1. Pricing and Other Product Management Decisions
Module 21
Pricing and Other Product Management Decisions
© Cambridge Business Publishers, 2018

2. 1
Explain the importance of the value chain in managing products and describe the key components of an organization’s internal and external value chain.
© Cambridge Business Publishers, 2018

3. The Value Chain
The set of value-producing activities that stretches from basic raw materials to the final consumer
Each product or service has a separate value chain
All entities along the value chain depend on the final customer’s perception of the value and cost of a product or service
Goal of every organization is to maximize the value, while minimizing the cost of a product or service to final customers.
© Cambridge Business Publishers, 2018

4. Three Levels of the Value Chain
First Level: Business entities
Refining the value chain into processes helps management understand how entities within the chain add and incur costs
Collections of related activities intended to achieve a common purpose
Second Level: Processes
The units of work
Third Level: Activities
© Cambridge Business Publishers, 2018

5. Three Levels of the Value Chain
The value chain for the paperboard cartons used to package beverages shows three levels with each successive level showing more detail.
© Cambridge Business Publishers, 2018

6. Internal Processes of the Internal Value Chain
Generic processes for an internal value chain:
© Cambridge Business Publishers, 2018

7. Value Chain Perspective
Fosters supplier-buyer partnerships
Buyers deal with a reduced number of suppliers
Relationships involve sharing customer and other data (internal processes)
Common value chain is studied
Often process modifications are made to reduce overall costs and share increased profits
Virtual integration is the use of information technology and partnerships to allow entities along a value chain to act as if they are one economic entity.
© Cambridge Business Publishers, 2018

8. Value Chain Perspective
Fosters focus on core competencies
Relationships with suppliers often begin to represent an extended family
Creates a competitive advantage
Suppliers can focus on efficient, low-cost manufacturing
Manufacturer can focus on marketing and product development
© Cambridge Business Publishers, 2018

9. Supplier-Buyer Partnership Example
TAL Group is headquartered in Hong Kong and is a manufacturer of men's and women’s clothing. TAL has identified the value of partnering with customers and offers value chain solutions tailored to meet customers’ individual needs.
Customers are identified as partners on their website and include companies such as Burberry, Chico’s, Nordstrom, and JCPenney.
Source:
© Cambridge Business Publishers, 2018

10. Value-Added vs. Value Chain Perspectives
Value-Added Perspective
Value Chain Perspective
Goal is to maximize the value-added.
Goal is to maximize the value and minimize cost to final customers.
Focus is on the cost of resources to the organization and the selling price of products or services to the customer.
Often achieved by developing linkages or partnerships with suppliers and customers.
© Cambridge Business Publishers, 2018

11. Distinguish between economic and cost-based approaches to pricing.2
Distinguish between economic and cost-based approaches to pricing.
© Cambridge Business Publishers, 2018

12. The Pricing Decision Important and complex decision for management
Directly affects the salability and profitability of individual products or services
Two pricing theories
Economic approaches
Cost-based approaches
© Cambridge Business Publishers, 2018

13. Economic Approaches to Pricing
Provide a useful framework for thinking about pricing decisions
Based on cost and revenue functions
Marginal revenue
The varying increment in total revenue derived from the sale of an additional unit
Marginal cost
The varying increment in total cost required to produce and sell an additional unit of product
Economic models are seldom used for day to day pricing decisions.
© Cambridge Business Publishers, 2018

14. Cost-Based Approaches to Pricing
Cost has traditionally been the most important consideration in pricing because
Cost data are available.
Feasible for setting prices in a short period of time
Cost-based prices are defensible.
Managers can argue they represent a fair profit
Revenues must exceeds costs if the firm is to remain in business.
Long run selling price must exceed the full cost of each unit
© Cambridge Business Publishers, 2018

15. Cost-Based Pricing for a New Product
Begin with market research *
*Proposed price should be evaluated based on competition and what customers are willing to pay.
© Cambridge Business Publishers, 2018

