.

University of Nigeria Research Publications

OGBONNA, Bigben Chukwuma

Aut

hor

PG/MBA/88/45887

Title

Pricing Decision in an Inflationary Economy (The Nigeria Experience)

Facu

lty

Business Administration

Dep

artm

ent

Accountancy

Dat

e

June, 2000

Sign

atur

e

PRICING DECISION IN AN INFLATIONARY ECONOMY (THE NIGERIA EXPERIENCE)

OGBONNA BigBen CHUKWUMA PGlMBAl98145887

DEPARTMENT OF ACCOUNTANCY SCHOOL OF POST GRADUATE STUDIES UNIVERSITY NIGERIA, ENUGU CAMPUS

,:$ ;'- -1: ,. . . i

+ 3 . ... . s

SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE AWARD

OF MASTER OF BUSINESS ADMINISTRATION (MBA) IN ACCOUNTANCY.

June 2000

CERTIFICATION

The Work embodied in this report has not been subrni~ted in part or in full for any

other Diploma or degree of this or any other university

This is to certify that OBGONNA BigBen Chukwuma, a postgraduate student in

the department of Accountancy and with Reg. No. PG/MBAJ98/45887 has

satisfactorily completed the requirement for project research in partial fulfillment

of the requirement for the award of Master of Business Administration (MBA) in L -'

Accountancy.

.................................... V. C. EZE UGWU HOD,ACCOUNTANCY.

DEDICATION

Juliet Ogbonna, My darling wife, Jesse Olisaerneka Ogbonna and Sidney

Abuchi Ogbonna, my dear sons.

ACKNOWLEDGEMENT

My Big thanks go to my darling wife and children for their unflinching support,

encouragement, tolerance and understanding throughout the duration of this

programme.

The financial and moral support offered by Engr. Silas N. Ugadu, the general

manager with Ebonyi State Rural Electrification Board earned him my profound

gratitude.

I most sincerely acknowledge the guides, advice and other academic contribution

made towards my successfid conclusion of the programme in general and this

project in particular by my supervisor and Head of Department, Accountancy Mr

V. C. Ezeugwu.

Finally, I am very grateful to God Almighty who oversaw the entire programme

and granted me both the physical and spiritual fitness to run this course to a

successful conclusion.

Ogbonna BigBen C.

PG /R/IBA / 981 45887

ABSTRACT

The choice of this topic at this point in time is informed by the inflationary nature

of world Economies in general and the Nigeria Development Economy in

particular.

As inflation reflects general rise in the prices of goods and services, pricing

under this economic condition should be big problem which all the operators in a

free market Economy must contend with if they should achieve their set objectives

and hence remain in business.

T -

It is this pricing decision problem in an inflationary economy and how best

to contend with that is the focus of this study. The study is divided into five

chapters:

Chapter one: Provides the introduction to the research study under such

subsections as statement of problem, the objectives, significance, scope,

limitations of the study and definition of terms

Chapter two: Dwells extensively on the review of related literatures in terms of

previous research on related topics, factors affecting pricing decision such as cost,

management by objective, and nature of product for internal factors, and

customers, competitors, budget, inflation and price system for external factors.

Chapters three and four feature research metrology and data presentation and

analysis respectively.

Findings, conclusion and recommendation for further studies are the content of

chapter five.

Pricing decision in an inflationary free market economy is a very hard and

complex one as was Ex-rayed in the detailed report of this research work.

vii

TABLE OF CONTENT TlTLE

1 . . CERTIFICATION 11 DEDICATION iii ACKNOlhZEDGEMENT iv ABSTRACT v TABLE OF CONTENT vi LlST OF TABLES

PAGE

CHAPTER ONE

1.0 INTRODUCTION ........................................................ 1 1.1 STATEMENT OF PROBLEM ......................................... 3 1.2 OBJECTIVES OF THE STUDY ........................................ 4 1.3 SIGNIFICANCE OF THE STUDY .................................... 5 1.4 SCOPE OF THE STUDY ............................................... 6 1.5 LIMITATIONS OF THE STUDY ..................................... 7 1.6 DEFINITION OF TERMS ............................................. 8

CHAPTER TWO

LITERATURE REVIEW ....................................... 12 PREVIOUS RESEARCH DONE AND ITS ACCOMPLISHMENT .. 13 FACTORS AFFECTING PRICING DECISION ................... 14 INTERNAL FACTORS .................................................... 15 COST .......................................................................... 15 MANAGEMENT OBJECTIVES .......................................... 18 THE NATURE OF PRODUCT ............................................ 18 THE EXTERNAL FACTORS ............................................. 19 THE CUSTOMERS ..................... .. ................................ 19 THE COMPETITORS ............................... .. ............... 22 BUDGET AND PRICING DECISION ................................. 23 INFLATION AND PRICING DECISION .............................. 25

.............. THE PRICE SYSTEM. THEORY AND MECHANISM 29

CHAPTER THREE

.......................................... 3.0 RESEARCH METHODOLOGY 32

............................................. 3 -0 SOURCES OF DATA 32 3.1.0 PRIMARY SOURCES OF DATA ................................. 32 3.1.1 ORAL/PERSONAL INTERVIEW ................................. 34 3.12 QUESTIONNAIRES .................................................. 34

.............................. 3.2 SECONDARY SOURCES OF DATA 35 3.3 STATISTICAL METHODS

CHAPTER FOUR

4.0 DATA PRESENTATION AND ANALYSIS ........................... 36 4 . 0 JNTRODUCTION ................................................... 36 4.1 PRICING POLICY AND MBO .................................... 36 4.2 BASIC PRICING MODELS ....................................... 43 4.3 TEST OF HYPOTHESIS ........................................... 46 4.4 PRICING DECISION IN A FREE MARKET ECONOMY ...... 56

CHAPTER FIVE

5.1 SUMMARY OF FINDINGS ......................................... 57 5.2 RECOMMENDATION ............................................. 58 5.3 CONCLUSION ......................... ... .................. 59

BIBLIOGRAPHY .................................................................... 60

LIST OF TABLES

TABLE

I

I1

111

IV

v

VII

VIII

DESCRIPTION PAGE

WHO MAKES PRICING DECISION - - - - - - - - - 37

PRICING OBJECTIVE 38

BUDGET AS A TOOL FOR PRICING DECISION --------- 38

DEGREE OF ASSOCIATION BETWEEN THE PRICING DECISION OBJECTIVE AND THE INDIVIDUAL ON WHOM PRICING DECISION RESPONSIBILITY IS VESTED --------- 39

THE RELATIONSHIP AMONG USERS OF FORMAL BUDGET AS PFUCING FACTORS --------- 40

FACTORS INFLUENCING PRICING DECISION --------- 4 1

DETERMINATION OF WEIGHTED PERCENTAGE AND DERIVED SCORES --------- 42

BASIS FOR USING COST AS THE KEY PRICING PRICING ELEMENT --------- 44

EFFECT OF INFLATION ON EXPENDITURE AND LOW INCOME EARNERS --------- 45

EFFECT OF INFLATION ON FIXED INCOME EARNERS --------- 46

TREND OF PRICE MOVEMENT IN AN INFLATIOYARY ECONOMY --------- 46

XIV 2x3 CONTINGENCY TABLE --------- 48

XV OBSERVED/ EXPECTED FREQUENCY TABLE --------- 49

XVI 2ND CONTINGENCY TABLE FOR EFFECT OF INFLATION ON FIXED INCOME EARNERS ------- 49

XVII OBSERVED / EXPECTED FREQUENCY TABLE FOR FIXED INCOME EARNERS ------- 50

XVIII CONTINGENCY TABLE (PRICE TREND) -------- 5 1

XJX OBSERVED AND EXPECTED FREQUENCY (TREND TN PRICE MOVEMENT IN INFLATION PERTOD). ------- 5 1

CHAPTER ONE

INTRODUCTION

1.0 BACKGROUND TO THE STUDY:

Pricing decision by any management is always arrived at with the volume and cost of the

products or services in question in mind. Decisions involving price, volume and cost can

be divided into two classifications as follows:

Those decisions that can be arrived at after the productive capital assets have been

acquired and those made in connection with the acquisition of necessary productive

capital assets.

