	Primary Interest
Owners / shareholders	Profit, return on investment
Managers	Business success, career progression
Employees	Job security, wages, working conditions
Customers	Value for money, quality, service
Suppliers	Regular orders, timely payment
Government	Tax revenue, compliance with law
Community / environment	Employment, sustainable practices

Section 2 – People in Business

2.1 Motivation Theories (AO2)

Theory	Key Idea	Relevance to Managers
Maslow’s Hierarchy of Needs	Physiological → Safety → Social → Esteem → Self‑actualisation	Design reward packages that meet lower‑level needs first.
Herzberg’s Two‑Factor Theory	Hygiene factors (salary, conditions) prevent dissatisfaction; motivators (recognition, achievement) create satisfaction.	Separate basic pay from motivational incentives.
McGregor’s Theory X / Theory Y	Assumptions about employee nature affect management style.	Adopt Theory Y (empowerment) where possible.

2.2 Organisational Structures

• Functional – grouped by specialist functions (marketing, finance, production).
• Divisional – based on product lines, geographic regions, or markets.
• Matrix – dual reporting (functional & product).

2.3 Recruitment, Selection & Training (AO3)

1. Job analysis & person specification
2. Advertising & attracting applicants
3. Shortlisting & interview
4. Offer & induction
5. Training & development – on‑the‑job, off‑the‑job, e‑learning.

2.4 Communication in Business

• Formal vs. informal channels
• Downward, upward, horizontal communication
• Barriers (language, cultural, technological)

2.5 Legal Controls on People

• Employment Rights Act – contracts, unfair dismissal
• Health & Safety at Work Act
• Trade Union & collective bargaining regulations

Section 3 – Marketing (The 4 Ps)

3.1 Role of Marketing

Identify, create, and satisfy customer needs profitably. Links directly to business objectives such as market‑share growth and brand positioning.

3.2 Market Segmentation & Targeting

• Segmentation variables – demographic, geographic, psychographic, behavioural.
• Target market – the segment(s) a business decides to serve.

3.3 Market Research (AO3)

Typical steps:

1. Define the problem & objectives.
2. Choose primary (questionnaire, interview) or secondary sources.
3. Collect data, analyse and present (e.g., bar chart of preferred product features).
4. Make decisions – e.g., adjust price, product design.

3.4 The Marketing Mix

Element	Key Decisions
Product	Features, quality, branding, packaging, life‑cycle stage.
Price	Pricing method, discounts, credit terms, price‑elasticity considerations.
Place (Distribution)	Channels, logistics, location, coverage.
Promotion	Advertising, sales promotion, public relations, personal selling.

3.5 Legal & Ethical Controls on Marketing

• Consumer Protection Act – product safety, misleading advertising.
• Competition law – prohibits price‑fixing, market sharing.
• Data‑protection regulations – handling of customer information.

