1. 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.

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

3. 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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7. 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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12. 22-12 Pricing Strategies: The blend of tradeoffs between the price objectives (cost & profit; market position; market share). Common price strategies are: Pricing Strategies

13. 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

14. 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

15. 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

16. 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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18. 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

19. 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

20. 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 ?

21. 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. 22-22   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

23. 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.

24. 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

25. 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.

26. 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

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

28. 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

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

30. 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

31. 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

32. 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

33. 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 ( )

34. 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

35. 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,

36. 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.

37. 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.

38. 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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40. 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

41. 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

42. 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. 2. 2.Cost-based transfer prices. 3. 3.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

43. 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 ????

44. 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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