Chapter 15

Target Costing and

Cost Analysis for
Pricing Decisions

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Major Influences on
Pricing Decisions

Customer Political, legal,

demand and image issues

Pricing
Decisions

Competitors Costs

15-2
How Are Prices Set?

Prices are determined by the market, subject

to costs that must be covered in the long run.

Market
Costs
Forces

Prices are based on costs, subject to

reactions of customers and competitors.

15-3
Economic Profit-Maximizing Pricing

Firms
Firms usually
usually have
have flexibility
flexibility in
in setting
setting prices.
prices.

The
The quantity
quantity sold
sold usually
usually
declines
declines as
as the
the price
price is
is increased.
increased.

15-4
Total Revenue Curve
Dollars
Total revenue

Curve is increasing throughout

its range, but at a declining rate

Quantity sold
per month
15-5
Demand Schedule and Marginal Revenue
Curve
Dollars
per unit

Sales price must decrease

to sell higher quantity

Demand
Revenue per Marginal
unit decreases revenue
as quantity increases Quantity sold
per month
15-6
Total Cost Curve
Dollars

Total cost increases

at an increasing rate

Total cost increases

at a declining rate
Quantity made
per month
15-7
Marginal Cost Curve
Dollars
per unit
Marginal
cost
Quantity where
marginal cost
begins to increase

Quantity made
c per month
15-8
Determining the Profit-Maximizing Price and
Quantity
Dollars
per unit

p*

Demand
Marginal
cost Marginal Quantity made
revenue
q* and sold
per month 15-9
Determining the Profit-Maximizing Price and
Quantity
Dollars
per unit Profit is maximized where
marginal cost equals
marginal revenue, resulting
in price p* and quantity q*.
p*

Demand
Marginal
cost Marginal Quantity made
revenue
q* and sold
per month 15-10
Determining the Profit-Maximizing Price and
Quantity
Dollars Total cost
Total revenue

Total profit at the

profit-maximizing
quantity and price,
q* and p*.

Quantity made

q* and sold
per month 15-11
 Cost-Plus Pricing

Price = cost + (markup percentage ×

cost)
Full-absorption Variable
manufacturing manufacturing
cost? cost?

Total cost, Total variable cost,

including selling including selling
and administrative? and administrative?
15-12
Strategic Pricing of New Products
Uncertainties make pricing difficult.
Production costs.
Market acceptance.

Pricing Strategies:
Skimming – initial price is high with intent to gradually lower
the price to appeal to a broader market.
Market Penetration – initial price is low with intent to quickly
gain market share.

15-13
 Target Costing

Market research
determines the price Management computes
at which a new a manufacturing cost that
product will sell. will provide an acceptable
profit margin.

Engineers and cost analysts design a product

that can be made for the allowable cost.
15-14
Target Costing

Price led Cross-functional

costing teams
Key
Life-cycle principles Value-chain
costs of target orientation
costing
Focus on Focus on
process product
design Focus design
on the
customer
15-15
 The Role Of Activity-Based
Costing In Setting A
Target Cost

Production Process

Component Activities
15-16
 Product Cost Distortion

High-volume products
may be overcosted

Low-volume products
may be undercosted

15-17
Value Engineering
and Target Costing

Target
Target cost
cost information
information
 Product
Product design
design
 Product
Product costs
costs
 Production
Production processes
processes

Value
Value Engineering
Engineering (VE)
(VE)
 Cost
Cost reduction
reduction
 Design
Design improvement
improvement
 Process
Process improvement
improvement
15-18
Time and Material Pricing

Price is the sum of

labor and material
charges.
Used by construction
companies, printers,
and professional
service firms.

15-19
Time and Material Pricing
Time charges:
Hourly Overhead Hourly charge Total
labor + cost per + to provide × labor hours
cost labor hour profit margin required

Material Charges:
Total Overhead Total
material per dollar material
cost
+ of material × cost
incurred cost incurred
15-20
Competitive Bidding

Low probability High bid High profit if

of winning bid price winning bid

High probability Low bid Low profit if

of winning bid price winning bid

15-21
Competitive Bidding
Guidelines
Guidelines for
for Bidding
Bidding
 Low bid price
 Any bid price in excess of
Bidder has
incremental costs of job
excess capacity will contribute to fixed
costs and profit.
 High bid price
 Bid price should be full
Bidder has no cost plus normal profit
excess capacity margin as winning bid will
displace existing work.
15-22
Legal Restrictions On Setting Prices
Price discrimination

Predatory pricing

15-23