This research is focused on pricing decision given a situation where the

productive capita1 assets are already in place. The problem of pricing decision making

when the productive capital assets have not yet been acquired are capital-Budgeting

decisions.

In any productive set up, three vital questions must arise as follows:

(a) What price should be charged?

(b) What out put should it produced?

(c) What should be the cost and profit decision?

These decisions can be considered in a reversed order. As to what profit decision can be

made? The answer is none. This is because the ideal situation is that the company could

decide on price and output, works towards producing the goods or services efficiently. It

is then if the planning process is effective and efficiently executed that a profit may

resuIt.

To this effect, it should be observed that the management does not 'plan' profit, but

rather profit is the resultant effect or rather an end to effective and efficient pricing and

output decision.

Pricing decision is a very hard and complex economic matter. This result from

the fact that pricing is a function of varying economic variables, such as, market

condition or structure, the management objective, the consumers income level and the

inflation rate subsisting among others.

Inflation refers to increase in the general price level of goods and services. High

and erratic rates of inflation are one of the most serious and universal economic problems

hitting hardest on developing economies, and economists throughout the world have

devoted great deal of their precious time to examining the causes which have been

identified to be either cost pushed or demand-pulled.

This research is therefore aimed at identi@ing the problem that may be associated

with pricing decision in an inflationary environment, critically analyzing such problem

and proffering solutions for them through established research methodology so as to

recommend the ideal pricing policy in an inflationary economy.

1.1 STATEMENT OF PROBLEM

Every profit-oriented organization has a key problem of how to meet its targeted

sales budget in order to achieve its profit objective.

With the knowledge that quantity demanded of any given products or service is a

direct function of price of such product or services among others and that the demand of

any product or service has an inverse relationship with its price, it becomes crystal clear

that the sustainability of the market demand u f any product or service is a function of

effective pricing policy.

On the other hand, inflation which affects both the production cost and the

purchasing power of the consumers is very prevalent in developing economies of which

Nigeria is one.

'To this end, the management of every productive organization which is profit

oriented battle with the following problems!

(i).

(i i)

(iii)

(i V)

(v>

Which pricing policy will achieve the equilibrium between demand and supply.

How can the manager cope with the inflation in costing and pricing their products.

Where the inflation rate is already known to be on the high side, how can the

management effect an inflation reduction oriented pricing policy?

How can the traditional pricing approach of cost-plus" be adapted to reflect the

modern economic realities.

How can the management reconcile the conflicting objectives of wanting to get

large market share and selling at high price through its pricing policy.

This research project is hinged on analyzing and proffering solutions to these problems

where applicable.

1.2 OBJECTIVES OF THE STUDY:

Policy decision in every organization is an exclusive responsibility of the management.

Pricing policy is one of the several policy decisions of the management. The

management must be extremely careful in its pricing decision because it is a singular

decision that could make or mar any profit oriented organization. To this effect, this

study aims at:

Identifying how Nigerian organizations price their products and the extent to

which they employ management by objective (MBO).

Identifying the pricing approaches of organizations that have been declaring profit

in the inflationary Nigerian economy.

Determining the effect of inflation on the prices and profit of any organization.

Ascertaining the basis of using costs as the main pricing variable and the

limitations of cost-plus" pricing approach.

Offering recommendations based on the findings with respect to the appropriate

pricing approach that suits an inflationary economy.

1.3 SIGNIFICANCE OF THE STUDY

Pricing decision in an inflationary economy is new area of research. Inflation itself as an

economic variable is as old as economic principle itself, but the constant fluctuations

associated with inflation will always leave it as area of current research.

Most of the researches conducted in pricing decision always had that inherit

assumption of stability in the economic variables. There is nothing surprising about the

above assertion as most, if not all the researches were conducted in countries with

developed economies which have relative stability of various economic variables as their

major characteristic.

Presently, in developing economy to be precise, it is not unusual to see well

managed or prospering organization suddenly go into liquidation. When investigation is

conducted on the cause of such sudden collapse it will be discovered that generally

established pricing approach has been applied in the pricing policy. The fact is that the

established general pricing approach was founded on developed economies of the west.

The question then is -'how can the generally established pricing approach be adapted to

the peculiar circumstances associated with developing econon~ies of the developing

countries, Nigeria inclusive.

This research project is aimed at adapting the generally established pricing

approach based on the western developed economies to the inflationary economies of the

developing countries. Therefore at the successf~~l conclusion of the research, many

profit-oriented organizations in inflationary economy will benefit from the

recommendations of this research.

1.4 SCOPE OF THE STUDY

Pricing is an economic variable which its effect transcends across the entire

society. In the process of conducting this research the researcher may have to take

careful study of the following:

The alternative pricing approaches as established by economists and accountants.

The inflationary trends in relation to developing economies (the Nigeria

experience).

The pricing decisions under different market structures of perfect and imperfect

markets, monopoly and monopolistic markets and the ~Iigopolistic market.

In the course of this study, the researcher will pay visits to some selected

companies for oral interviews and administration of questionnaires.

The researcher will go further to consider both the factors that are interval and

external to organizations which can influence the pricing decisions of the

management.

Price is one of the functions of demand and therefore we have emphasis on the demand

theory and price system under various market conditions. With the research

encompassing the outline of courses, the purpose for which the research was instructed

must have been established.

1.5 LIMITATIONS OF THE STUDY:

The topic of discussion is a very sensitive one that every economist, accountants and

finance managers would always like to make mention of. But from the available

readings, mentions of pricing decision is always very brief. Therefore just reading from

available materials may not provide sufficient information. Furthermore, pricing decision

in an inflationary environment is a new field of study. Therefore the researcher is only

left with one option of comparing the generally established pricing approaches founded

on the de\reloped economies of the west with the practical pricing effected by

organizations in developing inflationary economy as Nigeria.

To this effect, price has to be originally or directly sourced and analyzed from

different individuals and organizations. Therefore the number of firms to be visited in

the course of this research is bound to be limited by both financial and time constraint,

thus limiting the spread of the firms to be sampled and hence localizing the data to be

employed in the analysis.

Furthermore, how to obtain accurate statistical data from data banks may pose its own

limitation based on the fact that information agents like federal office of statistics,

national planning commission and the central bank of Nigeria at times present conflicting

report showing gross incompetence among them.

In a free market economy, the pricing decision is beyond the reach of

management because prices are fixed by the forces of demand and supply. In the same

vein, the volatility of developing economy, Nigeria inclusive makes it very difficult for

most econon~ic principles to work.

However, the extent to which the research was going to be accommodated will still

permit the researcher to achieve his objective OF instituting the research.

1.6 DEFINITION OF TERMS

INFLATION:

This refers to the general rise in the prices of goods and services resulting from

too much money chasing too few goods and services.

DEVELOPED ECONOMY

This refers to any economy characterized by, full employment, low rate of

inflation, high standard of living with minimum, marginal propensity to consume

and high marginal propensity to serve.

PRICE ELASTICITY OF DEMAND

This refers to the responsiveness of demand of a product or services to a change in their

prices.

DEVELOPING ECONOMY

This refers to an economy characterized by high rate of inflation, high rate of

unemployment and lour level of standard of Iiving.

INCOME ELASTICITY OF DEMAND

This refers to the responsiveness of demand of goods and or services to a change in the

income of the consumers.

ENVIRONMENTAL FACTORS

This refers to those factors that are not econon~ic in nature but can influence economic

activities such as social factors, political factors, cultural and other related factors that can

influence economic environment.

MARKET STRUCTCTRE

This means those characteristics of a market that influences the behaviour and the

performance of the firms operating in that market, such as number of sellers and the

nature of the products amongst others.

MANAGEMENT BY OBJECTIVE:

This is a concept which takes on an aspect of planning function and also in aspect of

organizing functions, used together by certain elements of directing function namely,

motivation and finally the controlling activities of measuring performance - "Agwu

Akpata"

MACRO ECONOMICS

Deals with the determination of prices and quantities in individual markets and with the

relations among these markets.

MICRO ECONOMICS

Focuses on much broader aggregates. It looks at such things as the total number of

people employed and unemployed, the average level of prices, total national output and

aggregate consumption.

RELATIVE PRICE

This refers to the price of a product expressed on the ratio of the average ruling price in

the market.