3.6 Pricing Methods – Advantages & Disadvantages (AO1‑AO3)

Method	Definition	When Most Appropriate	Advantages	Disadvantages
1. Cost‑plus Pricing
Cost‑plus Pricing	Add a standard markup to the unit cost.	Stable cost structures; low competition.	Simple to calculate. All costs covered. Predictable profit margin.	Ignores market demand & competition. May set price too high/low. Not responsive to consumer preferences.
2. Competition‑based Pricing
Competition‑based Pricing	Set price relative to rivals (match, undercut, or price‑lead).	Highly competitive markets (e.g., supermarkets).	Helps maintain market position. Reduces risk of price wars. Easy to benchmark.	May ignore own cost structure. Can erode margins if rivals cut prices. Limits product differentiation.
3. Demand‑oriented (Price‑elasticity) Pricing
Demand‑oriented Pricing	Set price based on how quantity demanded responds to price changes.	When reliable elasticity data are available (e.g., airline tickets).	Maximises revenue if elasticity is accurate. Supports strategic discounts or premium pricing. Facilitates market‑segmentation.	Requires accurate data – costly to obtain. Complex to calculate & monitor. Risk of mis‑estimation → lost sales or profit.
4. Psychological Pricing
Psychological Pricing	Prices set to influence perception (e.g., £9.99 vs £10).	Low‑involvement, fast‑moving consumer goods.	Creates bargain perception. Simple to implement. Effective for impulse purchases.	Effect fades with savvy shoppers. Can appear manipulative → brand damage. Limited impact on high‑involvement products.
5. Penetration Pricing
Penetration Pricing	Low introductory price to quickly gain market share.	New entrants or mass‑market products.	Rapidly builds a customer base. Discourages rivals from entering. Creates economies of scale.	Initial low profit margins. Risk of losing price‑sensitive customers when price rises. May damage perceived quality.
6. Skimming Pricing
Skimming Pricing	High initial price, then reduced over the product life‑cycle.	Innovative, luxury, or technology products with early adopters.	Recovers development costs quickly. Signals high quality/exclusivity. Allows price discrimination across stages.	Limits market size at launch. Attracts competitors seeking high margins. Negative consumer reaction if price drops sharply.
7. Bundle Pricing
Bundle Pricing	Sell a set of products/services together at a single price.	Telecommunications, software suites, fast‑food meals.	Increases perceived value. Encourages purchase of additional items. Smooths demand across product lines.	May reduce profit on high‑margin items. Complex to allocate fair price to each component. Customers may only want part of the bundle.
8. Dynamic (Yield) Pricing
Dynamic (Yield) Pricing	Price varies with real‑time factors such as demand, time, or inventory.	Airlines, hotels, online retailers with sophisticated data systems.	Optimises revenue per unit sold. Responds instantly to market changes. Can target different customer segments.	Requires advanced IT & data analysis. Can frustrate customers if prices fluctuate widely. Potential regulatory scrutiny in some sectors.

3.7 Worked Examples (AO3)

Example 1 – Cost‑plus Pricing

Unit costs: Direct materials £12, Direct labour £8, Variable overhead £5, Fixed overhead (allocated) £3.

Unit cost = £12 + £8 + £5 + £3 = £28

Markup = 25 % → Selling price = £28 × 1.25 = £35

Example 2 – Demand‑oriented Pricing (Elasticity)

Ticket price £10 → 1,200 tickets/week; price £12 → 900 tickets/week.

E = (%ΔQ ÷ %ΔP) = [(900‑1,200)/1,200] ÷ [(12‑10)/10] = (‑0.25) ÷ 0.20 = ‑1.25

Since |E| > 1, demand is price‑elastic; raising price would reduce total revenue.

Example 3 – Competition‑based Pricing

Company A’s shampoo £8.00; rivals £7.50 and £7.80.

• Match lowest rival → £7.50
• Price‑lead → £7.40
• Premium positioning → keep £8.00 and stress quality.

Choice depends on cost, brand image, and target market.

Example 4 – Dynamic Pricing (Yield Management)

An airline monitors seat occupancy. When occupancy < 30 % 48 hours before departure, price drops 15 %; when > 80 % occupancy, price rises 20 %.

3.8 Mini‑Data Set – Choose the Best Pricing Method (AO3)

Product	Unit Cost (£)	Competitor Price (£)	Elasticity (E)	Market Situation
Eco‑friendly water bottle	3.00	4.20	‑0.8 (inelastic)	New entrant, niche eco‑market
Smartphone model X	150	200	‑1.6 (elastic)	Highly competitive, rapid tech turnover
Monthly gym membership	25	30	‑1.2 (elastic)	Established brand, price‑sensitive customers

Task (AO3): Analyse each row and recommend the most suitable pricing method, justifying with cost, competition, and elasticity considerations.

3.9 Decision‑Making Flowchart (Suggested Diagram)

From cost analysis → market analysis (competition & elasticity) → product‑life‑cycle stage → legal/ethical checks → select appropriate pricing method (or combination).

Section 4 – Operations Management

4.1 Production Methods

• Job/Batch production – customised, low volume.
• Flow (mass) production – high volume, low variety.
• Lean production – minimise waste, continuous improvement.

4.2 Costs & Break‑Even Analysis (AO2)

Break‑even point (units) = Fixed Costs ÷ (Selling price per unit – Variable cost per unit).

