Presentation on theme: "Pricing Decisions and Cost Management"— Presentation transcript:
1 Pricing Decisions and Cost Management Chapter 12
2 Discuss the three major Learning Objective 1Discuss the three majorinfluences on pricing.
3 Major Influences on Pricing Decisions Customers influence prices throughtheir effect on demand.Competitors influence prices throughtheir actions.Costs influence prices because theyaffect supply.
4 Distinguish between short-run and long-run pricing decisions. Learning Objective 2Distinguish between short-runand long-run pricing decisions.
5 Time Horizon of Pricing Decisions Short-run decisionshave a time horizonof less than a year:pricing a one-time-only special orderadjusting productmix and output volumeLong-run decisionsinvolve a time horizonof a year or longer:pricing a product ina major market whereprice setting hassome leeway
6 Time Horizon of Pricing Decisions 1. Costs that are oftenirrelevant for short-runpricing decisions(fixed costs) are oftenrelevant in the long run.2. Profit margins inlong-run pricingdecisions are often setto earn a reasonablereturn on investment.
7 Costing and Pricing for the Short Run – Example Lomas Corporation operates a plant witha monthly capacity of 500,000 casesof tomato sauce.Lomas is presently producing300,000 cases per month.Del Valle has asked Lomas and two othercompanies to bid on supplying 150,000cases each month for the next four months.
8 Costing and Pricing for the Short Run – Example Cost Per CaseVariable manufacturing $38Variable marketing and distribution 13Fixed manufacturingFixed marketing and distributionTotal $80
9 Costing and Pricing for the Short Run – Example If Lomas makes the extra 150,000 cases, the existingtotal fixed manufacturing overhead ($4,200,000 permonth) would continue, plus an additional $165,000of fixed overhead will be incurred per month.Total fixed marketing and distributioncosts will not change.What price should Lomas bid?
10 Costing and Pricing for the Short Run – Example Relevant CostsVariable manufacturing $38.00Fixed manufacturingTotal $39.10$165,000 ÷ 150,000 = $1.10Any bid above $39.10 will improveLomas’s profitability in the short run.
11 Costing and Pricing for the Short Run – Example Suppose that Lomas believes that Del Vallewill sell the tomato sauce in Lomas’s currentmarkets but at a lower price than Lomas.Relevant costs of the bidding decisionshould include revenues lost on salesto existing customers.
12 Costing and Pricing for the Long Run – Example Latisha Computer Corporation manufacturestwo brands of computers: Simple Computer (SC)and Complex Computer (CC).Latisha uses a long-run time horizon to priceComplex Computer (CC).
13 Costing and Pricing for the Long Run – Example Direct materials costs vary with thenumber of units produced.Direct manufacturing labor costs varywith direct manufacturing labor-hours.Ordering and receiving, testing andinspection, and rework costs varywith their chosen cost drivers.
14 Costing and Pricing for the Long Run – Example Ordering: $78 per orderTesting: $ 2 per inspection hourRework: $38 per unit reworkedCost per UnitDirect materials $450.00Direct labor:3.50 $19 per hourTotal $516.50
15 Costing and Pricing for the Long Run – Example Number of orders placed: ,000Number of testing hours: 3,000,000Number of units reworked: ,000The direct fixed costs of machines usedexclusively for the manufacture ofComplex Computer total $7,000,000.What is the cost of producing 100,000units of Complex Computer?
16 Costing and Pricing for the Long Run – Example Direct material and labor $51,650,000Direct fixed costs ,000,000Ordering (17,000 × $78) ,326,000Testing (3,000,000 × $2) ,000,000Rework (8,000 × $38) ,000Total $66,280,000$66,280,000 ÷ 100,000 units = $662.80/unit
17 Alternative Long-Run Pricing Approaches Market-basedCost-based(also called cost-plus)
18 Price products using the target-costing approach. Learning Objective 3Price products using thetarget-costing approach.
19 Target Price and Target Cost Target price is the estimated price fora product (or service) that potentialcustomers will be willing to pay.Target Price– Target operating income per unit= Target cost per unit
20 Target Price and Target Cost Steps in developing target prices and target costs:1. Develop a product that satisfies the needsof potential customers.2. Choose a target price.3. Derive a target cost per unit.4. Perform value engineering to achieve target costs.
21 Implementing Target Pricing and Target Costing Latisha’s management wants a 15% targetoperating income on sales revenues of CC.Target sales revenue is $750 per unit.What is the target cost per unit?$750 × .15 = $112.50, $750 – $ = $637.50Current full cost per unit of CC is $662.80
22 Implementing Target Pricing and Target Costing Value engineering is a systematicevaluation of all aspects of thevalue-chain business function withthe objective of reducing costs.
23 Value-Added Costs A value-added cost is a cost that customers perceive as adding value, or utility, to a product or service:Adequate memoryPre-loaded softwareReliabilityEasy-to-use keyboards
24 Nonvalue-Added Costs A nonvalue-added cost is a cost that customers do not perceive as addingvalue, or utility, to a product or service.Cost of expeditingReworkRepair
25 Apply the concepts of cost incurrence and locked-in costs. Learning Objective 4Apply the concepts of costincurrence and locked-in costs.