FREE-MARKET ECONOMY

An economy in which the discussion of individual house-holds and firms (as distinct

from the central authority) exert the major influence over the allocation of resources

MARGINAL PROPENSITY TO CONSUME

This refers to the ratio or proportion of the earned income that is spent on consumption of

goods and services.

MARGINAL PROPENSITY TO SAVE

This is the reciprocal of M.P.C as it refers to the part of earned income not spent on

consumption.

CONSUMER SURPLUS

This is the difference between the total value the households place on all the commodities

consumed and the total payment they must make to purchase that amount of the

commodity i.e the different between the market price and the maximum price the

consumer is willing to pay for the product or service.

PRODUCT COST

This refers to all inputs into the production process of a product expressed in monetary

terms.

MARKET STRUCTURE

This refers to the characteristics of a market that influence the behavior and performance

of firms that operate in market, such as the number of sellers and the nature of product

among others.

BUDGET

This refers to the work plan as set out by the management, expressed in monetary terms.

ENDOGENOUS VARIABLES

This refers to variables that are explained within a theory. It is also know as induced

variable

EXOGENOUS VARIABLES

These are variables that influence endogenous variables but are themselves determrned

by factors out side the theory.

CHAPTER TWO

LITERATURE REVIEW

2.0 INTRODUCTION

Early trading was by means of barter, which implies trading of goods directly lor

other goods. But this system of barter was costly in terms of time spent searching out

satisfactory exchanges. Thus if a farmer has wheat but wants yam, he must have to find a

person who has yam and the same time required wheat. This posed the main problem

associated with the barter trade called a double coincidence of wants.

Introduction of money eliminated the cumbrous system of barter by separating the

transaction involved in the exchange of comn~odities. If a farmer has wheat and wants

yam, he does not have to find someone who has yam and wants wheat. The farmer takes

money in exchange, then finds a person who wishes to trade yam and gives up the money

for the yam.

By eliminating the cumbrousness of barter, the importance of money in greatly

facilitating trade and specialization cannot be over emphasized. It was this era of money

that ushered in the market economy and hence the price system. It was the introduction

of monetary economy that formalized the act of pricing and standardized it. Among the

numerous important functions of money, is that of money acting as a medium of

exchange. It is the rate of exchange of goods and services expressed in monitory terms

that is known as price. Pricing decision in one of the most important problems which the

management of any organization that thinks sustainability must take serious. All the

micro economic analysis have been alternatively called pricing decision. What is more,

all investigation conducted on micro economics relates primarily to deciding on

appropriate pricing policy.

Joh C Lere, Pricing Techniques for financia1 executives 1974. P. 3.

Then there abound theories and hypothesis on this area which must now be reviewed

before any reasonable step can be taken. Thus this chapter is going to concentrate on

reviewing what other authors have identified in the course of their research.

2.1 PREVIOUS RESEARCH DONE AND ITS ACCOMPLISHMENT

To enable us appreciate this research work, an insight into previous work on the

same sphere conducted by professionals has become inevitable. In all the previous

studies on this topic, it had been proved that internal and external factors bear direct

influence on the pricing policy of any organization, but the effect of uncertainty, risk, and

technical changes are not always properly considered. It was in the process of previous

research that models that help to see pricing problem clearly have been developed. In

facing the exposed problems of price determination and pricing policy in the context of

general prices level analysis, the afore-mentioned researches ran into several kinds of

problems. For instance if from definition, inflation deals with general price level and

hence the analysis here include both individual and general price level. But it is now

customary within the theoly of firms to set up a series of analysis of alternative market

situations. A distinction is always made among perfect competition, monopoly7

monopolistic and oligopolistic market or structures. In any industrialized or developed

economy the above market structures subsist to a certain degree so that it becomes very

difficult to characterize the general price level.

Furthermore, difficulty arises in connection with conventional analysis of firm

bel~aviour. In most texts the analysis takes place under the conditions of certainty and of

static expectation and the formal superstructures lose much of their precision when faced

with dynamic realities in which expectations become significant and uncertainty, the rule

rather than exception.

For the fact that this research is concerned with inflationary environment in which

expectation and uncertainty may play an important role, static text book theories can only

offer a limited foundation upon which to base the dynamic pricing decision analysis. In

the course of this research, the hypothetical relationship which are designed to assist us in

constructing some picture of the inflation process are to be chosen

2.2.0 FACTORS AFFECTING PRICING DECISION

These refer to those factors that have direct bearing with the choice of pricing

decision. These factors are classified into, two categories: those that are internal to the

organisation called internal factors and those that are external to the organisation, called

external factors.

2.2.1 INTERNAL FACTORS

Every organisation is confronted with some factors which originate from within

the organisation. These factors are relatively controllable by the management of the

orgainsation and could include the following among others.

2.2.2 COST

Horngren and Foster in their book, "Cost Accounting. A managerial Emphasis"

Identified cost as the first and most important anlong the three major factors the influeme

pricing decision. They asserted that the Maximum price that can be charge is that which

will not drive the customers away, while the minimum price is zero. The effect of cost

on pricing decision was illustrated with the use of the famous cost-volume-profit

analysis.

Donald S. Waston, in his book, "Pricing theory and its Uses", identified cost as

the common base for determining the selling prices of products. According to him, firm

computes the selling price of its products by provision of adequate markup based on cost

price or margin if based on the selling price. It is the price of product which is determined

by provision of adequate markup based on the business cost (not full cost) of the product

that is described as the cost plus pricing approach. He went further to explain that Ihe

business world employs simple rules of the thumb in this cost-plus pricing approach since

they just add the markup subjectively to the total average cost. This led him to the

observation that economists generally regard cost-plus pricing technique as a measure

which may never result in profit maximization unless by exception as it fails to take

cognizance of dernand analysis and the price system. Rut this not withstanding, it is

noted that cost-plus pricing need not be inconsistent with profit maximization if the

average variable cost of a firm's product remain constant over a relevant long range.

Donald S. Waston, Pricing theory and its uses 3rd edition 1972 P. 438. 4 ibidem P.

439. Ganison agreed with the preceding w-riters that cost has direct variation with price of

a product. He gave a key concept in pricing which states that selling price must be

sufficient to cover the cost of production in the long run if such a firm is to survive and as

well add a margin should the firm aim at growth. He sadly noted that the above

fundamental concept is often missed by some pricing enthusiasts who seem to impl) in

their writings that any price above variable or incrementaI cost is acceptable price for any

product under any circumstance (observe here that Ganison differ sharply with Waston in

his cost definition) for he specifically stated that in setting normal long run prices on

standard products, all cost were relevant in the pricing decision and must be considered

by the price setter. if the long run profit goal are to be achieved. But that not

withstanding, they both agreed on the common approach to the standard product cost-

plus pricing fomular. 5 ray H. Garison Managerial Accounting Concept for planning

control, Decision making, 3rd edition. 1972 P. 487 6, Ibiden P. 487.

According to Garison, this approach involves computing a cost base and then

adding to this, a predetermined markup to arrive at the targeted selling price. The cost-

plus pricing has two approaches of either absorption or contribution margin approach.

Garison expressly advanced four major reasons why cost data are used in pricing

as follows:

( 9

(ii)

(iii)

The foremost of the reasons is that in making pricing decision the manager is

faced with a myriad of uncertainties, among which is inflation. The cost-plus

target price represent the starting point, a way of removing some of the

uncertainties and shading some light on others. It is important to note how

uncertainty factors were just mentioned but no solution to their challenges was

proffered.

The second of this reason is that cost might be viewed as floor of protection

guiding the price setter from pricing too low as to incur loses although this line of

reasoning gives an illusionary protection than real" he added.

Further more, he stated that formula based on cost-plus approach to determir~ed

the target selling price may give the price setter some insight into competi:ors

price range. Cost will help the price seller predict what a competitive price will

look like considering the varying economic variables.

7 Ibiden P. 495

Finally many firms have such a wide rang of products that they do not siniply

have a time to do a detailed "Cost-Volume-Profit" analysis on every item in each product

line. So Garison claimed that Cost-Plus formula provides a quick and direct way to

achieve at least a tentative price level that can further be processed as time and

circumstance permit.

Given all these reason he still asserted that the optimum price to charge is best

determined at the point of intersection of firm's marginal revenue and marginal cost

curves. This is regarded as the market price where forces of demand and supply are at

equilihrium and hence the profit maximizing price in a free market economy.

