Chapter 5 Strategic Planning Regarding Operating Processes Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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

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

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

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

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

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

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

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

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

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

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

5-13 Other Compensation Issues… Gross pay versus net pay  Gross = amount earned  Net = amount received

5-14 Fringe Benefits Companies Provide and Why… Insurance  Protection for employees Paid leave  Protection for the company Bonuses  Additional pay based on some future event

5-15 How are Bonuses Calculated? Bonus amount  Net income before bonus (and taxes)  Net income after bonus (before taxes)  Net income (after bonus and taxes) Bonus rate  Percentage of bonus amount

Example A company anticipates an income before bonus or taxes of $400,000. It has set its bonus rate at 12% and it expects a tax rate of 20%. Determine the amount of the bonus if: 1.Bonus is based on income before taxes or bonus 2.Bonus is based on income before taxes (after bonus) 3.Bonus is based on net income (after taxes andafter bonus) 5-16

Answers; B = Bonus 1.B = 0.12 * $400,000 B = $48,000 2.B = 0.12 * ($400,000 – B) B = $48,000 – 0.12B 1.12B = $48,000 B = $42,

Answers continued; T = Tax 3. B = 0.12 * ($400,000 – B – T) B = $48,000 – 0.12B – 0.12T T = 0.20 * ($400,000 – B) T = $80,000 – 0.20B B = $48,000 – 0.12B – 0.12 * ($80,000 – 0.2B) B = $48, B - $9, B B = $38,400 – 0.096B 1.096B = $38,400 B = $35,

Review