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ACCA Performance Management > Chapter 7: pricing > Flashcards

Chapter 7: pricing Flashcards

1
Q

Why is pricing important?

A

Contributes to profit maximisation- aim of most businesses

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2
Q

How is price determined?

A

By the market they operate in

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3
Q

What happens in a perfect market

A

each buyer/ seller is a ‘price taker’
No participant influences the price of the product it buys/ sells

No entry/ exit barriers
Perfect information- prices & quality are assumed to be known to all consumers & producers
Companies aim to maximise profits
Homogenous products- characteristics of given market goods don’t vary

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4
Q

What imperfect competition

A

Monopoly
Oligopoly
Monopolistic competition

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5
Q

What is a monopoly

A

1 seller of a good
uses market power to set the price
e.g Microsoft

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6
Q

What is an oligopoly

A

few companies dominate the market
Firms look at competition to price goods
e.g UK supermarketsq

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7
Q

What is monopolistic competition

A

products are similar but not identical
many producers (price setters) and consumers
no business has total control

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8
Q

What are the 3 pricing approaches

A

1) Demand- based approaches
2) cost- based approaches
3) marketing- based approaches

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9
Q

What is a demand based approach

A

analysing the relationship between a selling price & demand to find the optimum price to max profits
It’s an inverse linear relationship- as price decrease demand increases
2 methods of investigating the relationship - algebraic or tabular

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10
Q

What is the algebraic approach

A

For demand based approaches
When marginal cost= marginal revenue –> monopolistic max profit

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11
Q

What is the procedure of establishing the optimum price of a product?

A

1) establish the linear equation between price and quantity. P= a-bQ
A=intercept (max price where demand falls to 0)
b= gradient (amount the price has to change to change demand of 1 unit- usually a negative value to show inverse relationship and shows elasticity)

2) Double the gradient = marginal rev
MR= a-2bQ

3) Establish marginal cost (variable cost per unit)

4) To max profit MC=MR and solve to find Q

5)Sub Q into the price equation to find optimum price

6) Might need to calc max profit

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12
Q

What is price elasticity

A

How responsive demand is to change in price in % (proportional changes)

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13
Q

Calculation for price elasticity

A

Change in quantity demanded (as % of demand)/ change in price (as % of the price)

Ignore any negative signs

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14
Q

What is elastic demand

A

% change in demand > % change in price
PED>1 = very responsive to changes in price

Total rev increases when price is reduced and vice versa

Price increases aren’t recommended but price cuts are

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15
Q

What is inelastic demand

A

% change in demand< % change in price
PED < 1= not responsive to changes in price

Total rev decreases when price decreases and vice versa
price increases recommended but cuts aren’t

e.g petrol

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16
Q

What is the tabular approach

A

different prices & volumes of sales being presented in a table- choose highest profit amount

Good for in the exam when there’s no a data table and no indication about demand function/ no simple linear relationship between output & profit

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17
Q

What is the equation for total cost function

A

Y= a + bx

A= fixed cost per period (y intercept)
B= variable cost per unit (gradient)
x= activity level (independent variable)
y= total cost= fixed cost + variable cost

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18
Q

How do volume based discounts work

A

E.g economies of scale. Buy more pay less per unit
Total cost equation is derived for each volume range

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19
Q

What do you need to know when increasing sales & production levels

A

will the increased contribution generated by the increased sales > additional Fixed costs from the increased sales?

If yes= pursue

20
Q

What is the price in cost plus pricing

A

Price= cost per unit + chosen margin or mark up

21
Q

What is a mark-up

A

Profit expressed as a % of the cost

22
Q

What is a margin

A

profit expressed as a % of the sales price

23
Q

What are the 3 costs that can be used

A

1) Actual or standard cost
2)Marginal or full cost
3) Relevant costs

24
Q

What are actual or standard costs

A

Ad of standard costing: price set in advance and fixed for that period
therefore marketing is simpler and customers know exactly how much they’ll pay

Disad of standard costing: if there are sig variances the price can be too low= losses

Ad of actual costing: profit is guaranteed although less incentive to control costs as inefficiencies are passed onto customers

Disad of actual costing: some customers may not want to deal with them e.g military contracts, trademan where markup is incorporated in price

25
Q

What are marginal or full costs

A

MC= simpler (don’t need absorption or fixed OH), more consistent using contribution in decision making.
Difficult to set appropriate margins/ mark-ups to ensure FC are covered
Useful for ST decisions with excess capacity or 1 off contracts

Full cost= all costs incorporated into pricing decision to ensure a profit is made if target volume is achieved
Criticism= to determine FC per unit it depends on volume, price and cost per unit. Method of absorbing OH is arbitrary. Prices may not be realistic compared to what customers want to pay

26
Q

What are relevant costs

A

Min tender price for a 1 off tender or contract
Min price= total of all relevant cash flows

Only suitable for 1 off decisions because:
FC may become relevant in the LT
Problems estimating the incremental cash flow
Conflict between accounting measures e.g profit & this approach