2.2.3 THE MANAGEMENT OBJECTIVE

Waston was of the view that every pricing policy/decision must always reflect

management objective rather than contradict it. On discussing barometric price

leadership and dominant price leadership" it was at least implied that the management of

a firm which determines to be the industry leader, must set that as its objective or goal

and that when this goal is set, it must be reflected in the price(s) it charges for its

product(s).

Garison concurred with Waston when he was identifying other factors which can

bring about variation in a company's mark-up according to custom, need or general

industry price. Therefore, the particular nced (which can also mean goal) in a firm.

directly or indirectly affects its pricing decision which is expressed in the budget as the

key element.

2.2.4 N A T U N OF PRODUCT

The pricing policy will be influence by this variable in that the quality of' the

product, the substitutionability of the product and other special attributes to any product

uilI very much influence the pricing policy of the product.

2.3.0 EXTERNAL FACTORS

Those factors that make an organisation and its environment to be inter dependent

and which are beyond the control of the management of the organization are considered

as external factors. Therefore for the sustainabiIity of any firms' operation, the

management, should be able to blend the internal factors with external factors in

appropriate proportion. Hence for the purpose of dynamic management, environmental

factors should be reflected in the management decision. Among the external factors to be

considered for the purpose of this study are as follows:

2.3.1 THE CUSTOMERS

Horngren and Foster (1987) were very confident that the nature of customers

directly affect the price of a product. They maintained that the price of any product as

may be fixed by management must reflect the opinion of the target customers in that

regard. This has to be so because a price fixed without reference to the customers stands

the risk of being rejected by the customers in preference to more cost effective product

that could serve for substitute. This is why as they further aimed, many firm reflect the

interest of the customer right from the developmental stage of the product.

Garison (P. 485 and 468) Considers the customer factor in price determination

under the sub-heading, "Elasticity of Demand"

Therefore, while noting that product price determined is a key concept, he

observed that though the measurement of the degree of price elasticity is difficult, s ~ c h

information will always be among the vital information required by management for the

purpose of sustainable pricing decision. This kind of information can only be obtained

through carefully planned marketing research problem.

It has been established that any product can be either price elastic or price

inelastic.

Price elasticity iust reflects the degree of responsiveness of demand of a product t o 2

change in its own price.

Hanson in his own contribution asserted that the nature of customer of a:ly

product, (ie whether they are rational or otherwise) must be established before a change

in the price of any product should be effected. The customers behaviour as they

influence price was extensively discussed to include the cross-elasticity of demand

resulting from change in the price of a substitute.

So there is a serious problem of identifying all substitutes of a product. But this

not withstanding. he concluded that, although problems of this nature are often very

difficult to quantify, the concept of Gross Elasticity of demand is an important concept

and cannot be disregarded in pricing decision.

Furthermore, Watson viewed the customers' factor in pricing decision to mean

customer's optimum budget. He said that customer' often allocate their resources

(income) in such a manner that the utilities yielded are equated at the margin. This does

not equal amount of money for each comn~odity.

H.R. GARISON Managerial Accounting, Concept for Planning control and decision

Making. P. 489.

He related this to the theory of consumer surplus which is defined as the

difference between the total value households place on all the units consumed of some

commodities ie that total consumption value of the commodity and the total payment they

must make to purchase that amount of the commodity ie the total market value of the

commodity. Expressed simply, it means the different between what the consumer is

willing to pay for a commodity and the ruling market price of the commodity.

Waston viewed this doctrine exactly the way it was propounded by Lord Alfred

Marshall'. If the price of a commodity goes up, the consumer is said to be injur.:d,

particularly if the price is that of essential commodity or service. Similarly if the price of

a commodity goes down, the consumer benefits". What does the injury and bencfit

consist of? Waston answered; "A loss or gain or consumer surplus". This is illustrated as

foIlows:

If the price of a commodity goes up, it implies the reduction in consumer surplus

which represents injury to the consumer, but if the price of commodity goes down it will

imply increase in consumer surplus and then represent gain or benefit to the consumer.

The velocity of the injury or benefit (gain or loss of consumer surplus) resulting

from price changes will depend largely on the gradient of the price elasticity of demand.

Donald S. Watson Price theory and its uses. P. 77

The Donald warned that price setters must be careful on how they benefit or

injure consumers through their price policy because injuring of the consumer may lead to

consumer resentment and ma}- automatically refuse to patronise the product.

Furthermore, in his book "Pricing techniques for financial executive". John C.

Lere was of the opinion that any body saddled with the responsibility of price setting

must at all times estimate the effect on and reaction of consumers before effecting any

price change. He considered that with the current prevailing computer environment when

almost all predictions are going scientific that pricier must not fail to predict consumers

preferences and expectation i i ~ any proposed price change. He however, warned that

several problems arise as the process of predicting consumers' responses to price change

appear to be very complex. The prohibitive cost of sophisticated analysis were two main

problems inherent in this consumers' behavior prediction, he identified.

But these notwithstanding he still maintained that consumer's reaction to a price

change must never be overlooked by price setters for the sustainability of the firms

business, as any step on the wrong direction in term of pricing decision couId spell doom

for the organisation.

2.3.2 COMPETITORS

According to Lere '-even if the customers are faithful to the firrr

competitors may be expected to have taken some action if the firms pric

The action he further explained depends largely on whether the price is v b l v r \ . uvvrr

that of the competitors. If the price is above that of the competitors, the firm can expect

competition to point out this fact frequently. But if the price is below, the competitors

may engage in heavy price war which will result in reduction in sales. This in either way

effect the target rate of return on sales. He therefore recommended that prices out of line

should be carefully evaluated by the marketing department.

However, Lere agreed to the simple fact that, the price is out of line does not

automatically mean that the price is in appropriate.

line, due to any of the following:

1. Advertising department promoting different (

2. Distribution through different types of retail 1

3. Using Advert to differentiate the products i

only the unexplained differential is a prt

competitors to increase their nrirp ~t the ~ ~ n f

Ganison included the compe

limitations to the general pricing

applicable only in condition of monopoly (ie no directly competing product in the

market) and monopolistic competition (many sellers of controlling market share). The

models are not applicable between these two theoretical extremes where the market is

characterised by situation of Oligopoly (A few large seIlers competing directly with each

other). "The reason is that the models make no allowance for retaliatory pricing decision

by competing firms.

2.3.3 THE BUDGET AND PRICING DECISION

Every profit oriented organization must identify prices as a key factors or eEeme~lt

in their Budget because of their over whelming importance.

A budget can be defined as "plan of action quantified or expressed in monetary

terms and serves as an aid to co-ordination and implementation".

"Uncertainty of future events" is the most constraining factor in budgeting, directly affect

product prices. Therefore, there is uncertainty of prices as may be i t

master budget, hence making all other plans that are dependent on the I

future. There are three main factors identified to pose a lot of problem

for prices

12 Ibidem P. 952

13 Ibidem P. 952

The first and the most important of them is the customer reaction. '

existence of intra-industrial con~petition.

He explained "and retaliatory pricing is a prime characteristic

industries."

Charls T. Horgreen and George Forster, Cost Accounting A Managerial Emphasis, 6"'

edition, P. 305.

In an effort to harmonize their writing with the findings, Horngreen and Foster

included competitors as the second of their three factors that influence pricing decision.

To this effect, they were of the opinion that "rivals" reactions or lack of reaction wdl

influence pricing decision", it was pointed out, that though the competitors, are very

useful whenever they are available.

In an ideal pricing approach, cost should be viewed as the key element. On this

note, the maximum price chargeable is that which drive away customers, while the

minimum price chargeable will be variable cost of a product which is always applied as

last resort in short term.

2.4 INFLATION AND PRICING DECISION

Till now we have develop the prices of individual production in

assumption that the prices of other commodities remain constant. Does this mean that the

theory is inapplicable during an inflationary period when in the average, all prices are

rising? 'The answer to this question should be no, because as we have mentioned several

times that what matters for demand and supply is the prices of the commodity in question

relative to the prices of other commodities. This is referred to as relative price.

In an inflationary economy a commodity's relative price can be measured by

changes in the commodity's own price relative to change in the average price of all other

commodities.

