McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 5 Strategic Planning Regarding Operating Processes

5-2 What are the Primary Influences on Selling Price? Customers customers want high quality and service at a reasonable price Must understand customers and respond to their needs Price increase, demand decreases Price decrease, demand increases These trends can be affected by loyalty and unwillingness to substitute (ex: coffee) staple vs. luxury item (hamburger vs steak) Perceived high quality and service (Toyota vs Ford)

5-3 What are the Primary Influences on Selling Price? Competitor Depending on the competitiveness of the market, competitors may influence the selling price Must monitor and learn from them Pure competition Market determines selling price Individual company is price taker (ex: agriculture industry) Monopolistic competition Market influences selling price Individual companies influence selling price through advertising (ex: airlines, computers, athletic wear)

5-4 What are the Primary Influences on Selling Price? Legal and social forces there are legal restrictions and social influences on selling price Must monitor changes and learn from them Monopoly (ex: utility companies) One company controls market and selling price Government approves price changes Oligopoly (ex: oil companies) Very few companies control selling price Government monitors selling prices Price fixing Price gouging

5-5 What are the Primary Influences on Selling Price? Cost In the long run, the selling price set by a company must cover all its costs and provide a sufficient return to the owners Must control costs and eliminate non-value added activities Markup - what is added to cost of product to ensure profit Selling margin = selling price - cost Selling margin % = selling margin/selling price

5-6 How does the External Market Influence Selling Prices? Pure competition Monopolistic competition Oligopoly Monopoly

5-7 What is the Difference between Penetration Pricing and Predatory Pricing? Penetration pricing Setting a lower initial selling price to entice customers to try the product/service Legal Predatory pricing Setting a low initial selling price (usually below cost) to drive out the competition Then raise prices once they control the market Illegal

5-8 What is the Difference between Skimming Pricing and Price Gouging? Skimming pricing Setting higher initial selling prices due to uniqueness of product Appeals to customers who want to be the first to own the product and are willing to pay more Later when novelty wears off, lowers the price Legal Gouging Setting high price due to unusual increase in demand (gas prices on 9/11) Illegal

5-9 What is the Difference between Life- cycle and Target Pricing? Life-cycle pricing Setting a selling price for the life of the product/service based on cost Determine cost, determine required markup, set selling price Target pricing Setting a selling price for the life of the product/service based on the market Determine selling price, determine required return, set target cost

5-10 What are the Common Reasons for Holding Inventory? Meet customer demand Smooth production scheduling Take advantage of quantity discounts Hedge against anticipated cost increases

5-11 What are the Common Reasons for Not Holding Inventory? Significant costs are incurred Holding inventory allows the company the hide its internal process problems because demand can be met from inventory

5-12 What are the Common Compensation Plans? Piece rate Pay based on units completed Commission Pay based on sales Hourly Pay based on hours worked Salary Pay based on period of time

5-13 What are Other Compensation Issues? Insurance Protection for employees Paid leave Protection for the company Bonuses Additional pay based on some future event Gross pay versus net pay Gross = amount earned Net = amount received