Pricing and Transfer Pricing Flashcards
Main factors that have an impact on pricing decisions
- customer demand
- competitors
- cost
- political, legal and image issues
Pricing models and approaches
- Economic pricing model (optimal):
- sophisticated model and information requirements
- marginal cost and revenue data
- more costly - Cost-based pricing (suboptimal):
- simplified model and information requirements
- accounting product-cost data
- less costly
Economic pricing model vs cost-based pricing
- best approach lies between
- depends how easy is to collect marginal data
- accounting data is readily available
- time consuming for firm that produces many products
Pricing strategies
- price competition
- market skimming
- market penetration
- newly launched products for well-established or startup companies
- loss/profit leader (complementary pricing
- market pricing
Traditional cost-based pricing
Calculate costs at gross margin level and apply markup
Activity-based pricing (ABP)
- volume sensitive model
- consider price elasticity of demand, buying habits and competition
- ABP integrates customer price response (demand) information with ABC data
- ABP has little risk of overpricing or underpricing (competitive advantage)
Transfer pricing rule
Transfer price = variable cost + opportunity cost of selling to external market
- external buyer: TP = opportunity cost
- no external: TP = variable cost
Problem in measuring transfer’s ‘opportunity cost’
- many sellers in a market: problem in deciding the appropriate benchmark
- dealing with unique goods/services: no external sellers/unreliable prices
No excess capacity
There are demands from external buyers:
Transfer price = opportunity cost
Excess capacity
There are no demand left from external buyers:
Transfer price = variable cost
Transfer pricing methods
- market-based prices
- negotiated prices
- cost-based prices
Market-based price pros and cons
- often set at a discount: selling division doesn’t incur costs that they would have if sold to external markets
- best method when competitive external markets exist:
• best make-vs-buy decisions
• Aligns Managerial incentives and firm interests - perfectly competitive markets may not exist
- alternative: adjusted market price
Negotiated prices pros and cons
- appropriate when no external market exists
- competition between departments, a lot depends on negotiation skills of divisional managers
Cost-based prices types and general idea
- variable-cost transfer prices
- full-cost transfer prices
- take production costs and apply markup to generate profit
Variable-cost transfer price
- transfer price = VC
- appropriate when no external market
- selling unit does not generate profit, not happy to sell internally
