12 - 1 pricing decisions and cost management chapter 12
Post on 22-Dec-2015
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TRANSCRIPT
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Major Influences onPricing Decisions
Major Influences onPricing Decisions
Customers influence prices throughtheir effect on demand.
Competitors influence prices throughtheir actions.
Costs influence prices because theyaffect supply.
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Learning Objective 2Learning Objective 2
Distinguish between short-runand long-run pricing decisions.
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Time Horizon ofPricing DecisionsTime Horizon ofPricing Decisions
Short-run decisionshave a time horizonof less than a year:
pricing a one-time-only special order adjusting product
mix and output volume
Long-run decisionsinvolve a time horizon
of a year or longer: pricing a product ina major market where
price setting hassome leeway
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Time Horizon ofPricing DecisionsTime Horizon ofPricing Decisions
1. Costs that are oftenirrelevant for short-run
pricing decisions(fixed costs) are often
relevant in the long run.
2. Profit margins inlong-run pricing
decisions are often setto earn a reasonable
return on investment.
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Costing and Pricingfor the Short Run – Example
Costing and Pricingfor the Short Run – Example
Lomas Corporation operates a plant witha monthly capacity of 500,000 cases
of tomato sauce.
Lomas is presently producing300,000 cases per month.
Del Valle has asked Lomas and two othercompanies to bid on supplying 150,000
cases each month for the next four months.
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Costing and Pricingfor the Short Run – Example
Costing and Pricingfor the Short Run – Example
Cost Per CaseVariable manufacturing $38Variable marketing and distribution 13Fixed manufacturing 14Fixed marketing and distribution 15Total $80
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Costing and Pricingfor the Short Run – Example
Costing and Pricingfor 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 $165,000
of fixed overhead will be incurred per month.
Total fixed marketing and distributioncosts will not change.
What price should Lomas bid?
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Costing and Pricingfor the Short Run – Example
Costing and Pricingfor the Short Run – Example
Relevant CostsVariable manufacturing $38.00Fixed manufacturing 1.10Total $39.10
$165,000 ÷ 150,000 = $1.10
Any bid above $39.10 will improveLomas’s profitability in the short run.
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Costing and Pricingfor the Short Run – Example
Costing and Pricingfor the Short Run – Example
Suppose that Lomas believes that Del Vallewill sell the tomato sauce in Lomas’s current
markets but at a lower price than Lomas.
Relevant costs of the bidding decisionshould include revenues lost on sales
to existing customers.
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Costing and Pricingfor the Long Run – Example
Costing and Pricingfor 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).
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Costing and Pricingfor the Long Run – Example
Costing and Pricingfor 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 vary
with their chosen cost drivers.
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Costing and Pricingfor the Long Run – Example
Costing and Pricingfor the Long Run – Example
Ordering: $78 per orderTesting: $ 2 per inspection hourRework: $38 per unit reworked
Cost per UnitDirect materials $450.00Direct labor:3.50 hours @ $19 per hour 66.50Total $516.50
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Costing and Pricingfor the Long Run – Example
Costing and Pricingfor the Long Run – Example
Number of orders placed: 17,000Number of testing hours: 3,000,000Number of units reworked: 8,000
The direct fixed costs of machines usedexclusively for the manufacture of
Complex Computer total $7,000,000.
What is the cost of producing 100,000units of Complex Computer?
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Costing and Pricingfor the Long Run – Example
Costing and Pricingfor the Long Run – Example
Direct material and labor $51,650,000Direct fixed costs 7,000,000Ordering (17,000 × $78) 1,326,000Testing (3,000,000 × $2) 6,000,000Rework (8,000 × $38) 304,000Total $66,280,000
$66,280,000 ÷ 100,000 units = $662.80/unit
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Alternative Long-RunPricing Approaches
Alternative Long-RunPricing Approaches
Market-based
Cost-based(also called cost-plus)
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Target Price and Target CostTarget 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
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Target Price and Target CostTarget 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.
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Implementing Target Pricingand Target Costing
Implementing Target Pricingand 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 – $112.50 = $637.50
Current full cost per unit of CC is $662.80
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Implementing Target Pricingand Target Costing
Implementing Target Pricingand Target Costing
Value engineering is a systematicevaluation of all aspects of the
value-chain business function withthe objective of reducing costs.
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Value-Added CostsValue-Added Costs
A value-added cost is a cost that customers perceiveas adding value, or utility, to a product or service:
Adequate memory
Pre-loaded software
Reliability
Easy-to-use keyboards
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Nonvalue-Added CostsNonvalue-Added Costs
A nonvalue-added cost is a cost thatcustomers do not perceive as adding
value, or utility, to a product or service.
Cost of expediting
Rework
Repair
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Learning Objective 4Learning Objective 4
Apply the concepts of costincurrence and locked-in costs.
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Cost IncurrenceCost Incurrence
This describes when a resource is sacrificedor forgone to meet a specific objective.
