1. Pricing Decisions, Including Target Costing and Transfer Pricing 12

2. The Pricing Decision and the Manager OBJECTIVE 1: Identify the objectives and rules used to establish prices of goods and services, and relate pricing issues to the management process.

3. Figure 1: External and Internal Factors Affecting Pricing Decisions

4. The Pricing Decision and the Manager Pricing issues are addressed at each stage of the management cycle.

5. The Pricing Decision and the Manager Possible pricing policy objectives include the following: –Identifying and adhering to both short- and long- run pricing strategies –Maximizing profits –Maintaining or gaining market share –Setting socially responsible prices –Maintaining a minimum rate of return on investment –Being customer focused

6. The Pricing Decision and the Manager Pricing and the management process –For a company to stay in business, the selling price of its product or service must Be competitive with the competition’s price Be acceptable to the customer Recover all costs incurred in bringing the product or service to market Return a profit –Breaking these pricing rules for a long period will lead to bankruptcy.

7. The Pricing Decision and the Manager When making and evaluating pricing decisions, managers must consider both external and internal factors.

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9. Economic Pricing Concepts OBJECTIVE 2: Describe economic pricing concepts, including the auction-based pricing method used on the Internet.

10. Figure 2a: Microeconomic Pricing Theory

11. Figure 2b: Microeconomic Pricing Theory

12. Economic Pricing Concepts Economic pricing concepts are based on microeconomic theory. –Profits are maximized when total revenue minus total cost is greatest. –On a graph, profits are maximized at the point at which the marginal revenue and marginal cost curves intersect. Marginal revenue is the increase in total revenue from one additional unit. Marginal cost is the increase in total cost from one additional unit.

13. Economic Pricing Concepts Significant uncertainty and the necessity of using estimates make the microeconomic approach difficult to apply. Because of the increasing amount of business conducted over the Internet by both companies and individuals, auction-based pricing has become an important pricing mechanism.

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15. Cost-Based Pricing Methods OBJECTIVE 3: Use cost-based pricing methods to develop prices.

16. Figure 3: Cost-Based Pricing Methods: Bookit Company

17. Cost-Based Pricing Methods In a competitive environment, market prices and conditions influence price, but if prices do not cover a company’s costs, the company will eventually fail.

18. Cost-Based Pricing Methods Gross margin pricing –Emphasizes the use of income statement information to determine a selling price. –The price is computed using a markup percentage based on a product’s total production costs.

19. Cost-Based Pricing Methods Gross margin pricing –Three ways of determining a price Use Markup Percentage and Gross Margin-Based Price formulas

20. Cost-Based Pricing Methods Gross margin pricing Express the gross margin-based price is to state the formula in terms of a company’s desire to recover all of its costs and make a profit.

21. Cost-Based Pricing Methods Gross margin pricing Determine gross margin-based price on a per unit basis

22. Cost-Based Pricing Methods Return on assets pricing

23. Cost-Based Pricing Methods Gross margin pricing and return on assets pricing will produce the same selling price, given the same data. –Cost bases include total product costs per unit and total costs and expenses per unit. –Managers should select the method that uses the more reliable cost base.

24. Cost-Based Pricing Methods Pricing services –Most service organizations use a form of time and materials pricing. –Use two computations Direct labor Materials and parts –Services that do not require materials and parts use only direct labor costs, so professionals apply a factor that represents all overhead costs to the base labor costs.

25. Cost-Based Pricing Methods Factors Affecting Cost-Based Pricing Methods –To set a price, managers should combine their experience with an appropriate pricing method.

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27. Pricing Based on Target Costing OBJECTIVE 4: Describe target costing, and use that concept to analyze pricing decisions and evaluate a new product opportunity.

28. Figure 4: Comparison of Price Decision Timing

29. Pricing Based on Target Costing Target costing involves the following steps: –Market research identifies the potential demand for a new product and the maximum price that customers would be willing to pay for it. –The company’s minimum acceptable profit is established. –The desired profit is subtracted from the competitive market price to determine the target cost.

30. Pricing Based on Target Costing Differences between Cost-based pricing and Target pricing –The target cost is the maximum cost to be incurred in designing and manufacturing the product; if the cost goal cannot be met, the product is not manufactured. –Cost-based pricing methods focus on controlling incurred costs. Incurred costs occur after the product reaches the marketplace. –Target costing focuses on controlling committed costs. Committed costs occur during production.

31. Pricing Based on Target Costing Target costing analysis in an activity-based management environment –Find the target cost per unit. –Find the projected unit cost. –Make a decision.

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33. Pricing for Internal Providers of Goods and Services OBJECTIVE 5: Describe how transfer pricing is used for transferring goods and services and evaluating performance within a division or segment.

34. Figure 5: Transfer Price Alternatives at Simple Box Company

35. Exhibit 1: Transfer Price Computation

36. Exhibit 2: Performance Report Using Transfer Prices

37. Pricing for Internal Providers of Goods and Services Transfer price –A transfer price is an artificial price at which goods and services are exchanged among a company’s divisions or segments. –Transfer prices are internal prices used only to evaluate the performance of a division or segment. –Three basic kinds of transfer prices Cost-plus transfer price Market transfer price Negotiated transfer price

38. Pricing for Internal Providers of Goods and Services Using Transfer prices to measure performance –Because a transfer price contains an estimated amount of profit, a manager’s ability to meet a targeted profit can be measured.

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