16. Cost-Based Pricing in Single-Product Companies
Example
Lawn Chopper mows lawns and has an annual facilities cost totaling $110,000. Each lawn mowed costs $18. Management desires to achieve an annual profit of $25,000 at an annual volume of 4,000 lawns.
Profit = Total revenues – Total costs
Known data are entered into the profit formula.
$25,000 = (Price × 4,000) – ($110,000 + [$18 × 4,000])
Price = $51.75 per lawn
A price of $51.75 per lawn will allow Lawn Chopper to achieve its desired profit totaling $25,000.
© Cambridge Business Publishers, 2018

17. Cost-Based Pricing in Multiple-Product Companies
Desired profits are obtained for entire company
Standard procedures are established for determining initial selling prices of each product
Typically include
Cost assigned to the product or services
Plus a markup to cover unassigned costs and to provide a profit
© Cambridge Business Publishers, 2018

18. Cost-Based Pricing in Multiple-Product Companies
Possible cost bases for markups based on behavior and function
Direct materials costs
Variable manufacturing costs
Total variable costs (manufacturing, selling, and administrative costs)
Full manufacturing costs
© Cambridge Business Publishers, 2018

19. Markup on Cost Base
General approach to developing a markup is to recognize that the markup must be large enough to provide for costs not included in the base, plus a profit.
Costs not included in the base + Desired profit
Costs included in the base
Markup on cost base =
© Cambridge Business Publishers, 2018

20. Variable Cost Basis Example
Lawn Chopper has total assets of $320,000. Management desires an annual return of 9% on total assets. Fixed costs and expenses total $50,000, and variable costs and expenses total $180,000. Estimated variable costs per unit equals $15.
Desired annual profit = 9% x $320,000 = $28,800
Markup on variable costs =
$50,000 + $28,800
$180,000 =
Selling price = $15 + ($15 x 0.438) = $21.57
© Cambridge Business Publishers, 2018

21. Full Manufacturing Cost Basis Example
Lawn Chopper’s fixed costs and expenses total $50,000, of which $10,000 are selling and administrative costs. Total variable costs and expenses total $180,000, with $30,000 of this amount selling and administrative costs. Estimated variable costs per unit equal $15 (with $1 of this selling and administrative costs).
Desired annual profit = 9% x $320,000 = $28,800 =
Markup on full manufacturing costs
$10,000 + $30,000 + $28,800
$190,000 =
Selling price = $14 + ($14 x 0.362) = $ Selling and administrative costs must be covered.
© Cambridge Business Publishers, 2018

22. Cost-Based Pricing for Special Orders
Used to bid on unique projects
If the project requires
Dedicated assets, or
Acquisition of new fixed assets, or
An investment in employee training
The desired profit on the special order or project should allow for an adequate return on the additional investment.
© Cambridge Business Publishers, 2018

23. Critique of Cost-Based Pricing
If cost-based pricing does not have accurate cost assignments, some products could be priced too high and others too low.
The higher the portion of unassigned costs, the greater is the likelihood of over- or underpricing individual products.
Cost-based pricing assumes goods or services are relatively scarce and, generally, customers who want a product are willing to pay the price.
In a competitive environment, cost-based approaches increase the time and cost of bringing new products to market.
© Cambridge Business Publishers, 2018

24. 3
Explain target costing and discuss its acceptance in highly competitive industries.
© Cambridge Business Publishers, 2018

25. Allowable cost = Target cost of product or service
Target Costing
Starts with determining what customers are willing to pay for a product or service
Then subtracts a desired profit on sales to determine the allowable cost of the product or service
Allowable cost = Target cost of product or service
Cost is communicated to the target costing team
Team must design a product that meets customer price, function, and quality requirements while providing the desired profit
© Cambridge Business Publishers, 2018