If during the period when the general price level rose by 40%, the price of

mangoes, for instances, rose by 60%, then it indicates that the price of mangoes rose

relative to the average price level in the market or economy. But where the price of

mangoes had risen by only 30%, then the price of mangoes relatively would have fallen.

Therefore even though the money price of mangoes rose substantially, mangoes become

relatively cheap.

In Lewis Carrolls famous story Through the Looking Glass, Alice finds a countly

where everyone has to run in order to stay still. So it is with inflation. A commodity's

price must rise as fast as the general price level just to keep its reIative price constant.

With the above establishments, to arrive at any price decision for any product, in

an inflationary economy, the price setter must as a matter of fact establish the inflation

rate and hence the general price level to act as guide to setting up the price.

If the price so fixed is above the general price level ruling in the market in relative

terms, the product could thus be considered expensive and may hinder its introduction

into the market. for new product or bring about decrease in quantity demanded for

existing product and vice versa.

'The above assertion not withstanding, inflation poses the greatest impediment to

proper and sustainable pricing decision. Inflation can be defined as the general rise in

prices of goods and services. This problem is practical in nature because despite the price

changes which result from inflation. the organization battlcs to accomplish its set

objective. The non stable rate of inflation has resulted in information distortion, resulting

in our earlier assertion of at times providing conflicting data by some information centres

as FOS, CBN and FIC

To this effect, management will be left to operate amidst confusion when the

leading inflationary rate can neither be provided for the whole economy (Nigeria

Economy) in general and the industry in particular.

When there is a continuous increase in the cost of production with the rate of

inflation constant and determinable, the plans as to the prices and quantity of products to

be sold can be pre-determined with minimal deviation from the actual outcome. Elut

where the rate of inflation is very uncertain and inconsistent, the setting of future prices

or predicting of prices to take cognizance of the cost of production, competitors, and

customers view of the product, becomes a serious problem. The impact of this problem

can be appreciated bearing in mind that no organization can con~promise its objective for

any cause at all.

Furthermore, inflationerodes the purchasing power of the consumers through

reduction in their real income. The pricing decision is made more complex while trying

to incorporate and reflect customers income and purchasing power.

This is the thought Garison (Pages 485 and 486) had in mind when he considered

the issue of elasticity of demand. He asserted that where the income of the consumers of

a product is fixed, the producers must be extremely careful with any decision to incrt:ase

the price of his product as this will directly reduce the real income of the consumers and

hence erode their purchasing power. In this situation the reduction in total income

resulting from decrease in demand may be greater that additional income resulting fiom

the price increase hence leading to loss of income and profit.

Proper understanding of this topic as a whole unit is pertinent here. Continuous

increase in the cost of production should normally be followed by increase in the

p r o d ~ ~ c t ~ s prices. But the management cannot afford to lose its market share through

constant product price fluctuations as competitors are always waiting to capitalize on

such short comings to gain customers, especially where the price eIasticity of the product

is high. But for the management to carefdly decide on their product prices, thc

importance of objective budget to serve as a guide to price decision cannot be over

emphasis. Presently the uncertainty resulting from inflationary trend has left most

budgets subjective rather than objective.

There have been two established ways of setting product prices as follows:

(a) Prices could be set philosophicaIly - when management sets prices to suit the

wish of the customers with little or no regard to costs. (customer driven)

(b) Prices could be set rationally - when costs are the key determinant of the product

prices. (cost driven).

Hence this research work is limited to rational pricing.

In summary therefore, product prices have a direct relationship with the costs of inputs,

inflation, budget and the market so that management must clearly understand both the

organization and its environment before any hope out of this identified problem can be

2.5 THE PRICE SYSTEM, THEORY AND MECHANISM

The impoflance of price in any market economy can never be over emphasized.

Therefore. because of the importance of prices in market economies we say that they

employ a price system. This term refers to the role played by prices in determining the

allocation of resources and the distribution of National product.

According to Richard G. Lipsey in his book, .'lntrodection to Positive

Economics", Seventh Edition, P. 11; the great insight is that: "Markets function without

conscious control because individuals take their private decisions in response to publicly

known signals such as prices, while these signals in turn respond to the coIlective actions

entailed by the sum of all individual decisions; in short, the price system is an

automatically functioning social-controI mechanism.'

By social-control mechanism, he means a technical term for anything that

influences social behaviour prices, which provides an incentive for people to adopt

certain patterns of behaviour voluntarily, are one example, while laws, which force

bthaviour into certain patterns are another.

In 1776, Adam Smith in his book, The Wealth of Nations which resulted from the

desperate early search to understand the working of market economics, spoke of price

decentralized among millions of individual producers and consumers.

me concept of system is only applicable in a free mrke t economy *here

- .I - c,,,~, nf demand and supply

at point where both demand and supply are equated at the margin. It is often remarked

that in a free - market society the consumer is the king.

Sitch a Maxim reveals only half the truth as prices are determined by sitppl)~ as

well as demand. Therefore, free - market society gives sovereignty to two groups,

producers and consirrners and clecisiott of both groirps affect prices attd hence the

allocation of resoiirces.

Although theory of the determination of price is a powerful tool, there is no point

in memorizing the laws of demand and supply. The price theory should become our

servant rather that master. To this effect the price theoiy should be applied to a number

of actual practical cases.

Therefore, though in free market economy the prices in the market are determined

by the forces of demand and supply, which could have eschewed the need for this study

in such a market, in application, some actions external to the price system such as price

control by which prices can be fixed disregarding the forces of demand supply. The price

so fixed is referred to as dis-equilibrium price because it creates imbalance between the

quantity demanded and quantity supplied.

At any dis-equilibrium price, the quantity exchanged is determined by the lesser

of quantity demanded or supplied. This resiilt is often expressed by the rmxirn: in dis-

eqttilibriitm, the short side of the market dominates.

In summary tlte result of this strt@ will still assist the price control agents in

free - market economy to apply their price legislntion in freeing tile dis-eqitilibriurn

price taking into consideration the existing rtlte of infition.

To this end, it is pertinent to conclude that pricing decision and its environmental

requirements have been detailed. A prospective look is now necessary for clear

understanding of the state of this research, it is evident that the static assumption of

theoretical economists with respect to prices though important is misleading.

Given this theoretical conflict with the real world or practical world situation as

per inflationary environment. this investigation is primarily going to spell out actually

how firms decide on their product prices.

CHAPTER THREE

RESEARCH METHODOLOGY

This research deals with those techniques and methods applied by the researcher in

conducting the research with regards to the provision of relevant information. It involves

step by step analysis which will be used to cany out the research. This makes possible

for each reader or user of this research to evahate the information provided by this

research confidently.

In general ternls. the study is based of current and practical issues. The research

method adopted is the "Survey Method". In the course of this study, relevant information

were obtained from both secondary and primaly sources. The collection of primary data

were made through the use questionnaires in conjunction with personal oral interviews.

3.0 SOURCE OF DATA

In conducting this research, two sources of data were explored as follows:

1. Primary sources of data

2. Secondary sources of data

3.1.0 PRIMARY SOIJRCES OF DATA

This refers to those data obtained as first hand or original information specifically

for the purpose of this research work. This was obtained using the following media.

3.1.1 ORALPERSONAL INTERVIEW:

This implies the researcher meeting with the relevant management staff of an

organization or private individuals and engaging them in relevant discussion on the

research topic in the form of question and answer session (inttmiew).

It should be noted that oral interview cannot serve as an alternative to written

questionnaire but rather should be seen as complimentary. This is because most times,

the researcher uses it where he notices some contradictions in some answers to

administered questionnaire and researcher made use of both method in this research. To

this effect, unstructured interview method was adopted in this research to get some

insight into a particular circumstance involved in pricing decision.

3.1.3, QUESTIONNAIRE

In this research work, the major medium for the aszembling of primary data was

the questionnaire. It was prepared and administered to the same population (corporate

institutions and individuals).

The questions as contained in the questionnaire were problem oriented and

professionally structured which makes them difficult and irrelevant to those that are not

associated with pricing decisions to answer.

But this not withstanding the questions used were carefully constructed,

unan~biguous, simple, unbiased, clear and concise, and capable of furnishing useful

information about the methods of pricing decision in an inflationary economy. The scope

of the questionnaire administration was inevitably limited or hampered by lack of financ:

and time.

