22-1 Chapter 22 Pricing Learning Objectives After studying this chapter, you should be able to: [1] Compute a target cost when the market determines a product price. [2] Compute a target selling price using cost-plus pricing. [3] Use time-and-material pricing to determine the cost of services provided. [4] Determine a transfer price using the negotiated, cost-based, and market-based approaches. [5] Explain issues involved in transferring goods between divisions in different countries.

22-2 Three main objectives when setting prices: Cost & Profit: Prices must cover costs and generate a profit. Pricing Objectives

22-3 Market Positioning: Developing a specific marketing mix to influence potential customers overall perception of the organization, brand or product line. Lexus vs Fiat Harvard vs UNLV In-N-Out vs McDonalds

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22-7 Market Share: Refers to a company's portion of sales within the entire market in which it operates. Pricing affects the rate at which a product penetrates a market. In general, low pricing creates less buyer resistance during the sale process and promotes faster product adoption and growth.

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22-12 Pricing Strategies: The blend of tradeoffs between the price objectives (cost & profit; market position; market share). Common price strategies are: Pricing Strategies

22-13 Predatory Pricing: Company prices its product at very low margin, or even at cost in order to gain entry into a new market. Over time, it increases prices to be more in line with its target brand position. Pricing Strategies

22-14 Skimming: The company prices at a premium to capture the high end segments first (electronics … first adopters). As it saturates a buyer segment, it drops prices to appeal to new buyer segments. Pricing Strategies

22-15 Bundling: Offering two or more goods or services together as a package deal. Bundled items are sold at a price lower than the total of their individual selling prices. Ex: auto … by bundling together desirable but costly options (automatic trans) with less desirable but more profitable features ("all weather" pkg), the overall profitability of the car can be optimized. Pricing Strategies

22-16 Multi-tier: The company offers distinct product categories at different price segments to appeal to different buyers. Ex: auto industry: Honda Fit, Civic, Accord Hyundai Elantra ($17,500) vs Hyundai Equus ($60,000) Pricing Strategies

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22-18 The price of a good or service is affected by many factors.   IF - products are not easily differentiated from competitors … prices are not set by the company, but rather by “the market”. Smartphones … Energy Drinks … Smoothies “The Market” indicates the price point I must be at to complete in that market niche. BUT – can I make a profit at that price ? Pricing Goods for External Sales

22-19   Cost that provides the desired profit … when the market determines a product’s price. Target Costing … works “backwards”. Determine selling price and then work backwards to determine the target cost. Pricing Goods for External Sales Target Costing

22-20 The desired profit in $$ $1,000,000 x 25% = $250,000 Each unit must result in profit of $250,000 ÷ 200,000 units = $1.25 Market price Desired profit Target cost per unit $20 $1.25 $18.75 per unit FL phones considering a fashion cover for its phones. Research indicates that 200,000 units can be sold if price is $20 max. If FL makes items, it must invest $1,000,000 in new equipment. FL requires a 25% profit (return). What is “target cost” per unit. - = Can the company make this new cover for $18.75 ?

22-21 The price of a good or service is affected by many factors.   IF - products are unique or clearly distinguishable from competitors … prices are set by the company. Pricing Goods for External Sales

22-22   When a company sets price, the price is normally a function of product cost: cost-plus pricing.   Requires establishing a cost base and adding a markup to determine a target selling price. Cost-Plus Pricing Pricing Goods for External Sales

22-23 Ex: JCo. has a new video “button camera”. It records up to 2 hours of audio-video. Per unit variable cost estimates are: JCo also has fixed costs per unit at a sales of 10,000 units.

22-24 JCo must invest in new equipment costing $1,000,000 to make the product. Jco needs to earn a 20% Return On Investment. Per unit markup = 20% ROI of $1,000,000 Expected ROI = $200,000 ÷ 10,000 units = $20 Cost-Plus Pricing

22-25 Limitations of Cost-Plus Pricing   Advantage of cost-plus pricing: Easy to compute.   Disadvantages: ► ► Does not consider demand side: o o Will the customer pay the price? ► ► Fixed cost per unit changes with in sales volume: o o At lower sales, company must charge higher price to meet desired ROI.

22-26 Alternative to “Cost-Plus” pricing approach: Simply add a markup to variable costs.  Avoids the problem of uncertain cost information related to fixed-cost-per-unit computations.  Helpful in pricing special orders or when excess capacity exists. Major disadvantage is that managers may set the price too low and fail to cover fixed costs. Variable-Cost Pricing Pricing Goods for External Sales

22-27 Air-Corp produces air purifiers. Using a 45% markup percentage on total per unit cost, compute the target selling price.

