short term pricing Flashcards
what factors should we be aware of when charging prices?
- organisation’s objectives
- market within which organisation operates
- demand
- supply
- price elasticity of demand
- costs
- competition
- inflation
- legislation
- availability of substitutes
what is demand influenced by?
- price of the good
- price of other goods
- size and distribution of household income
- for most products and services the quantity demanded falls as price increases
- tastes and fashion
- expectations
- obsolescence
what is supply?
refers to the quantities of commodities or services actually offered for sale at particular prices per unit of time
what factors influences supply?
- the goals of the firm (assumed to be profit maximisation)
- the prices of commodity
- the price of other commodities
- the prices of factors of production
- the state of technology
- natural factors (e.g. weather)
generally the higher the price, the more profitable it is to supply, so the greater will be quantity supplied
how do companies establish their prices?
- many companies use variations of formula pricing
- that is they establish formulas to to guide salesmen and managers regarding the prices they should charge their customers
- the most widely used formulas are cost-plus pricing approaches
what types of pricing are there?
- full cost plus
- marginal cost plus/mark-up
- minimum pricing
- the contribution approach
what is the formula used for full-cost plus pricing?
sales price = full cost + %mark-up
- mark-up can be varied from product to product and to take account of prevailing market conditions
- costing system is geared up to provide costs for goods and services and is convenient for pricing
- varying the mark-up provides flexibility to adjust to market conditions
what are the advantages of full-cost plus pricing?
- covers all fixed costs and makes a profit (when a company is working at normal capacity)
- simple, quick and cheap method
- can justify prices
- flexible = can cope with differing mark up %s
- suitable if difficult to estimate expected demand
disadvantages of full-cost plus pricing
- must be large enough to cover non-production costs
- too simplistic to reflect demand and market conditions
- pricing problem looks deceptively simple = fails to recognise that since demand may be determined by price, there is a profit-maximising combination of price and demand
what is marginal cost-plus/mark-up pricing?
adding a profit margin onto marginal cost (either marginal cost of production or marginal cost of sales)
what are the advantages of marginal cost-plus pricing/mark-up pricing?
- draws managements attention to contribution and the effects of higher or lower sales volume on profit
- mark-up can be adjusted to reflect demand conditions
- convenient when readily identifiable variable costs
what are the disadvantages of marginal cost-plus pricing/mark-up pricing?
- although you can vary mark-up in accordance with demand conditions, it does not pay sufficient attention to demand conditions, competitors’ prices and profit maximisation
- it ignores FCs, so how can you be sure we’re covering them
what is rate of return pricing?
a variation on cost-plus pricing which is designed to ensure that the company achieves a particular target rate of return on capital employed
how is the mark-up % determined?
- a mark-up is chosen to earn a target rate of return on investment
- look at the capital investment needed for a company’s product and their target rate of return on investment
- calculate their target annual operating profit (= capital investment x target rate of return)
- look at how much they expect to sell and calculate the target operating profit per unit = target annual operating profit / units expecting to sell
what is minimum pricing?
the prices that would be charged so that it covers:
- incremental costs of producing and selling the product or service
- the opportunity cost of the resources consumed in making and selling the product or service
therefore based on relevant costs!!