Research and development
Manufacturing
Distribution
Design
Marketing
Customer support
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Locked-in CostsLocked-in Costs
These are those costs that have not yet beenincurred but which, based on decisions thathave already been made, will be incurred
in the future (designed-in costs).
It is difficult to alter or reducecosts that are already locked in.
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Cost Incurrence andLocked-in Costs
Cost Incurrence andLocked-in Costs
R&D andDesign Manufacturing Mkt., Dist.,
& Cust. Svc.
Value-ChainFunctions
Cu
mu
lati
ve C
osts
per
Un
it
Locked-in Cost Curve
Cost-Incurrence
Curve
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Cost Incurrence andLocked-in Costs
Cost Incurrence andLocked-in Costs
At the end of the design stage, direct materials,direct manufacturing labor, and many
manufacturing, marketing, distribution,and customer-service costs are all locked in.
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Cost Incurrence andLocked-in Costs
Cost Incurrence andLocked-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 designs
at the product design stage.
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Cost-Plus PricingCost-Plus Pricing
The general formula for setting acost-based price is to add a markup
component to the cost base.
Cost base $ XMarkup component YProspective selling price $X + Y
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Cost-Plus PricingCost-Plus Pricing
Assume that Latisha’s engineershave redesigned CC into CCI at
a new cost of $637.50.
The company desires a 20% markupon the full unit cost.
What is the prospective selling price?
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Cost-Plus PricingCost-Plus Pricing
Cost base: $637.50
Markup component: (637.50 × .20) 127.50
Prospective selling price: $765.00
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Cost-Plus PricingCost-Plus Pricing
Assume that the capital investment needed forCCI 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
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Cost-Plus PricingCost-Plus Pricing
What is the target operating income per unit?
$12,750,000 ÷ 100,000 units = $127.50/unit
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Cost-Plus PricingCost-Plus Pricing
The 17% target rate of return on investmentexpresses the company’s expected annual
operating income as a percentage of investment.
The 20% markup expresses operatingincome per unit as a percentage of the
full product cost per unit.
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Advantages of Using Full CostsAdvantages of Using Full Costs
Full recovery of all costs of the product
Price stability
Simplicity
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Alternative Cost-Plus MethodsAlternative Cost-Plus Methods
Variable manufacturing costs
Variable costs of the product
Manufacturing function costs
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Learning Objective 6Learning Objective 6
Use life-cycle budgetingand costing when making
pricing decisions.
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Life-Cycle BudgetingLife-Cycle Budgeting
The product life cycle spans the time fromoriginal research and development, throughsales, to when customer support is no longer
offered for that product.
A life-cycle budget estimates revenues andcosts of a product over its entire life.
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Life-Cycle BudgetingLife-Cycle Budgeting
Features that make life-cycle budgeting important:
Nonproduction costs
Development period for R&D and design
Other predicted costs
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Nonproduction CostsNonproduction Costs
These costs are less visible on aproduct-by-product basis.
When nonproduction costs are significant,identifying these costs by product is
essential for target pricing, target costing,value engineering, and cost management.
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Development PeriodDevelopment Period
When a high percentage of total life-cyclecosts are incurred before any production
begins and before any revenues are received,it is crucial for the company to have as
accurate a set of revenue and costpredictions for the product as possible.
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Predicted CostsPredicted Costs
Many of the production, marketing, distributionand customer service costs are locked in
during the R&D and design stage.
Life-cycle budgeting facilitates value engineeringat the design stage before costs are locked in.
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Life-Cycle Budgetingand Costing
Life-Cycle Budgetingand Costing
Consider a life-cycle average salesprice of $55,000 per unit.
If the desired life-cycle contribution is45%, what is the allowable cost over
the life cycle of the product?
$55,000 – ($55,000 × .45) = $30,250
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Learning Objective 7Learning Objective 7
Describe two pricing practicesin which noncost factors are
important when setting prices.
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Other Considerations inPricing Decisions
Other Considerations inPricing Decisions
Price discrimination
Peak-load pricing
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Price Discrimination LawsPrice Discrimination Laws
Under the U.S. Robinson-Patman Act, amanufacturer cannot price-discriminatebetween two customers if the intent is to
lessen or prevent competition for customers.
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Price Discrimination LawsPrice Discrimination Laws
They apply to manufacturers, not service providers.
Price discrimination is permissible if differencesin prices can be justified by differences in costs.
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Price Discrimination LawsPrice 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 money
it lost by pricing below cost.
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Price Discrimination LawsPrice Discrimination Laws
Most courts in the United States have definedthe “appropriate measure of costs” as the
short-run marginal and average variable costs.
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Price Discrimination LawsPrice Discrimination Laws
Dumping occurs when a non-U.S. company sellsa product in the United States at a price below
the market value in the country of its creation, andits action injures an industry in the United States.
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Price Discrimination LawsPrice Discrimination Laws
Collusive pricing occurs when companiesin an industry conspire in their pricingand output decisions to achieve a price
above the competitive price.