3.2 SECONDARY SOURCES OF DATA

Secondary sources of data comprised of review of related literature - with special

emphasis on accounting. management and marketing text books, Journals, articles and

lecture notes.

Ebonyi and Enugu State of Nigeria served as the territorial boundary of this model. 'The

samples were randomly drawn from profit oriented organizations.

Furthermore, twenty-four (24) top level management personnel were sampled in their

individual capacity making for a total sample space or population of thirty-six (36) -

twelve firms and twenty-four individuals.

CHAPTER FOUR

DATA PRESENTATION AND ANALYSIS

4.0 INTRODUCTION

It has been necessary to recall the problen~ that led to this research. since the data

to be discussed and summarized in this chapter, are to form the bed rock upon which the

conclusion and recommendations will be founded. It had already been established that

cost is the most important factor influencing the pricing decision of profit orientated

organization, hence the famous cost-plus pricing method. This approach has an imphi t

assumption of reasonable stability in the value of cost of production and the general price

level over a period of time. This assumption is far from reality. Then the problem is how

do firms decide on their product prices in the face of the handicap noticed in the

economist model.

In this chapter therefore, the researcher will present, and analyze the primary data

as collected from the twelve firms and 24 individuals, which formed the sample size with

editorial comments where necessary.

4.1 PRICING POLICY AND MANAGEMENT BY OBJECTIVE (MBO)

The management of every profit oriented organization has three major alternative

pricing objectives such as:

(a) Profit maximization

(b) Maintenance of key market shares.

(c) Attract new customers.

My visit was extended to twelve (12) firms uF this number, eight (8) firms elected

price maximization as their main pricing objective. while two (2) each affirmed

inaintenance of key market share and attraction of new customers as their man pricing

objcctives respectively.

On the use of budget as a tool for pricing decision, (10) ten firm attested to

preparation and use of budget in pricing decision while two (2) firm were not favourably

disposed to the use of budget in pricing decision.

While those that practice the use of budget as a price decision too1 accepted that

the strategic goals of the organization are incorporated in the budget, the two (2) that

were not used to formal budgeting base their planning on management experience. We

slrould note the hrtdget as used h the research impliesflexible brmget.

011 further investigation to determine the most important budget factor, (10) ten

out of the twelve firms sampled elected sales as the key budgeting factor while the

remaining two (2) prescribed cost as the key factor

The above analysis is presented in tabular form below:

Table i WHO MAKES PRICING DECTSION

I S/N / DECISION MAKER 1 NO. IN FAVOUR / % TO SAMPLE

66.67

16.67

Marketing manager 16.66

I Total 12 100%

Response to the question on who takes pricing decision in a company conducted

in twelve (12) firms.

TABLE ii: PRICING OBJECTIVE

/ S/N I PRICING OBJECTIVES 1 NO. IN FAVOUR 1 % TO SAMPLE / 1. Maximize profit

2. Maintain key market share

3. Attract new customers

I I I I I

Responses obtained while interviewing 12 companies 011 what in forms their pricing

policy

TABLE iii: BUDGET AS A TOOL FOR PRICING DECISION

RESPONSES

No Budget Experienced 16.67

Table to Ex-Raying the ratio of the firms that make use of budget as a guide to pricing

decision to those that have no experience of formal budget which stands at 5:l

respectively.

TABLE iv: MAIN BUDGET FACTOR

Budget Factor (MOND)

The table expresses the ratio of those of sales as the major budget factor to those that

No. of Firm in Favour

(responses)

sales

Cost of production

Total

consider cost of production as the major factor which stands at 3: 1 respectively.

Table 5 , 6 and 7 below exhibits the relationship that exists from the individual

9

3

12

responsible for pricing decision to the type of budget used.

7 5

25

100 YO

TABLE v: DEGREE OF ASSOCIATION BETWEEN THE PRICIKG DECISION OBJECTIVE AND THE INDIVIDUAL ON WHOM THE PRICISG DECISION RESPONSIBILITY IS VESTED

ALTERNATIVE PRICING O B J E C T I V E S ~ -

RESPONSIBILITY

ORGAN

From the above table it could be observed that out of the (12) twelve companies samples,

8 affirmed that pricing decision is the sole responsibility of management. When these

eight were filrther interview on their pricing objective, five said it was profit

Management

Accountant

Marketing Manager

Total

CON'

-

-

MAXIMIZE PROFIT

5

2

0

7

KEY MKT SHARE NEW

CONSUMER'S

2

-

1

3

1

-

1

2

maximization, two said it is to maintain the key market share while only one of them

considered attraction of new consumers as its main pricing objective.

In the same vein, 2 firms saw the accountant as those responsible for pricing

decision and the whole 2 firms considered their main pricing objective to be profit

maximization.

The balance of 2 firms saw the marketing manager as being responsible for

pricing decision and under further investigation it revealed one of them chose

maintenance of key market share as its main objective while the other considered the

attraction of new consumers as the main pricing objective.

TABLE vi: THE RELATIONSHIP AMONG USERS OF FORMAL BUDGET

FACTORS

BUDGET FACTOR I SALES I COST OF PRODUCTION^^^

decision)

Yes (use budget as guide to pricing

No (No knowledge of formal I 2 l budget

8

In table 6 above it was shown that out of 10 firms that make use of formal budget as

L. 7

Total

guide to pricing, 8 consider sales as the main budget factor while the remaining 2

l o 1

consider cost of production as the main factor.

10

In the same vein, the 2 firms that confirmed that they have no knowledge

2 l2 J

of formal budgeting all consider sales as the main budget factor should they practice

formal budgeting.

TABLE vii: FACTORS INFLUENCING PRICING DECISION RANKED IY THEIR ORDER OF IMPORTANCE

I I I FACTORS INFLUENCMG PRICING DECISION

POSITION

1st

2nd

rd

'p

FACTOR

, TOTAL

In the above table, 10 out of the 12 companies sampled indicated that the major

factor influencing their pricing decision is their cost of production, while the remaining 2

gave cost the 2nd position.

In terms of customers factor, five companies gave i t the 2" position, six gave it

the 3rd position while only one firm gave it the 4Lh positio~ to make a total of 12 films

investigated.

For competitions factor, the spread are as follows: 3: 4, 3 and 2 firms ranked this

fac~or in the lS', 2": 3rd and 4''' positions respectively.

WEIGHTED FACTOR

TOTAL

WEIGHT ATTACHED

TO POSITION

4

3

2

1

I 10

46 1 28 1 32 1 18 --

COST

10

2

0

0

I l2 I 12 1 12 I 12

COMPETITORS

3

4

3

2

CUSTOMER

0

5

6

1

INFLATION

0

2

2

8 --

And finally, for the inflation factor, 2 of the firms ranked it 2", further two (2)

ranked it 3rd while (8) eight out of the twelve firms investigated ranked inflation in 4'h

position.

TABLE viii: DETERMINATION OF WEIGHTED, PERCENTAGE AND DERIVED SCORES.

1 FACTORS INFLUENCING PRICING DECISION I / SCORES / Cost / Customer / Competitors 1 Inflation I 1 Weighted score Total 1 46 1 28 I 32 I 18 1

FACTOR TOTAL = 12 X 4 = 48

Total weighted score per factor was arrived at as follows.

% core

DERIVED SCORE

1. Cost => 4x10 + 3x2 + 2x0 + 1 x0 => 46 2. Customer => 4x0 + 3x5 + 2x6 + 1x1 =>28 3. Competitors => 4x3 + 3x4 + 2x3 + 1x2 =>32 4. Inflation => 4x0 + 3x2 + 2x2 + 1x8 => 18

The percentage score per factor was arrived as follows:

96%

1

1. Cost => &5x 100 = 96% 48 1

2. Customer => 28 x = 58% 48 1

3. Competitor => 32 x 100 = 66% 48 1

4. Inflation => 18 x =38% 48 1

Based on the data gathered and analyzed, it has shown that if weights are applied to the

5 8%

3 rd

factors influencing pricing decision as represented in table 7 above, the overall result

show that cost of production is the prime factor to be considered in pricing decision as its

66%

2"*

3 8% 4'11

percentage score in table 8 was as high as 96% and occupying the first position.

Competitors, customers and inflation took, 2nd, 3'*, and 4'h positions respectively.

