Approaches to pricing Flashcards
Cost classification
DIRECT COSTS - traced directly to a specific product/service
INDIRECT COSTS (overhead) - cannot be directly traced to a specific product but necessary for production.
Cost behaviour
FIXED COSTS - not affected by changes in level of activity
eg, rent, advertising
VARIABLE COSTS - directly related to changes in level of activity
eg, material, labour costs, commission
SEMI-VARIABLE COSTS - combine fixed and variable elements
eg, phone/electricity bills
The Accountant’s Perspective of the pricing decision: 3 PRICING METHODS
- Full Cost Pricing
- Marginal Cost Pricing
- Activity Based Costing (ABC)
The Pricing Decision:
FULL COST PRICING
- Business must cover all costs when setting prices.
- Add markup % for profitability
Selling price = Cost + (Markup% * cost)
Markup =
Markup = ( Profit / Cost ) * 100%
The Pricing Decision:
Marginal Cost plus pricing
- Only considers variable costs
- Treats fixed costs as period costs, not assigned to individual units.
The Pricing Decision:
BENEFITS of Marginal Cost plus pricing
- Direct costs more easily established
- No need to estimate any costs
- Frequently used in retailing and by professional service businesses
The Pricing Decision:
Activity-based Costing (ABC)
- Tries to allocate costs more accurately by:
- Identifying costs by activity
- Allocating costs by amount of
each activity involved
Cost management strategies
- Lifecycle pricing
Adjusts price over a product’s life cycle, considers demand, competition and costs. - Target costing
Determines a cost structure based on market price constraints. - Kaizen
Focuses on small improvement continuous, incremental cost reductions.
The Marketer’s perspective:
PRICING STRATEGIES
- Market skimming pricing
- Premium pricing
- Value pricing
- Perfect competition
The Marketer’s perspective:
Market Skimming Pricing
- Price starts high and gradually lowers
- Best for new tech eg, Apple
- Businesses recover research/development costs and maximise initial profits
- Form of price discrimination
The Marketer’s perspective:
Premium Pricing
- Charge higher price than market average
- Must convince customers of higher quality and easier access to services
The Marketer’s perspective:
Value Pricing
- Sell a product similar quality to competitors but at lower price
- Aims to attract customers by offering better value, undercutting market
The Marketer’s perspective:
Competitive Pricing Strategy
- Price at the going market rate
- Price close to perfect competition