22-28 Time-and-material pricing … Time-and-material pricing … an approach to cost- plus pricing in which the company uses two pricing rates:   One for labor used on a job - includes direct labor time AND benefits costs as well as other employee costs.   One for parts (or material) - includes cost of direct materials and a “material loading charge” for related overhead (such as ordering, shipping, receiving, inventorying). Widely used in the “trades” and service industries, (auto repair) AND professional services like: public accounting, law etc. Pricing Services

22-29 Ex: Assume the following data for Lake Holiday Marina, a boat and motor repair shop. Pricing Services

22-30 Using time-and-material pricing involves three steps: 1)calculate the per hour labor charge, 2)calculate the charge for obtaining and holding materials, and 3)calculate the charges for a particular job. Pricing Services

22-31 Step 1: Calculate the labor charge.   Express as a rate per hour of labor … to include: ► ► Direct labor cost (includes fringe benefits). ► ► Selling, administrative, and similar overhead costs. ► ► Allowance for desired profit (ROI) per hour.   Labor rate for Lake Holiday Marina for 2011 based on: ► ► 5,000 hours of repair time. ► ► Desired profit margin of $8 per hour. Pricing Services

22-32 Multiply the rate of $38.20 x # labor hours used on a job to determine the labor charges for the job. Step 1: Calculate the labor charge. Pricing Services

22-33 Step 2: Calculate the material loading charge.   Material loading charge added to invoice cost of materials.   Covers the costs of purchasing, receiving, handling, storing + desired profit margin on materials. Estimated purchasing, receiving, handling, storing costs Estimated costs of parts & materials Desired profit margin % on materials + Pricing Services ( )

22-34 The marina estimates that the total invoice cost of parts and materials used in 2011 will be $120,000. The marina desires a 20% profit margin on the invoice cost of parts and materials. Step 2: Calculate the material loading charge. Pricing Services

22-35 Labor Charges + Material Charges (often includes material loading charge) Total Charge to Customer Step 3: Calculate charges for a particular job. Pricing Services * Often used as an “estimate” (or a bid) to get a job – such as: building you a new fence, installing sink, car brake job, dental work, new tires – balanced, installed with warranty,

22-36 Marina prepares a “quote” (estimate) of the cost to refurbish a 28-foot boat. Marina estimates that the job will require 50 hours labor and $3,600 in parts and materials. Pricing Services Step 3: Calculate charges for a particular job.

22-37 Below are data for Repair Shop for next year. Desired profit margin per labor hour is $10. Material loading charge is 40% of invoice cost. Shop estimates that 8,000 labor hours will be worked next year. Compute the rate charged per hour of labor.

22-38 If Harmon repairs a TV that takes 4 hours to repair and uses parts of $50, compute the bill for this job.

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22-40 Companies “globalize” their operations   Going global increases transfers between divisions located in different countries.   60% of trade between countries is estimated to be transfers between divisions.   Different tax rates make determining appropriate transfer price more difficult. Transfer Between Divisions in Different Countries

22-41 Vertically integrated companies   Grow in either direction of its suppliers or its customers.   Frequently sells (transfers) goods to other divisions as well as outside customers. How do you price goods “sold” within the company? Transfer Pricing for Internal Sales

22-42 Transfer price: price used to record the transfer between two divisions of the same company or corporation.   Ways to determine a transfer price: 1. 1.Negotiated transfer prices Cost-based transfer prices Market-based transfer prices.   Conceptually - a negotiated transfer price is best.   Due to practical considerations, companies often use the other two methods. Transfer Pricing for Internal Sales

22-43 You are marketing manager for “Disney Cruises” To offer a 7 day vacation package including: 4 - day Disney cruise, 3 - days at Disney-World with a 3 - nights stay in Disney-World hotel you must: Negotiate a transfer price (your “cost”) with ????

22-44 You are marketing manager for “Disney Cruises” To offer a 7-day vacation package including: 4-day Disney cruise, 3-days at Disney-World with a 3-night stay in Disney-World hotel you must: Negotiate a transfer price (your “cost”) with * Disney Cruises (your own employer) * Disney “Parks” Division (3-day park-hopper pass) * Disney “Hotel” Division (3-night hotel stay) * Plus “others” (busses for transport from ship to hotel) to offer the vacation package

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