1. Cost Based Pricing Rules Ted Mitchell

2. Pricing Two Views 1. We give you a good price Price Is Relative To Competition 2. We ask for this in exchange Price = Product + Place + Promotion Price Is A Reflection of Value

3. There are Price Setters and Price Takers A basic idea of marketing is to make your product sufficiently better than your competitors’ product from the customer’s point of view and not to be a price taker.

4. Pricing Goals  Profit  long run, short run  Sales Revenue (Growth)  Market Share (Penetration)  Unit Sales Volume (Learning Curve)

5. Pricing Goals Cont’d  Image Maintenance  Cash Flow (survival)  Competitive Pricing (Stability, Price leader, price taker  Avoid price competition

6. Basics C’s for Pricing Costs of making the product, etc. Customer Demand Competitors

7. Pricing Methods (Formulas)  Cost Based Methods  Demand Based Methods  Competitive Based (Going Rate, Bidding) Pricing

8. Cost Based Pricing Is Most Important

9. Why Cost Based Pricing Four Reasons 1 Fair 2 Easy to Calculate 3 Industry Stability 4 “guarantee a profit”

10. Types of Cost Based Methods  Cost Plus (profit)  Traditional Markup (Discount rate)  Target Return on Investment  Discounts & Allowances

11. Some Costing Is Crude  Direct Materials plus  Direct Labor plus  300% of Direct Labor (to cover Fixed Costs) plus  A 50% Markup plus  Competitive adjustment plus  What the customer will bear

12.  Pricing Formulas Tend To Be The Same Across An Industry  Reduces Price Competition

13. Z = (P - V)Q - F Price Formula Comes From The Basic Profit Formula

14. The Basic Cost Based Pricing Formula is Z = (P - V)Q - F Price Formula Comes From The Basic Profit Formula

15. 15 Calculate the Price Knowing Cost and Profit Targets

16. The Variable Cost Is Crucial In The Idea Of Pricing Down The Learning Curve

17. Learning Curve Variable Cost Per Unit Is Reduced As Experience In Its Production Is Learned

18. Learning Curve V Production Experience

19. Learning Curve V Production Experience

20. Learning Curve V Cumulative

21. Forecasting Future Variable Cost Is A Very Important Part Of Modern Pricing Strategy!

22. Variable Cost Is Not Unit Cost UNIT COST COMBINES AVERAGE FIXED COSTS AND VARIABLE COSTS

23. Basic Cost Based Pricing Formula is Substitute Unit Cost

24. Example “We charge what it costs to make each unit plus a standard approved markup of 10% for our profit.”

25. Example “We charge what it costs to make each unit plus a standard approved markup of 10% for our profit.” Unit Cost is considered the cost to make each unit in a pricing formula

26. Profit is being measured as a percentage of sales revenue. Substitute

27. Profit is being measured as a percentage of sales revenue. Substitute

28. Simplify Substitute

29. Example “We charge what it costs to make each unit plus a standard approved markup of 10% for our profit.”

30. P = Unit Cost + x% of Final Price P = Unit Cost + x(P) P - xP = Unit Cost (1-x)P = Unit Cost P = Unit Cost Classic Cost Plus Formula Is (1- x)

31. P = Unit Cost + x% of Final Price P = Unit Cost + x(P) P - xP = Unit Cost (1-x)P = Unit Cost P = Unit Cost Classic Cost Plus Formula Is (1- x) Note: we use unit cost and a target profit margin

32. Types of Cost Based Formulas  Cost Plus (Profit)  Traditional Markup Pricing (Discount rate)  Target Return on Investment  Discounts & Allowances

33. 33 Markup Pricing  Very Popular with Retailers  It uses the purchase cost of the merchandise which is the Variable cost.  The Target Markup which includes the fixed costs and the target profit.