26. Target Costing and Cost Management
Reflects the belief that costs are best managed by decisions made during product development
Helps orient employees toward the final customer
Reinforces the notion that all departments within the organization and through the value chain must work together
© Cambridge Business Publishers, 2018

27. Target Costing in a Competitive Environment
© Cambridge Business Publishers, 2018

28. Encouraging Design for Production
Target costing keeps the customer's function, quality, and price requirements in the forefront at all times.
Design for manufacturers
Target costing forces product design engineers to explicitly consider the costs of manufacturing and servicing a product while it is being designed
Examples
Placing a side access panel in an appliance for easy access for repairs
Using standard-size parts to reduce inventory
Using molded parts to avoid assembling
© Cambridge Business Publishers, 2018

29. Time Reduction to Introduce Products
Eliminates the evaluation of marketability of a product at a cost-plus price and having to recycle the design though several departments
Involving vendors makes the vendors aware of the necessity of meeting a target cost
Facilitates concurrent engineering of components to be produced outside the organization and reduces time to obtain components
© Cambridge Business Publishers, 2018

30. Target Costing Requirements
Requires cost information
Detailed information on the cost of alternatives activities is needed
Allows decision makers to select design and manufacturing alternatives
Requires coordination with all involved
Need a basic understanding of the overall processes required to bring a product to market
Should appreciate cost consequences
Must respect, cooperate, and communicate with other team members
© Cambridge Business Publishers, 2018

31. Pros and Cons of Target Costing
Takes proactive approach to cost management
Orients organization toward customer
Breaks down barriers between departments
Enhances employee awareness and empowerment
Fosters partnerships with suppliers
Minimizes non-value-added activities
Encourages selection of lowest-cost-value-added activities
Reduces time to market
CONS
To be effective, requires the development of detailed cost data
Requires willingness to cooperate
Requires many meetings for coordination
© Cambridge Business Publishers, 2018

32. Product Life Cycles
Products with a relatively long life go through four stages during their life cycle.
Time
Sales Revenue
Maturity
Sales level off. Price pressure increases. Price reductions could be needed.
Growth
Sales increase as product gains acceptance. Selling prices often remain high Customers are loyal. Low competition.
Decline
Sales decline as product becomes obsolete. Significant price cuts needed to sell inventories.
Start-up
Sales are low. Often selling prices are high. Customers are affluent trendsetters.
© Cambridge Business Publishers, 2018

33. Life Cycle Costs
Lifecycle costs include all costs associated with a product or service including:
Cost incurred with initial conception
Design
Pre-production
Production
After production support
Cost management aided by target costing
© Cambridge Business Publishers, 2018

34. Commitment and Expenditures
Commitments and expenditures of organizations for high-technology products with relatively short product lives:
© Cambridge Business Publishers, 2018

35. 4
Illustrate the relation between target costing and continuous improvement costing.
© Cambridge Business Publishers, 2018

36. Continuous Improvement (Kaizen) Costing
A costing approach focused on continuous improvement
Calls for establishing cost reduction targets for products or services
Begins where target costing leaves off
Often found in companies that have adopted a lean production philosophy
Successful world-class companies use Kaizen to avoid complacency.
© Cambridge Business Publishers, 2018

37. 5
Explain how benchmarking enhances quality management, continuous improvement, and process reengineering.
© Cambridge Business Publishers, 2018

38. Benchmarking is no longer regarded as spying.
A systematic approach to identifying best practices to help an organization take action to improve performance
Typically deals with
Target costs for a product, service or operation
Customer satisfaction
Quality
Inventory levels
Inventory turnover
Cycle time
Productivity
Benchmarking is no longer regarded as spying.
© Cambridge Business Publishers, 2018

39. Benchmarking Provides measurements in setting goals
Can lead to dramatic innovations
Can help overcome resistance to change
Typical benchmarking steps
Decide what to benchmark
Plan the benchmark project
Understand your own performance
Study others
Learn from the data
Take action
© Cambridge Business Publishers, 2018