Setting the price for an organization’s product or service is one of the most important decisions a manager faces.
It is also one of the most difficult, due to the number and variety of factors that must be considered.
Customer demand is a very important consideration in pricing decisions.
Decisions regarding customers mean that management must find the proper balance between perfect quality and perfect price.
The higher the quality, the higher the price.
Lower quality means lower price.
It is critical for management to find the proper balance that their customers want.
Competition is another consideration in pricing decisions.
If a competitor lowers its price for a similar product, you may have to match its price, or risk losing market share to the competitor.
Costs must be held below the market price of the product.
In some businesses, the market determines the price. Management can only charge the market price, so it must insure that its costs are below that price in order to make a profit.
In the legal area, there are certain laws regarding pricing policies that management must follow.
For example, the law prohibits from discriminating against customers when setting prices.
Collusion with other businesses in setting prices is also illegal.
Public perception of unfair prices could cause political pressure on legislatures for regulatory relief from high prices.
The company’s business image and reputation may rest on their pricing policies.
Some businesses sell service with higher prices.
Others rely on low prices period.
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Target Costing and Cost Analysis for Pricing DecisionsChapter 15Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Major Influences on Pricing DecisionsPricing DecisionsPolitical, legal, and image issuesCompetitorsCostsCustomer demand15-*How Are Prices Set?CostsMarket ForcesPrices are determined by the market, subject to costs that must be covered in the long run.Prices are based on costs, subject to reactions of customers and competitors.15-*Economic Profit-Maximizing PricingFirms usually have flexibility in setting prices.The quantity sold usually declines as the price is increased.15-*Total Revenue CurveTotal revenueCurve is increasing throughout its range, but at a declining rateDollarsQuantity sold per month15-*Demand Schedule and Marginal Revenue CurveDemandSales price must decrease to sell higher quantityDollars per unitQuantity sold per monthMarginal revenueRevenue per unit decreases as quantity increases15-*Total Cost CurveDollarsQuantity made per monthTotal cost increases at a declining rateTotal cost increases at an increasing rate15-*Quantity made per monthMarginal Cost CurveMarginal costDollars per unitQuantity where marginal cost begins to increase15-*cQuantity made and sold per monthDetermining the Profit-Maximizing Price and QuantityDollars per unitDemandMarginal revenueMarginal costq*p*15-*Quantity made and sold per monthDetermining the Profit-Maximizing Price and QuantityDollars per unitDemandMarginal revenueq*p*Marginal costProfit is maximized where marginal cost equals marginal revenue, resulting in price p* and quantity q*.15-*Determining the Profit-Maximizing Price and QuantityTotal revenueDollarsTotal costTotal profit at the profit-maximizing quantity and price, q* and p*.Quantity made and sold per monthq*15-*Cost-Plus PricingPrice = cost + (markup percentage × cost)Variable manufacturing cost?Full-absorption manufacturing cost?Total cost, including selling and administrative?Total variable cost, including selling and administrative?15-*Strategic Pricing of New ProductsUncertainties make pricing difficult.Production costs.Market acceptance.Pricing Strategies:Skimming – initial price is high with intent to gradually lower the price to appeal to a broader market. Market Penetration – initial price is low with intent to quickly gain market share.15-*Target CostingMarket research determines the price at which a new product will sell.Management computes a manufacturing cost that will provide an acceptable profit margin.Engineers and cost analysts design a product that can be made for the allowable cost.15-*Target CostingKey principles of target costingPrice led costingFocus on the customerFocus on product designFocus on process designCross-functional teamsLife-cycle costsValue-chain orientation15-*The Role Of Activity-BasedCosting In Setting ATarget CostProduction ProcessComponent Activities15-*Product Cost DistortionHigh-volume productsmay be overcostedLow-volume productsmay be undercosted15-*Value Engineering and Target CostingTarget cost information Product design Product costs Production processesValue Engineering (VE) Cost reduction Design improvement Process improvement15-*Time and Material PricingPrice is the sum of labor and material charges.Used by construction companies, printers, and professional service firms.15-*Time and Material PricingTime charges:Total labor hours requiredHourly labor cost+Overhead cost per labor hour+Hourly charge to provide profit margin×Material Charges:Total material cost incurred+Overhead per dollar of material cost×Total material cost incurred15-*Competitive BiddingHigh bid priceLow probability of winning bidHigh profit if winning bidLow bid priceHigh probability of winning bidLow profit if winning bid15-*Competitive BiddingGuidelines for BiddingBidder has excess capacity Low bid price Any bid price in excess of incremental costs of job will contribute to fixed costs and profit. Bidder has no excess capacity High bid price Bid price should be full cost plus normal profit margin as winning bid will displace existing work.15-*Legal Restrictions On Setting PricesPrice discriminationPredatory pricing15-*
