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Chapter 15 - Target costing and cost analysis for pricing decisions. After completing this chapter, you should be able to: List and describe the four major influences on pricing decisions, explain and use the economic, profit-maximizing pricing model, set prices using cost-plus pricing formulas, discuss the issues involved in the strategic pricing of new products,...
Chapter 15 Target Costing and Cost Analysis for Pricing Decisions Copyright © 2014 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Major Influences on Pricing Decisions Customer demand Political, legal, and image issues Pricing Decisions Competitors Costs 152 How Are Prices Set? Prices are determined by the market, subject to costs that must be covered in the long run Costs Market Forces Prices are based on costs, subject to reactions of customers and competitors 153 Economic Profit-Maximizing Pricing Firms Firms usually usually have have flexibility flexibility in in setting setting prices prices The The quantity quantity sold sold usually usually declines declines as as the the price price is is increased increased 154 Total Revenue Curve Dollars Total revenue Curve is increasing throughout its range, but at a declining rate Quantity sold per month 155 Demand Schedule and Marginal Revenue Curve Dollars per unit Sales price must decrease to sell higher quantity Demand Revenue per Marginal unit decreases revenue as quantity increases Quantity sold per month 156 Total Cost Curve Dollars Total cost increases at an increasing rate Total cost increases at a declining rate Quantity made per month 157 Marginal Cost Curve Dollars per unit Marginal cost Quantity where marginal cost begins to increase c Quantity made per month 158 Determining the Profit-Maximizing Price and Quantity Dollars per unit p* Demand Marginal cost Marginal Quantity made revenue q* and sold per month 159 Determining the Profit-Maximizing Price and Quantity Dollars per unit Profit is maximized where marginal cost equals marginal revenue, resulting in price p* and quantity q* p* Demand Marginal cost Marginal Quantity made revenue q* and sold per month 1510 Determining the Profit-Maximizing Price and Quantity Total cost Total revenue Dollars Total profit at the profit-maximizing quantity and price, q* and p* Quantity made q* and sold per month 1511 Cost-Plus Pricing Price = cost + (markup percentage × cost) Full-absorption manufacturing cost? Variable manufacturing cost? Total cost, including selling and administrative? Total variable cost, including selling and administrative? 1512 Strategic Pricing of New Products Uncertainties make pricing difficult Production costs Market acceptance Pricing Strategies: Skimming – initial price is high with intent to gradually lower the price to appeal to a broader market Market Penetration – initial price is low with intent to quickly gain market share 1513 Target Costing Market research determines the price at which a new product will sell Management computes a manufacturing cost that will provide an acceptable profit margin Engineers and cost analysts design a product that can be made for the allowable cost 1514 Target Costing Price led costing Life-cycle costs Focus on process design Cross-functional teams Key principles of target costing Focus on the customer Value-chain orientation Focus on product design 1515 The Role Of Activity-Based Costing In Setting A Target Cost Production Process Component Activities 1516 Product Cost Distortion High-volume products may be overcosted Low-volume products may be undercosted 1517 Value Engineering and Target Costing Target Target cost cost information information Product Product design design Product Product costs costs Production Production processes processes Value Value Engineering Engineering (VE) (VE) Cost Cost reduction reduction Design Design improvement improvement Process Process improvement improvement 1518 Time and Material Pricing Price is the sum of labor and material charges Used by construction companies, printers, and professional service firms 1519 Time and Material Pricing Time charges: Hourly labor cost + Overhead cost per labor hour + Hourly charge to provide profit margin × Total labor hours required Material Charges: Total material + cost incurred Overhead per dollar of material cost × Total material cost incurred 1520 Competitive Bidding Low probability of winning bid High bid price High profit if winning bid High probability of winning bid Low bid price Low profit if winning bid 1521 Competitive Bidding Guidelines Guidelines for for Bidding Bidding Bidder has excess capacity Low bid price Any bid price in excess of incremental costs of job will contribute to fixed costs and profit Bidder has no excess capacity High bid price Bid price should be full cost plus normal profit margin as winning bid will displace existing work 1522 Legal Restrictions On Setting Prices Price discrimination Predatory pricing 1523 ... Dollars Total cost increases at an increasing rate Total cost increases at a declining rate Quantity made per month 15? ?7 Marginal Cost Curve Dollars per unit Marginal cost Quantity where marginal cost... manufacturing cost? Total cost, including selling and administrative? Total variable cost, including selling and administrative? 15? ?12 Strategic Pricing of New Products Uncertainties make pricing difficult... Marginal cost Marginal Quantity made revenue q* and sold per month 15? ?10 Determining the Profit-Maximizing Price and Quantity Total cost Total revenue Dollars Total profit at the profit-maximizing