26 Cost Incurrence This describes when a resource is sacrificed or forgone to meet a specific objective.Research and developmentDesignManufacturingMarketingDistributionCustomer support
27 Locked-in Costs These are those costs that have not yet been incurred but which, based on decisions thathave already been made, will be incurredin the future (designed-in costs).It is difficult to alter or reducecosts that are already locked in.
28 Cost Incurrence and Locked-in Costs Locked-in Cost CurveCumulative Costs per UnitCost-Incurrence CurveValue-ChainFunctionsR&D andDesignManufacturingMkt., Dist.,& Cust. Svc.
29 Cost Incurrence and Locked-in Costs At the end of the design stage, direct materials,direct manufacturing labor, and manymanufacturing, marketing, distribution,and customer-service costs are all locked in.
30 Cost Incurrence and Locked-in Costs When a sizable fraction of the costs are locked inat the design stage, the focus of value engineeringis on making innovations and modifying designsat the product design stage.
31 Price products using the Learning Objective 5Price products using thecost-plus approach.
32 Cost-Plus Pricing The general formula for setting a cost-based price is to add a markupcomponent to the cost base.Cost base $ XMarkup component YProspective selling price $X + Y
33 Cost-Plus Pricing Assume that Latisha’s engineers have redesigned CC into CCI ata new cost of $The company desires a 20% markupon the full unit cost.What is the prospective selling price?
35 Cost-Plus Pricing Assume that the capital investment needed for CCI is $75 million, and the company (pretax)target rate of return on investment is 17%.What is the target annual operating incomethat Latisha needs to earn from CCI?$75,000,000 × .17 = $12,750,000
36 What is the target operating income per unit? Cost-Plus PricingWhat is the target operating income per unit?$12,750,000 ÷ 100,000 units = $127.50/unit
37 Cost-Plus Pricing The 17% target rate of return on investment expresses the company’s expected annualoperating income as a percentage of investment.The 20% markup expresses operatingincome per unit as a percentage of thefull product cost per unit.
38 Advantages of Using Full Costs Full recovery of all costs of the productPrice stabilitySimplicity
39 Alternative Cost-Plus Methods Variable manufacturing costsVariable costs of the productManufacturing function costs
40 Use life-cycle budgeting and costing when making Learning Objective 6Use life-cycle budgetingand costing when makingpricing decisions.
41 Life-Cycle Budgeting The product life cycle spans the time from original research and development, throughsales, to when customer support is no longeroffered for that product.A life-cycle budget estimates revenues andcosts of a product over its entire life.
42 Life-Cycle BudgetingFeatures that make life-cycle budgeting important:Nonproduction costsDevelopment period for R&D and designOther predicted costs
43 Nonproduction Costs These costs are less visible on a product-by-product basis.When nonproduction costs are significant,identifying these costs by product isessential for target pricing, target costing,value engineering, and cost management.
44 Development Period When a high percentage of total life-cycle costs are incurred before any productionbegins and before any revenues are received,it is crucial for the company to have asaccurate a set of revenue and costpredictions for the product as possible.
45 Predicted Costs Many of the production, marketing, distribution and customer service costs are locked induring the R&D and design stage.Life-cycle budgeting facilitates value engineeringat the design stage before costs are locked in.
46 Life-Cycle Budgeting and Costing Consider a life-cycle average salesprice of $55,000 per unit.If the desired life-cycle contribution is45%, what is the allowable cost overthe life cycle of the product?$55,000 – ($55,000 × .45) = $30,250
47 Describe two pricing practices in which noncost factors are Learning Objective 7Describe two pricing practicesin which noncost factors areimportant when setting prices.
48 Other Considerations in Pricing Decisions Price discriminationPeak-load pricing
49 antitrust laws on pricing. Learning Objective 8Explain the effects ofantitrust laws on pricing.
50 Price Discrimination Laws Under the U.S. Robinson-Patman Act, amanufacturer cannot price-discriminatebetween two customers if the intent is tolessen or prevent competition for customers.
51 Price Discrimination Laws They apply to manufacturers, not service providers.Price discrimination is permissible if differencesin prices can be justified by differences in costs.
52 Price Discrimination Laws Predatory pricing occur when……the predator company charges a price that isbelow an appropriate measure of its costs, and…the predator company has a reasonableprospect of recovering in the future the moneyit lost by pricing below cost.
53 Price Discrimination Laws Most courts in the United States have definedthe “appropriate measure of costs” as theshort-run marginal and average variable costs.
54 Price Discrimination Laws Dumping occurs when a non-U.S. company sellsa product in the United States at a price belowthe market value in the country of its creation, andits action injures an industry in the United States.
55 Price Discrimination Laws Collusive pricing occurs when companiesin an industry conspire in their pricingand output decisions to achieve a priceabove the competitive price.