34. 34 We remember that  The target markup for a target profit was  Mp* = (F+Z)/ R  We consider Mp*(R) = F+Z and substitute into  PQ - vQ = F+Z  PQ - vQ = Mp*(R)  and substitute R = PQ  (P-V)Q = Mp*PQ  P-V = Mp*P  P-Mp*P = V  P = V / (1-Mp*) is markup pricing

35. 35 Another Way  Consider the breakeven price with a target profit  P = V +(F+Z)/Q  Divide both sides by P  (1/P)P = V/P + (F+Z)/PQ  Where (F+Z)/PQ = M p = Target markup  1 = V/P +Mp  (1-Mp)P = V  P = V/(1-Mp)

36. When you have a target markup, The Markup Pricing Formula Is

37. 37 Markup Pricing  Remember the markup pricing is to cover the total contribution needed to cover the Fixed Costs and the Target Operating Profit!

38. Types of Cost Based Formulas  Cost Plus (Profit)  Traditional Markup Pricing (Discount rate)  Target Return on Investment  Discounts & Allowances

39. Calculating A Price From A Cost Based Formula Is Easier If They Give You A Target Return or Profit Z in dollars

40. Then You Get to Substitute For The Profit, Z, and Solve

41. Example: Target Profit Pricing Formula A Expected Profit of 15% ROI

44. Target Returns (Profits) Where Do They Come From?

45. Sources of Targets  1 Deciding What Seems Fair  2 Wanting A Better Return Than Last Year  3 Establishing What They Believe They Can Get  4 Estimated Cost Of Capital  5 Wanting To Stabilize Prices

46. Types of Cost Based Formulas  Cost Plus (Profit)  Traditional Markup Pricing (Discount rate)  Target Return on Investment  Weakness Of Cost Based  Discounts & Allowances

47. Basic Cost Based Pricing Formula is

48. Where Does The Q Come From?

49. Q Can Come From  Target Level Of Desired Production Percent Of Normal Capacity  Sales Forecasts

50. Dollars Fixed Cost Total Cost Cost Structure is Very Important Quantity Produced

51. Dollars 85% of Capacity Fixed Cost Total Cost #1 Percentage Of Normal Capacity Often Becomes The Bases For Expected Sales = Q!

52. #2 Forecasting The Quantity That Will Be Sold From Simple Projections Of Past Sales Is Popular Time

53. To Cost Based Pricing You Need To Know Variable cost, Fixed cost, Target Profit, & Estimate of Future Sales or Production = Q

54. The Fundamental Weakness Of Cost Based Pricing Is

55. Using An Expected Sales Forecast, Q, To Select The Price

56. Why? Because Price is Key Factor in Causing Sales Revenue = f(Price, Promotion, Place, Product) Price Causes Sales!

57. Remember  The Expected Quantity Of Sales Should NOT Set The Price.  The Price Determines The Quantity!

58. Remember  The Expected Quantity Of Sales Should NOT Set The Price. You Need Sales Estimates Based On The Demand At The Planned Price (i.e. Demand Based Pricing)

59. Types of Cost Based Formulas  Cost Plus (Profit)  Traditional Markup Pricing (Discount rate)  Target Return on Investment  Weakness Of Cost Based  Discounts & Allowances

60. Discounts & Allowances  Cash Discounts  Trade Discounts  Quantity Discount  Rebates (Cumulative)

61. Discounts & Allowances Everything Is A Percentage Off Catalog List Prices Importance Of Catalog And Pricing Sheet Updates

62. Cash Discount 3% /10 net 30  Encourage prompt payment  Reduce cost of credit  Industry standard

63. Trade Or Functional Discount Straight Percentage Off List  Pay For The Functions A Middleman Performs  Class A or B Distributor  OEM  Educational  Government

64. Quantity Discount  Must Be Offered To All Customers  Must Demonstrate Cost Saving Being Passed On

65. Rebates & Allowances  Cumulative  Competitive Rebates (software)  Seasonal  Advertising Allowances  Case Allowances

66. Shipping Costs  FOB origin  FOB Destination  Phantom Freight  Postage Stamp Pricing

67. Cost Based Pricing Does  Not Guarantee Demand  Not Guarantee A Net Profit  Not Simplify e.g. Managers Confused About Costs  Unit cost versus variable cost  Sunk costs vs fixed cost  Discretionary