27
Q

Advantages of cost plus pricing

A

1) Widely used & accepted
2) Simple to calculate if costs are known
3) Selling price decision may be delegated to junior management
4) justification for price increases
5) may encourage price stability- if all competitor have similar cost structures and use similar mark-up

28
Q

Disadvantages of cost-plus pricing

A

1) Ignores the economic relationship between price& demand
2) No attempt to establish optimum price
3) Different absorption methods give rise to difficult costs and selling prices
4) Doesn’t guarantee profit- if sales volumes are low- FC may not be recovered
5) Decide between full cost, marginal or manufacturing cost
6) structured method doesn’t recognise the manager’s need for flexibility in pricing
7) circular reasoning- price increase can reduce volume, increase cost per unit, and pressure to increase price further

29
Q

What is customer based pricing

A

Customers perception of the benefits of the products
price reflect the benefits
Small regard to cost. The greater the benefit of understanding the customer the better placed to price the products

30
Q

What is competition based pricing

A

set a price based on competing products
Competing products:
1) same type of product not easily distinguishable e.g petrol so price changes of competitors have a serious impact

2) Sub products which are different but fulfill the same need e.g ice cream instead of cold drink on hot day
impact of price changes depend on relative price/ performance of substitute

31
Q

What are the 8 pricing strategies

A

1) cost plus pricing
2) Market skimming
3) Penetration pricing
4) Complementary product pricing
5) Productline pricing
6) volume discounting
7) price discrimination
8) relevant cost pricing

32
Q

What is market skimming

A

charging a higher price when product is first launched to max ST profitability =. Take advantage of the novelty appeal of new products when demand is initially inelastic

When the market becomes saturated the price is reduced to attract the part of market which is untouched

33
Q

What are the suitable conditions for market skimming

A

1) product is new & different w/ little competition (most common)

2) products have a short life cycle. Recover R&D quickly and make profit

3) strength and sensitivity of demand to price is unknown. Better to start high and go lower if demand isn’t there

4) Firm has liquidity problems- generate high cash flows early on

34
Q

Market conditions for entry

A

If products are selling at a high price= high demand to join this market
To contain this demand there must be 1+ significant barriers e.g patent protection, strong brand loyalty

35
Q

What is penetration pricing strategy

A

charging low prices at product launch to gain market share & rapid acceptance of product
When market share is achieved - prices are increased

Opposite of market skimming

36
Q

Conditions to favour a penetration pricing strategy

A

1) firms wishes to increase market share
2 ) firm wants to discourage new entrants from entering the market
3) If there’s sig economies of scale to be achieved from high volume output- quick penetration is desirable
4) if demand is highly elastic and respond well to low prices

37
Q

What is complementary product pricing

A

normally used with another product e.g razors & razor blades, games consoles & games etc

Complementary goods give the supplier additional power over the consumer

38
Q

What are the 2 forms of complementary product pricing?

A

1) major product priced low = encourages the purchases and locks them into subsequent purchases at a high price e.g printers/cameras

2) major product priced high = barrier to entry/ exit and consumer locked into subsequent purchases at low price e.g high end sports centres & cheap green fees

39
Q

What is a product line pricing strategy

A

product line= range of products related to eachother/ price differences between upgrades of a product or service
Set the price steps between various products in a product line based on:
Cost differences between products
Customer evaluations of different features
competitors prices

40
Q

What is volume discounting

A

offering customers a lower price per unit if they purchase a particular quantity of a product

1) Quantity discounts- for customers that order larger quantities
2) Cumulative quantity discounts - discount increases as cumulative total ordered increases. Ideal for people who don’t want to place large individual orders but purchase large quantities

41
Q

What are the benefits of using a volume discounting strategy

A

1) increased customer loyalty- they’re locked in so further purchases can be made a lower price per unit

2) attracts new customers- exceptional discount on 1 off basis. Supplier can get their feet in the door

3) Lower sales processing costs- increased proportion of sales is bulk of orders

4) lower purchasing costs - discounts from suppliers

5) discounts help sell items bought primarily on price

6) clearance of surplus stock/ unpopular item through use of discounts

7) discounts geared to particular off peak periods

42
Q

What are the conditions suitable for volume discounting pricing strategy

A

1) substantial sales margin so profits still made after discounting

2) product bought on price so difficult to distinguish it from competing products

3) products with limited shelf life can be discounted to shift them (e.g clothes)

43
Q

What is a price discrimination strategy

A

Company sells the same product/ service at different prices in different markets for reasons not associated with costs

44
Q

What are the conditions for price-discrimination strategies

A

1) seller has some monopoly power or price will be driven down

2) customers can be segregated into different market

3) customers can’t buy at lower price in 1 market and sell at higher in another

4) price discrimination strategies are effective for services

5) must be different price elasticities of demand in each market so prices can be raised in 1 and lowered in another

45
Q

What are the dangers of price discrimination as a strategy

A

1) black market can develop so those in a lower priced segment can resell in a higher priced segment

2) competitors join the market and undercut the firm’s prices

3) customers in the higher priced brackets look for alternatives and demand becomes more elastic over time

ACCA Performance Management (15 decks)

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