chapter 12 Flashcards
major influences on pricing decision
- customers
- competitors
- costs
short-run pricing decisions
include (1) pricing for a one-off special order with no long-term implications and (2) adjusting product mix and output volume in a competitive market.
long-run pricing decisions
include pricing a product in a major market where price setting has considerable leeway. many pricing decisions have both short-run and long-run implications.
stable prices
are preferred by customers. it reduces the needs for continuous monitoring of suppliers’ prices, improves planning, and builds long-run buyer-seller relationships.
the market-based approach to pricing
asks ‘given what our customers want and how our competitors will react to what we do, what price should we charge?’ this approach is logical in very competitive markets.
the market-based and cost-based approach both consider customers, competitors, and costs. only the starting points are different.
the cost-based approach to pricing/”cost-plus”
asks ‘what does it cost us to make the product, and hence what price should we charge, that will recoup our costs and produce a desired profit?’ the price is calculated on the basis of costs to produce and sell a product. then, a mark-up is added. often, this price is modified by anticipated customer reaction to alternative price levels and the prices charged by competitors for similar products (market forces).
target price
the estimated price for a product or service that potential customers will be willing to pay.
target operating profit per unit
the operating profit that a company wants to earn on each unit of product or service sold.
target cost per unit
the estimated long-run cost per unit of a product or service that, when sold at the target price, enables the company to achieve the target operating profit per unit. it is derived by subtracting the target operating profit per unit from the target price.
value engineering
a systematic evaluation of all aspects of the value-chain business functions, with the objective of reducing costs while satisfying customer needs. it can result in improvements in product design, changes in materials specifications or modifications in process methods. it seeks to reduce or eliminate non-value-added activites and hence non-value-added costs by reducing the cost drivers of the non-value-added activities.
steps for developing target prices and target costs
- develop a product that satisfies the needs of potential customers
- choose a target price based on customers’ perceived value for the product, the prices charged by competitors, and a target operating profit per unit
- derive a target cost per unit by subtracting target operating profit per unit from the target price
- perform value engineering to achieve target costs
cost incurrence
occurs when a resource is sacrificed or used up.
locked-in (designed-in) costs
those costs that have not yet been incurred but that will be incurred in the future based on decisions that have already been made. distinguishing cost incurrence and locked-in costs is important, because it is difficult to alter or reduce costs that have already been locked in.
two key concept of value engineering and managing value-added and non-value-added costs
- cost incurrence
- locked-in costs
undesired consequences of value engineering and target costing
- adding too many features
- long development times
- organisational conflict
these can be avoided by focusing on the customer, paying attention to schedules, and building a culture of teamwork and cooperation across business functions.
target rate of return on investment
the target operating profit that an organisation must earn divided by invested capital. usually specified on investments.
invested capital
can be defined in many ways. we define it as total assets (long-term or fixed assets plus current assets).
advantages of including fixed costs per unit in pricing decisions/full-cost formula
- full product cost recovery
- price stability
- simplicity
price discrimination
the practice of charging some customers a higher price than is charged to other customers.
peak-load pricing
the practice of charging a higher price for the same product or service when demand approaches physical capacity limits. under price discrimination and peak-load prices prices differ among market segments even though the outlay costs of providing the product or service are approximately the same.
general formula for setting a price
prospective selling price = cost base (X) + mark-up component (Y)
product life-cycle
spans the time from initial R&D to the time at which support to customers is withdrawn.
life-cycle budgeting
used to estimate the revenues and costs attributable to each product from its initial R&D to its final customer servicing and support in the marketplace.
life-cycle costing
tracks and accumulates the actual costs attributable to each product across the entire value chain.
‘cradle-to-grave costing’ and ‘womb-to-tomb costing’
convey the sense of fully capturing all costs associated with the product.
two essential points to price effectively throughout the life of a product or service
- actively managing the trade-offs between price and volume or profit and market share to maximise returns
- making price decisions in the context of their broader product portfolios
benefits of the product life-cycle reporting format
- the full set of revenues and costs associated with each product becomes visible
- differences among products in the percentage of their total costs incurred at early stages in the life cycle are highlighted
- interrelationships among business function cost categories are highlighted
customer profitability analysis
refers to the reporting and analysis of customer revenues and customer costs. managers need to ensure that customer contributing sizable to the profitability of an organisation receive a comparable level of attention from the organisation.
customer revenues
inflows of assets from customers received in exchange for products or services being provided to those customers. more accurate customer revenues can be obtained by tracing as many revenue items as possible to individual customers. the amount of detail affects the analysis of customer profitability.
price discounting
the reduction of selling prices below listed levels in order to encourage an increase in purchases by customers.
customer cost hierarchy
categorises costs related to customers into different cost pools on the basis of different types of cost drivers or different degrees of difficulty in determining cause-and effect relationships.
categories of the customer cost hierarchy
- customer output-unit-level costs
- customer batch-level costs
- customer-sustaining costs
- distribution channel costs
- corporate sustaining costs
customer output-unit-level costs
resources sacrificed on activities performed to sell each unit to a customer.
customer batch-level costs
resources sacrificed on activities that are related to a group of units sold to a customer.
customer-sustaining costs
resources sacrificed on activities undertaken to support individual customers, regardless of the number of units or each batch of product delivered to customers.
distribution channel costs
resources sacrificed on activities related to a particular distribution channel rather than to each unit of production, batches of product, or specific customers.
corporate sustaining costs
resources sacrificed on activities that cannot be traced to individual customers or distribution channels.
factors to consider when allocating resources across customers
- customer profitability reports
- short-run and long-run profitability
- likelihood of customer retention
- potential for customer growth
- increases in overall demand for having well-known customers
- ability to learn from customers
