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Pricing theory with a taste of summer

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As festival season begins, Makbul Patel is intent on exploring how pricing theory and its integration with management accounting is reflected in creating successful events.

5th Jun 2024
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I am sure many readers are quite fond of summers. Winter may bring that sense of cosiness and early nights but, sorry, you can’t beat summer. And for the past few summers I have been lucky enough to be involved with food and drink festivals around the country.

Things have moved on for me since the early days of The Great British Bake Off where I was mostly demonstrating my kitchen skills in front of an audience, trying to control my nerves and not panic when the pastry wasn’t rolling out in one piece. These days the organisers have enough faith and confidence in me to help organise the festivals and the chef line-ups. I am more backstage and hosting with no getting my hands dirty.

This in itself brings challenges but I usually have wonderful chefs to work with, who know their audience and the arena.

Managing demand

As food and drink festivals gain popularity, usually containing other activities such as market stalls and music stages, the demand for tickets has to be managed accordingly. As a management accountant the pricing of events has always intrigued me. This is where pricing theory comes in, and food festivals are a perfect example of how it comes into effect and the role of management accountants in implementing a pricing strategy.

We see pricing strategies in most parts of our lives, from basic food shopping, to going on holidays, to buying goods. Pricing theory has its fingerprints on many aspects of our lives.

Concepts in pricing theory

Pricing theory examines how prices are set in various market conditions and how they affect consumer behaviour and business profitability. Here are the key concepts in pricing theory.

Cost-based pricing

Cost-based pricing is the very basic pricing model. It does not take into account external factors.

  • Cost-plus pricing is setting prices by adding a fixed mark-up to the cost of producing the product. This works well for a bought product that is to be sold without much modification.
  • Break-even analysis is determining the price at which total revenue equals total costs, resulting in no profit or loss. Slightly more sophisticated than the cost-plus model. The organisation is determined to cover its sunk (or fixed) costs first before moving onto profitability.

Value-based pricing

We are now moving up a gear or two from cost-based pricing and looking at the demographic we aim to serve, bringing in demand and trying to comprehend the market and competition.

  • Perceived value is when you set prices based on the perceived value of the product to the customer, rather than the actual cost. Think of games consoles and other similar gadgets when they are first launched. I remember my kids driving me crazy to get them the latest video games and muggins falling for the hype.
  • Willingness to pay involves understanding how much customers are willing to pay for the benefits they receive. This is where exclusivity is a big factor, and of course demand. I remember soon after the pandemic there was a scarcity of electronic parts that caused the price of second-hand cars to shoot up. People were willing to pay daft prices.

Competition-based pricing

It is very rare that there will be no competition for your product. We are now in an age of almost perfect knowledge of the market, so customers are dictating the prices to a much higher degree.

  • Penetration pricing is setting a low price to enter a competitive market and attract customers quickly.
  • Skimming pricing is setting a high price initially and then gradually lowering it to capture different market segments.

Dynamic pricing

We are now entering a more nuanced pricing area, and this will be the target of curses from many parents wishing to take the kids on a break during school holidays.

  • Real-time adjustment is changing prices based on current demand and supply conditions. As we know, booking something well in advance will usually attract a cheaper price. Like our festivals, the closer one gets to the event the more expensive it will be. Travel and hotel prices during peak times is another example.

Psychological pricing

  • Price endings is where you use prices such as 149.9p per litre for fuel instead of 150.0p to make the price appear lower.
  • Bundling is offering multiple products for a single price, which can enhance perceived value. We’ve all experienced that conundrum in supermarkets – 3 for the price of 2 or buy one get one half price. 

Integration of pricing theory and management accountancy

Pricing decisions are deeply rooted in management accounting data. As management accountants, the information we analyse and share has a real impact on the overall pricing mechanisms and strategy.

Cost information

Accurate cost information from cost accounting helps determine the minimum price needed to cover costs and achieve profitability.

Financial analysis

Budgeting and forecasting provide insights into the financial implications of different pricing strategies, allowing for informed decision-making.

Performance metrics

KPIs and variance analysis help assess the impact of pricing decisions on sales volumes, profitability and market share. Historical data on performance will dictate the price of the product. A giant tech firm, for example, will know their market presence and demand. This information is gathered with the aid of management accountants.

Strategic alignment

Tools like the balanced scorecard ensure that pricing strategies align with the overall strategic objectives of the company, such as market penetration or premium positioning.

Customer value and costing

Activity-based costing can identify cost drivers and help price products based on the value delivered to customers rather than just cost-plus methods.

By combining insights from pricing theory with robust management accounting practices, businesses can develop pricing strategies that optimise profitability, competitiveness and customer satisfaction.

Working together

It is clearly evident that management accountancy has a key role to play within this area of economics. An organisation has roles and functions that must work together as one entity with goal congruence at the centre of its operation. Pricing theory pulls this demand – economic viability and success are dependent on it.

Replies (4)

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By vstrad
06th Jun 2024 09:20

An interesting and clear article. Thank you, Makbul.

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By Paul Crowley
07th Jun 2024 12:10

Material error
It is butter, then jam, with cream on top.

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Replying to Paul Crowley:
Rob Swan
By Rob Swan
07th Jun 2024 12:19

Noooo.... No butter! ;)

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Rob Swan
By Rob Swan
07th Jun 2024 12:18

Any mention of 'Theory' in connection with accounting and finance and I immedaitely fall....... Zzzzzzzz....

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