Lecture 10 Flashcards
Determinant of prices: 3 B’s
Competition: use it benchmark, analyse yourself
Customers: justify the price, transparency of price
Costs: time horizon
Target costing
Market driven approach (what) can we deleover given what customers are willing to pay for our product (given quality, competitors products)
- determine customers expectations
Willingness to pay at that price
Target price - target profit = target cost
Perform value engineering to achieve target cost
Cost plus pricing
Cost driven approach: given costs, what price / profit do we target (eg 10% mark up)
Determine cost base
TArgeted mark up (eg 10% on the full costs)
Selling price = costs + mark up (eg price =1.1*full costs)
Cost plus pricing example
Sales vol 2000 units Full costs 8950 Inversted capital 14,000,000 Target rate of roi 15% Target op profit 2,100,000 Target op profit per unit 1050 unit
Selling price: 8950+1050 =10,000
Mark up: operating profit / full costs = 1050 /8959 =11.73%
Benefits of including full costs in the cost base:
Full product cost recovery
Price stability
Simplicity
Cost plus pricing: ignoring the market
Case 1: prices too high
Assume: price = full costs (acc unit costs) +20% mark up
Customer not willing to pay the price as the market offers competitive alternatives
Unit base decreases > higher full costs (unit costs) > higher price > even less units sold
Company gets pushed out of the market (amount of units sold too low)
Case 2: prices too low
Assume: price = full costs +20% mark up
Price is lower than market allows
More good thanks planned are sold
Unit base increases >per full costs > lower price > even more units sold
Company gets sucked into the market (profits are lower than they could be)
Transfer prices
Transfer prices is the amount charged by one segment of an organisation for a product or service that if supplies to another segment of the same organisation
Functions of transfer prices
Functions of TP:
Coordination on depts and transferring products and services between them
Performance evaluation of depts and management (based on dept prof it)
Justification of the price of product and services
Foundation for external purchase (cheaper to go external rather than internal)
Transfer pricing: coordination
A firm produces and sells products. The firm is centralised and top management makes all decisions. Inverse demand function and cost function are:
P(x) = 100 - 2*x C(x) = x2 / 2
At which output level (x) is the profit the highest?
Revenue = x* (100-2x) = 100 x - 2*x^2
Profit = rev - costs:
100x -2x^2 - x^2 /2
Set derivative to 0:
X =20
For a quantity of 20, the company’s profit is maximised. (20is optimal from the company’s perspective)
Transfer pricing coordination 2:
Production: c(x) = x^2 /2
Sales: profit = x(100-2x)
Which output level x would the sales dept choose
Profit = x (100-2x) = 100x - 2x^2 Set derivative to 0: 100x - 2x ^2 =0 100-4x =0 25 = x
Transfer pricing costs based approach
Optimal coordination reached when tp equals mc of production
Transfer pricing: market based approach
Market based approach: tp = price of a similar product (service) in market
Transfer pricing: negotiation based approach
Negotiation based approach: tp determined by a negotiation process.
Very decenteralised approach:
Transfer prices and taxes
Transfer prices can be a tool to optimise tax payments
Transfer pricing is not illegal but it can be used for illegal purposes(mispricinf, manipulations)
Arms length principle: tp between depts should
Be set as if depts would not be part of the same company
Very basic mechanism to move profits (away from a country eg the us)
Buy cheap resources at high costs (within depts) then record the profits in countries with lower tax Rates
