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Pricing Product
& Service

Fakultas Program Studi Tatap Muka Kode MK Disusun Oleh

Economic & Business Accountancy 8403 Alfiandri MAcc

Abstract Kompetensi
Diisi dengan abstract 1. Understand Pricing Product
2. Understand Target Costing
1. Introduction

The trading in the market occurs if there is demand there is supply. Both buyers and
sellers conduct trade transaction in order to fulfill their needs. Consumers will not pay
more than this price and there is no reason for a supplier to charge less, therefore, the
supplier can sell all that it produces at this price.

The most problems occurs in the market is about the price. Basically, the price
decision is critical. It is because if the price is set too high, customers won’t buy the
company’s products. If the price is set too low, the company’s costs won’t be covered.

The common approach in pricing is “to mark up cost” A product’s markup is the
difference between its selling price and its cost and is usually expressed as a percentage
of cost. Therefore the formula:

Selling price = (1 + Markup percentage) × Cost

If the company used to markup of 50% adds 50% to the costs of its products to
determine selling prices. If a product costs $10, then the company would charge $15 for
the product. This approach is called cost-plus pricing because a predetermined markup
percentage is applied to a cost base to determine the selling price.

There are 2 key issues must be address with the cost-plus approach to pricing:

1. What cost should be used

2. How should the markup be determined

In order to answer these issues, several alternatives are considered:

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1. Elasticity of Demand

A product’s price elasticity should be a key element in setting its price. If a company
raises the price of a product, unit sales ordinarily fall. Because of this, pricing is a
delicate balancing act in which the benefits of higher revenues per unit are traded off
against the lower volume that results from charging a higher price. The sensitivity of
unit sales to changes in price is called the price elasticity of demand.

The price elasticity of demand measures the degree to which a change in price
affects the unit sales of a product or service, on the other hand, demand for a product
is said to be inelastic if a change in price has little effect on the number of units sold.

For example, Perfumed sold by trained personnel at cosmetic counters in department

stores is relatively inelastic. This is because raising or lowering prices on these luxury
goods has little effect on unit sales. On the other hand, demand for a product is
elastic if a change in price has a substantial effect on the volume of units sold. For
example is gasoline. If a gas station raises its price for gasoline, unit sales will drop
as customers seek lower prices elsewhere and this apply in the US, UK and Australia

Price elasticity is very important in determining prices. Managers should set higher
markups over cost when customers are relatively insensitive to price (i.e., demand is
inelastic) and lower markups when customers are relatively sensitive to price (i.e.,
demand is elastic).

The price elasticity of demand for a product or service, ϵ d , can be estimated using
the following formula

For example, Nature’s Garden is the company which sells bathroom fixtures.
The manager believes that 10% increase in the selling price of their apple-almond
shampoo would result in a 15% decrease in the number of bottles of shampoo sold.

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Therefore, the price elasticity of demand for this product would be compute as

For comparison purposes, the managers of Nature’s Garden believe that another
product, strawberry glycerin soap, would experience a 20% drop in unit sales if its
price is increased by 10%. (Purchasers of this product are more sensitive to price
than the purchasers of the apple-almond shampoo.) The price elasticity of demand
for the strawberry glycerin soap is

Both of these products, like other normal products, have a price elasticity that is less
than -1. Note that the price elasticity of demand for the strawberry glycerin soap is
larger (in absolute value) than the price elasticity of demand for the apple-almond
shampoo. This indicates that the demand for strawberry glycerin soap is more elastic
than the demand for apple-almond shampoo.

2. The Profit Maximizing Price

Under certain conditions, the profit-maximizing price can be determined by marking up

variable cost using the following formula

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Using the above markup, the selling price would be set using the formula

The profit-maximizing prices for the two Nature’s Garden products are computed below

Note that the 75% markup for the strawberry glycerin soap is lower than the 141%
markup for the apple-almond shampoo. The reason for this is that the purchasers of
strawberry glycerin soap are more sensitive to price than the purchasers of apple-almond
shampoo. Strawberry glycerin soap is a relatively common product with close substitutes
available in nearly every grocery store.

The formulas rely on simplifying assumptions and the estimate of the percentage
change in unit sales that would result from a given percentage change in price is likely to be
inexact. Nevertheless, the formulas can provide valuable clues regarding whether prices
should be increased or decreased. For example, the strawberry glycerin soap is currently
being sold for $0.60 per bar. The formula indicates that the profit-maximizing price is $0.70
per bar. Rather than increasing the price by $0.10, it would be prudent to increase the price
by a more modest amount to observe what happens to unit sales and to profits.

Take a note that, the formula for the profit-maximizing price conveys a very important lesson.
If the total fixed costs are the same whether the company charges $0.60 or $0.70, they
cannot be relevant in the decision of which price to charge for the soap.

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The optimal selling price should depend on two factors such as, the variable cost per unit
and how sensitive unit sales are to be changed in price. Fixed costs play no role in setting
the optimal price. Fixed costs are relevant when deciding whether to offer a product but are
not relevant when deciding how much to charge for the product.

Saying that the Nature’s Garden is currently selling 200,000 bars of the soap per year at the
price of $0.60 a bar. If the change in price has no effect on the company’s fixed costs or on
other products, the effect on profits of increasing the price by 10% can be computed as

Target Costing

Target costing is the process of determining the maximum allowable cost for a new product
and then developing a prototype that can be profitably made for that maximum target cost

The target cost for a product is computed by starting with the product’s anticipated selling
price and then deducting the desired profit, as follows

Target cost = Anticipated selling price − Desired profit

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Reason Using Target Costing

There are two reasons the company use target costing

1. Many companies have less control over price than they would like to think. The market
(i.e., supply and demand) really determines price and a company that attempts to ignore
this does so at its peril. Therefore, the anticipated market price is taken as a given in
target costing

2. The observation is that most of a product’s cost is determined in the design stage. Once
a product has been designed and has gone into production, not much can be done to
significantly reduce its cost. Most of the opportunities to reduce cost come from
designing the product so that it is simple to make, uses inexpensive parts, and is robust
and reliable. If the company has little control over market price and little control over cost
once the product has gone into production, then it follows that the major opportunities for
affecting profit come in the design stage where valuable features that customers are
willing to pay for can be added and where most of the costs are really determined

Example of Target Costing

Handy Company wishes to invest $2,000,000 to design, develop, and produce a new hand
mixer. The company’s Marketing Department surveyed the features and prices of competing
products and determined that a price of $30 would enable Handy to sell an estimated 40,000
hand mixers per year. Because the company desires a 15% ROI, the target cost to
manufacture, sell, distribute, and service one mixer is $22.50 as computed below

This $22.50 target cost would be broken down into target costs for the various functions:
manufacturing, marketing, distribution, after-sales service, and so on. Each functional area
would be responsible for keeping its actual costs within target

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Daftar Pustaka

Garrison, R.H. 2006. Managerial Accounting. Edisi 11. Penerbit Salemba Empat. Jakarta

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