4.2 BASIC PRICING APPROACHES

A survey was carried out in twelve firms as to identify the pricing approaches. to this it

was revealed that there are three basic pricing approaches as follows:

1. The contribution margin pricing approach

2. The absorption cost pricing approach

3. The total cost pricing approach

As shown in table 9 below, out of the twelve firms surveyed, (10) ten of them

favoured the contribution margin pricing approach. Further critical survey of the ten

shows that eight (8) of them practice rational mark - up pricing system while two (2)

make use of intuitive pricing approach. The remaining 2 firms practice absorption cost

pricing approach. The total cost pricing approaches is not feasible in any economic

environment and therefore was not reflected in the analysis.

TABLE ix PRICING APPROACHES

I PRICING APPROACHES I I I I

/ Intuition Pricing I 2 ! O 1 2 1

Pricing Method

Rational Marketing

Contribution Margin

8

I I I

Absorplanted

2

12 Total

Total

10

10 2

The break down of pricing methods per pricing approaches.

THE BASIS FOR USING COST AS A KEY PRICING ELEMENT:

The data as collected for this research indicate that 10 out of the 12 firms sampled modify

the cost-plus pricing model to current cost-plus or replacement cost-plus pricing approach

8 out of the ten firms affirmed that they do obtain the real value of their income (ie

income as adjusted for inflation).

All the 10 firms that practice this replacement cost pricing approach, agreed that their

profitability have been enhanced just as they equally agreed that this approach

incorporated the other factors that influence pricing decision.

From table 10 below it will be seen that none of the firms applied price index in it pricing

decision (both interfial and external price index). From the investigations, 2 firms

indicated that they have no clear approach to pricing while 10 make use of replacement

cost-plus approach to account for the total of 12 firms investigated.

Those that make use of the clear method have no option as to whether their profitabilities

have been enhanced as represented in table 10 below.

TABLE x BASIS OF USING COST AS THE KEY PRICING ELEMENT

I I I I

Total 12 2 10 2

APPLICATION

Replacement cost-plus

Price Index I I I I

2 No clear method

RESPONDENTS

YES

10

-

ENHANCED PROFITABILITIES

2

NO

2

-

YES

10

N O

0

- -

From the data collected, presented and analyzed so far, it has been observed as follows:

I . Most of the firm accepted that pricing decision is the responsibility of management.

2. Profit maximization as one of the main objectives of pricing decisicn attract as much

as 83%.

3 . According to question 21 and 23,21 people were in the affirmative while three

responded natively.

TABLExi: EFFECT OF INFLATION ON EXPENDITURE AND INCOME

EARNERS.

I RESPONSE / NOOFRESPONDENTS(F1RM) I O/o

The above table present the response of 30 individuals and companies that was

circularized on the effect of inflation on expenditure and low income earners. 25

respondents affirmed that during inflation, people spend much on goods and services and

low income earners suffer while 5 answered negatively, representing 83.33% and 16.67%

respectively.

83.33 I

No

Total

Yes 25

5

30

16.67

100

TABLE xii: THE EFFECT OF INFLATION ON FIXED INCOME EARNERS:

RESPONSE / RESPONDENT (INDIVIDUAL I FIRMS) 1 %

The above table shows that 24 respondents agreed that fixed income earners suffer during

Yes

No

Total

period of inflation, while 6 said that they don't suffer any thing. This represents 80% and

20% percent respectively. This was in response to question 22 and 25.

2 4

6

30 --

TABLE xiii: TREND OF PRICE MOVEMENT IN INFLATIONARY ECONOMY

8 0

2 0

100

The representation in the table depicts that 30 respondents affirms to the fact that prices

- - of goods and service persistently move upward during inflation, while only 5 stated that

they don't move like that. The percentage of respondents is 85.71% and 14.29%

respectively.

4.3 TEST OF HYPOTHESIS

The objective of this test is the determination of the statistical significance of the result

RESPONSES

Yes

No

Total

obtained from the sample data.

NO OF RESPONDENTS (firms I individuals)

3 0

5

35

%

85.71

14.29

100

4.3.1 IDENTIFICATION OF TEST STATISTICS.

The researcher is to make use of chi-square statisfically response by (s2) distribution, the

Chi-square is given by the equation

(1) x2 = value of the random variable whose sampling distribution is approaximated

closely by chi-square distribution.

(2) Oi = Observed frequency in the ith row and column.

(3) Ei = Expected frequency in the ith row and column.

(4) K = Number of rows / column.

4.3.2: FORMULATION OF THE DECISION RULE

The researcher is to perform this test at 0.05 or 5% level of significance which is

denoted by X.5% level of significance means that there are five chances per hundred that

a true Null hypothesis will be rejected. The critical value is the value of x2 that leaves

5% of the area to the right. The degree of freedom for the 2x3 contingency table used

below is 3-1=2. Hence the critical value of x2, 0.05 with 2 degree of freedom from the

critical values ofthe Chi-square (x2) distribution table. This value is 5.991.

The decision therefore, is to reject Hi and accept Ho if the computed value of x2 >

5.991. but if the computed value of x2 5 5.991 we accept Hi and reject Ho.

STATEMENT OF HYPOTHESIS

Hi: In inflationary Economy, consumers spend much on goods and services and luw

income earners suffer.

Ho: In inflationary Economy consumers do not spend much on goods and services and

low income earners do not suffer.

TABLE xiv: 2 X 3 CONTINGENCY TABLE

POSTULATION (Hypothesis) - Hi

Ho

Test of homogeneity of those that favoured the alternate hypothesis (Hi) = == 0.833 30

To calculate the expected frequency for Hi

FIRM

Total

To calculate the expected frequency for Ho

People spend much on goods and services

People don't spend much on goods and

services

INDIVIDUAL

8

TOTAL

5

3 2

22 30

TARLE xv: OBSERVED I EXPECTED FREQUENCY TABLE

FREQUENCIES I FIRM

Expected frequency (6.67)

Observed frequency

Observed Frequency

Expected frequency

5

INDIVIDUAL

- - 0.42 + 0.15 + 2.097 + 0.76

- - 2.743

Observation: The computed value of the test statistics is less than the critical value x2

2.743 < 5.991, hence the researcher should accept the alternative (Hi)

hypothesis and thus affirm that people spend much on goods and services

in an inflationary economy.

TABLE xvi: 2ND CONTJGENCY TABLE (EFFECT OF INFLATION ON FIXED INCOME EARNERS)

POSTULATION (HYP) I FIRM I INDIVIDUAL I TOTAL

/ I-Io 1 Fixed income earners don't suffer / 2 1 4 1 6

come earners suffer I I I

24 5

Total

19

7 23 3 9

To test for homogeneity of those in favour of Hi (alternate)

- - 24 =0.8

30 To calculate the expected frequency for Hi.

To calculate the expected frequency for Ho:

TABLExvii: OBSERVED / EXPECTED FREQUENCY TABLE (FIXED INCOME EARNERS)

I 1 FREQUENCIES 1 FIRM / INDIVIDUALS

Using x2 - - C ((,. 7 2 1 - El

Observed frequency

Expected frequency

0.382 < 5.991. Therefore the researcher accepts alternate (HE) Hypothesis; which states

that fixed income earners suffer in inflationary economy.

5

(5.60)

2

(1.44)

19

(1 8.4)

4

(4.60)

TABLE xviii: CONTINGENCY TABLE (PRTCE TREND)

1 PROPOSITION I FIRMS INDIVIDUALS I TOTAL

Iii

Ho

Test of homogeneity of those that favour the alternative Hypothesis (Hi) = 30 = .86 3 5

To calculate the expected frequency for Hi

'To calculate the expected frequency for Ho:

There persistent rise in

prices of goods and services

There is no persistent rise in

prices of goods and services

Total

TABLE xix: OBSERVED AND EXPECTED FREQUENCIES (TREND OF PRICE MOVEMENT IN INFLATION PERIOD)

10

3

- 13

I / POSTULATION (Hypothesis) I FIRM

Using x2 - - (Oi - ~ i ) '

Hi

Ho

INDIVIDUAL

Observed frequency

Expected frequency

Observed frequency

Expected frequency

10

(11.18)

3

(1.82)

Observation:

1.33 < 5.991, hence we reject the Ho and accept the alternative hypothesis (Hi),

which states that there is persistent rise in the prices of goods and services in inflationary

environment.

