Ch14 Pricing

Question 1

Three major influences on pricing

Answer 1

1) Costs: cannot sell below costs
2) Customers： determining how much they value and will pay
3) Competitors: influence industry dynamics

Question 2

Pricing options

Answer 2

1. Cost - based pricing (4)
2. Demand - based pricing (7)
3. Value-based pricing
4. Short-term / longer-term pricing decisions

Question 3

Variable product costs
(Cost based pricing 1/4)

Answer 3

1) suitable for non-competitive markets

2) focused on recovering relevant costs and achieving positive CM

3) not fit when fixed costs are a large component of total costs (may not cover fixed cost and general overhead)

Question 4

Full absorption costs
(Cost based pricing 2/4)

Answer 4

1) to ensure all product costs are being recovered with the price set

2) full absorption costing is required for financial reporting per GAAP

3) may not be accurate because based on budget (fixed OH allocation)

4) may not responsive to competition when lower price still provides CM

Question 5

Life-cycle costs
(Cost based pricing 3/4)

Answer 5

1) Five stages of a product’s life-cycle: development - introduction - growth -maturity - decline

2) 80% to 90% of a product’s life-cycle cost will be incurred during the pre-production stages (initial cost)

3) to recover initial costs by mapping out the intended prices over each of the stages of the product

• objective of product life-cycle management is to maximize profits over a product’s entire life cycle, rather than to maximize revenues and minimize costs for each stage of the life cycle

Question 6

Target based cost
(Cost based cost 4/4)

Answer 6

Step 1: Develop a product that satisfies the needs of potential customers.

Step 2: Choose a target price.

Step 3: Derive a target cost per unit by subtracting target operating income per unit from the target price.

Step 4: Perform cost analysis to target cost reduction.

Step 5: Perform value engineering to achieve target price, reducing costs and achieving desired quality levels.

Question 7

Issues with cost-based pricing

Answer 7

1) poor-quality cost information leads to poor pricing and product decisions

2) death spiral issue:
+ sales volume drops, causing unit cost to increase
+ if price is based on cost, increased cost leads to increased price
+ increased price leads to decreased sales volume

Question 8

Demand - based pricing

Answer 8

1) applies to companies with INELASTIC demand (utility) - monopoly / oligopoly

2) test consumers’ price sensitivity to products to arrive at the final price

3) companies first decide what return to achieve given certain cost structure, then set a price to achieve the return

Question 9

Seven demand-based pricing techniques

Answer 9

1. Predatory pricing
2. Penetration pricing
3. Price skimming
4. Price building
5. Loss leader pricing
6. Peak-load pricing
7. Tender / contract pricing

Question 10

Predatory pricing
(Demand-based pricing 1/7)

Answer 10

1. Deliberate price cutting or offers of “free gifts / products”
2. Forces smaller / weaker rivals out of business or prevents new entrants ( intent - to eliminate competition)
3. Works in the short term but not in the long term
4. Anti-competitive and illegal if it can be proven, but very difficult to prove

Question 11

Penetration pricing
(Demand-based pricing 2/7)

Answer 11

1. Price set to “penetrate the market”
2. Low price to secure high volumes
3. Intent is to lower costs over the long term by gaining production and distribution economies of scale before competitors (major difference btw predatory pricing)
4. Suitable for products with long product life
5. May be useful if launching into a new market

Question 12

Price skimming
(Demand-based pricing 3/7)

Answer 12

1. High price first to sacrifice volume for higher profit (limited volumes) - target “early adopters” who value products more than economics and have more disposable income

2.Short window of opportunity (will soon lower price for higher volume)

3.Suitable for products that have short life cycles or that will face competition at some point in the future (such as after a patent runs out)

Question 13

Price bundling

Answer 13

1. Offered when customers purchase more than one product or service from a company
2. The more you buy, the less you pay
3. Package deals

Disadvantage: profit loss if customers are willing to buy all bundled products/services individually

Advantages:
1. can sell one or more products that are not wanted by customers if sold individually

2. prevent customers from buying one or more from competitors (internet and cable )

Question 14

Peak-load pricing (aka. dynamic pricing)
(Demand-based pricing 4/7)

Answer 14

to limit demand when supply is restrained by capacity

1. Prices adjusted to demand and volume
2. The higher the demand, the higher the price

（airline, resort)

Question 15

Loss leader pricing
(Demand-based pricing 5/7)

Answer 15

1. Products sold below market price
2. Customer draw to stimulate sales of more profitable goods or services
3. Purchases of other items more than cover “loss” on item sold
   (retail - usually limited purchase items)
   (printer - sell less for printer and recover loss from sale of ink)

Question 16

Tender/contract pricing

Answer 16

1. Proposal submitted for a contract / job
2. Aims to cover materials and labour costs, and generate a profit
3. Often undisclosed and in competitive markets

open bids to all / closed bids to selected ones who have worked with

Question 17

Value - based pricing

Answer 17

based on a trade-off between the perceived value to the consumer and the producer’s incentive to produce the product (profit maximizing)

the price set could be high in relation to the costs of the product due to the perceived value by the customer

products are sold on emotion

1. Focuses on a single market segment
2. Compares based on the next best alternative
3. Focuses on differentiated features, not the brand

(fashion apparels)

Question 18

Short-term pricing decisions

Answer 18

1. one-time only and have no long-run implications
2. adjust product mix and production volume in a competitive market

Two key factors affect short-term pricing:
* Many costs are irrelevant in short-run pricing decisions.
* Short-term pricing is opportunistic.

Qualitative considerations: discounts will upset current customers

Question 19

Pricing considerations

Answer 19

1. Structure of industry:
   + strength of competitors - price and market share
   + monopoly / oligopoly - perfect competition
2. Product life-cycle
   + short life-cycle products (smartphones/computers)
   It is difficult to identify the stages of a product’s life cycle while it is in progress
3. Bell-shaped price curve
   Many factors affect the shape of the curve:
   1) the nature and timing of product enhancements
   2) introduction of new technology
   3) pricing
   4) degree of segmentation, and
   5) choice of distribution channels

Two external factors shape the nature of the sales curve for a new product: the rate at which consumers adopt it, and the degree to which existing and future products can better meet consumer needs.

Question 20

Extending product life-cycle

Answer 20

maturity phase is the most important phase to prolong and lengthen from a financial perspective.

extending the maturity phase strategies such as:
* increasing product demand within the existing customer base with special exclusive offers
* encouraging trial versions of the current product so that new customers may be introduced to the product
* enhancing current product features or usability to make the product more attractive
* offering special incentives and promotions to attract customers who use alternative brands