Fixed Costs	£50,000
Selling price per unit	£25
Variable cost per unit	£15
Break‑even units	£50,000 ÷ (£25‑£15) = 5,000 units

4.3 Quality Management

• ISO 9001 certification
• Six Sigma – reduce defects to 3.4 per million.
• Quality‑control checklist – specifications, inspection points, corrective action.

4.4 Location Decisions

• Factors: transport costs, labour availability, market proximity, government incentives.
• Methods: cost‑benefit analysis, break‑even for different sites.

Section 5 – Financial Information and Decisions

5.1 Sources of Finance (AO1)

Source	Type	Typical Cost	Control
Bank loan	Debt	Interest (5‑10 %)	Fixed repayments
Shares (issue of new equity)	Equity	Dividend expectations	Shareholder voting rights
Retained earnings	Internal	Opportunity cost of reinvestment	Full control retained
Leasing	Debt‑like	Lease payments	Asset not owned

5.2 Cash‑flow Forecast (AO2)

Month	Cash Inflows (£)	Cash Outflows (£)	Net Cash (£)
Jan	30,000	25,000	5,000
Feb	35,000	28,000	7,000
Mar	40,000	32,000	8,000

5.3 Income Statement (Profit & Loss) – Example

Revenue	£200,000
Cost of sales	£120,000
Gross profit	£80,000
Administrative expenses	£30,000
Operating profit	£50,000
Interest expense	£5,000
Profit before tax	£45,000
Tax (20 %)	£9,000
Net profit	£36,000

5.4 Balance Sheet – Example (at 31 Dec)

Assets	£	Liabilities & Equity	£
Non‑current assets (machinery)	150,000	Long‑term loan	80,000
Current assets (stock)	60,000	Creditors	30,000
Cash	20,000	Owner’s capital	100,000
Total assets		Total liabilities & equity
£230,000		£210,000

5.5 Key Financial Ratios (AO2)

• Gross profit margin = Gross profit ÷ Revenue × 100 %
• Current ratio = Current assets ÷ Current liabilities
• Return on capital employed (ROCE) = Profit before interest & tax ÷ (Capital employed) × 100 %

5.6 Pricing Methods – Recap (see Section 3.6)

Section 6 – External Influences on Business

6.1 Economic Cycle

• Expansion → higher consumer spending, demand‑pull inflation.
• Peak → capacity constraints, possible price rises.
• Recession → reduced demand, price‑sensitive buying.
• Recovery → gradual increase in demand.

6.2 Government Policy

• Fiscal policy – tax rates, subsidies, public spending.
• Monetary policy – interest rates, money supply.
• Regulation – health & safety, environmental standards, competition law.

6.3 Environmental & Ethical Issues

• Carbon footprints, waste reduction, sustainable sourcing.
• Corporate social responsibility (CSR) – philanthropy, ethical labour.

6.4 Globalisation & MNCs

• Opportunities: larger markets, lower production costs.
• Threats: exchange‑rate risk, cultural differences, competition from overseas.

6.5 Exchange Rates (AO1)

Appreciation of the home currency makes imports cheaper but exports more expensive; depreciation has the opposite effect.

How to Choose the Most Appropriate Pricing Method (AO4)

1. Analyse the cost structure – are all costs known and stable?
2. Assess the market conditions – level of competition, price sensitivity (elasticity), and consumer behaviour.
3. Identify the product’s life‑cycle stage – introduction, growth, maturity, decline.
4. Consider the brand positioning – premium vs. value‑oriented image.
5. Check for any legal or regulatory constraints – price caps, competition law, sector‑specific rules.
6. Determine the availability of data – can reliable cost, competitor, or elasticity information be obtained?
7. Decide whether a single method or a combination (e.g., cost‑plus as a floor, then adjust for competition) best meets the business objectives.

Key Take‑aways

• No single pricing method fits all situations; the optimal choice depends on internal costs, external market forces, product life‑cycle, and strategic objectives.
• Understanding the advantages and disadvantages of each method enables managers to anticipate risks and align pricing with overall business goals.
• Combining methods (e.g., cost‑plus baseline plus competition‑based adjustments) often yields a balanced, flexible approach.
• Always verify that chosen pricing strategies comply with legal controls and consider the wider external environment (economic, social, environmental).