AN EXPLANATION OF THE ANALYSIS:

Since this research topic is based on Nigerian economy, the researcher after

administration and collection of 36 questionnaires, comprising of 12 firms and 24

individuals was able to analyse the answers given by respondent as regards the pricing

policy in an inflationary environment.

The schedule of the names of twelve firms sampled are as stated below.

NAME OF FIRMS

Abakaliki Rice Mill owners Association Ltd.

Ezzamgbo Building Material Ltd.

Law Frank (Nig) Ltd.

Sun Rise Timbers Ltd.

B.U Ofoke & Sons Farms Ltd.

OGENYI WORKS Ltd.

Chichebem (Nig) Ltd.

Quiz International

Millenium Trust Ltd.

Ehuoha ConsuItancy Services

Pazolla enterprise

LOCATION

Abakaliki

Ezzamgbo

-

-

12. DE Standard (Nig) Ltd.

The names of the 24 individuals sample will not bc disclosed here dice to circumstances

beyond the researcher's control.

1 . Question 12 sought to know what nature of product being produced by the

companies. whether final consumable product or industrial product. The question

was informed by the reed to know whether the firm produces for consumption,

resale or for further production of other good. The answers collected shows that 8

finns produced for consumption, representing 75% and 4 firms produced

industrial goods representing 25% of sampIed firms.

2. Question 13 was based on whether the firm is in a competitive industry and a11 the

answers obtained were in affirmative ie 100% of the firms sampled are in the

competitive industry. Because of the competitive native of the industry the firms

must be extra careful in their pricing decision during inflation.

-I 3. Question 14 asked if the firm engages in pricing decision and a11 of them

responded positively

4. Question 15 asked if there were legal stipulations in pricing their product and/or

services. By this question the researcher wanted to find out if there were some

legal restrictions which can influence the pricing policy during inflation. Out of

the I2 firms sampled four of then responded positiveIy while 8 said that they have

no legal restrictions.

5 . Question one (1) in section B asked to know who makes the pricing decision. Out

of the 12 firms sample, 8 then said "management" while 2, each said "ac~ountant~~

and "marketing manager" respectively.

6. Question 2 section B asked to know what the major pricing objective is. In

answer to this question, 8 said profit maximization while two (2) stated attraction

of new customers and maintenance of majvr market shares respectively as the

major pricing objective.

7 . Question 10 of section B asked to know the factors that influence pricing

decision, cost, customers, competitors and inflation. List the above factors in

their order of importance in your pricing decision. With this question the

researcher intends to know the actual impact of these factors in pricing decision.

When all the responses were collected, analysised and summarized, cost came l",

followed by competitors while customer and inflation factors took 3rd and 4"'

positions respectively.

8. Question 14 was: In your pricing decisions, how do you treat the difficulty

brought about by inflation: Use of official price index or use of replacement cost?

By this question the researcher wanted to know how this problem is solved. Of

all the 12 firms sampled, all opted for use of replacement cost method of pricing

during inflation.

At this paint the researcher wanted to know the impact of inflation on both the 12

firms and 24 individuals.

9. Question 21 inquired: In inflationary environment, consumers spend much money

on goods and service and low income earners suffer. In responding 6 firms

agreed and 6 disagreed, 18 & 6 individuals agreed and disagreed respectively.

10. Question 23: In inflationaiy environment, consumers don't spend much money

on good and service and low income earners don't suffer. In responding, 6 firm

agreed and G firm disagreed, 6 and 18 individuals agreed and disagreed

respectively.

11. Question 23: In inflationary economy fixed income earners don't bear any burden,

everything is normal. 4 firms agreed, 8 firms did not agreed, 20 individual

disagreed, while 4 individuals agreed.

12. Question 24 was: In inflationary economy there is no persistent in rise prices of

goods. r While all the firms answered to the contrary, 20 and 4 individuals

answered no and yes respectively.

13. Question 25 was the opposite of question 22 and the answer therefore should be

the compliment of the answer to question 22.

14. Question 26 Stated that in an inflationary environment there is persistent rise in

prices of goods and services. The answers to this question was the compliment of

the answers to 24.

4.4 PRICING DECISION IN A FREE ECONOMY

Free market economjr refers to an economic environment, which is relatively free

from government control. In the so called 'free' economics such as found in the western

worId, decisions about what, for whom and how much to produce are still to a large

extent made by way of the operation of thc price system. Therefore in a free economy,

pricing decision is not effected within the confine of the organization, but rather absolute

decision to this effect is effected by the forces of demand and supply in the market

environment. It is this economic system whereby the prices of goods and service ruling

in the market is established by the forces of demand and supply that brings about the

equilibrium price concept. Equilibrium price is the price at which the market is cleared ie

the price at which quantity demanded is equal to the quantity supplied.

In a free economy. each family is free to decide for itself what it shall purchase, it

is free to spend its disposabIe income on any of the hundreds of thousands of

commodities offered for sale by the distributive system, while each producer is free to

own or hire the means of production, free to own land, factories and machinery, free to

hire labour and management skill, free within certain legal limits to produce what he

wishes, free to decide on quantity to be produced and the method of production that he

thinks best suited to his purpose. Meanwhite no country operates an absolute free

economy.

CHAPTER FIVE

SUMMARY RECOMMENDATlON CONCLUSION

5.1 SUMMARY

Among the most important responsibilities of management is pricing decision.

This is because the success of any organisation is dependent on how wisely this decision

is made. Pricing decision is a management function as has been established by this

research paper. From this paper, it has been established that this pricing decision

becomes a very difficult task in an inflationary environment. In other to find the most

effective way of performing this function under inflationary condition, various pricing

I methods were x-rayed among which cost- plus pricing model was adjudged the most

effective and reliable.

Furthermore, considering that inflationary environment is associated with

constant changes in econon~ic variable, flexible budget rather than fixed was considered

as effective management tool in an inflationary economy. From the data collected and

analysed the indication is that the cost-plus pricing model has been adjusted to

accomlnodate inflationary effect and enhances profitability of operating firms.

5.2 RECOMMENDATIONS

The experience drawn from the entire research process has spurred the researcher to

advance the following recommendations.

1 Any pricing policy that must be meaningful and not to the detriment of the

organisation must be customer oriented.

. . 11 During the period of inflation, management should use the replacement - cost

approach for their products.

iii It is this replacement cost that should form the basis for pricing the firms product.

iv For a firm's management to be MBO oriented, flexible budgeting approach

should be adopted, to reflect the different levels of prices associated with

inflationary environment.

v The traditional "Cost - plus" model, should be adopted as it reflects the modern

economic realities through the use of current cost-plus pricing as replacement cost

are intuitively determined.

vi Despite al! these recommendations, while all these pricing approaches fix the

prices of products temporarily the final price of any economic product is

established by the forces of demand and supply in any relatively free market-

economy. The final sales price is that established at a point where both the

demand acd the supply of a product is equated at the margin and it is known as

"Equilibrium price". This is the profit maximizing price in any free market -- - -.

-G*k - t. k,---

, . * \ J - . - <>r \ economy and it is absolutely customer oriented. ++

4

5.3 CONCLUSION:

In an inflationary economic environment, the management should employ the

current "Cost-plus" approach to temporarily determine the prices of their products

and leave the final sales price to be determined by the forces of demand and

supply for the product in the market through the "price mechanism".

BIBLIOGRAPHY

Ball R. J. Inflation and the theory of money Raifflin Company, 1975

Black Homer A et a1 Accounting in Business Decisions, theory and Uses. 3rd

Edition, Prince Ha11 Inc. 1973

Ganison Ray H. Managaria] Accounting concepts for Planning, control and

Decision Making, 3'" Edition, Business Publications Inc. USA

1982

Horngren Charles T &

Foster George Cost Accounting: Amanagerial Ern~hasis. 6Ih ~6i t ion , printice

Hall International, 1 987, USA

Lere H. John C . Pricing Techniqies or Financial Executive Inter-Science

Publication, 1974.

Liversay F. Pricing Macinillan Press LTD, 1976.

Decoster Don et a1 Accounting for managerial Decision making 2" Edition.

l,l[~~i/ll~~lr[~ I (t tal and Decision Prentice

sII\\ R W"" rd Edition-

(-j ~obe" flu1:dick