CHAPTER 5

MARKETING DECISIONS

Pricing Decisions
Among the many pricing decisions to be made are:
‡ ‡ ‡ ‡
Setting the price of a new or refined product Setting the price of products sold under private labels Responding to a new price of a competitor Pricing bids in both sealed and open bidding situations

Perfect Competition
In perfect competition, all competing firms sell the same type of product at the same price. Thus, a firm can sell as much of a product as it can produce, all at a single market price.

Perfect Competition
Price ¼, $, £, Dkr. Horizontal Demand Curve The Market Price Is Given

X Demand

Perfect Competition
Price ¼, $, £, Dkr. Marginal cost

Capacity limit X Demand

Marginal Cost
The marginal cost is the additional cost resulting from producing one additional unit.

Marginal Revenue
The marginal revenue is the additional revenue resulting from the sale of one additional unit, which is the price.

Imperfect Competition
In imperfect competition, the price a firm charges for a unit will influence the quantity of units it sells.

Imperfect Competition
Price ¼, $, £, Dkr. Demand curve is falling from the left to the right, given the same market conditions. Higher price means fewer units sold.

X Demand

Imperfect Competition
Price ¼, $, £, Dkr. MC Demand Curve

MR

X Demand

Price Elasticity
To estimate marginal revenue, managers must predict the effect of price changes on sales volume, which is called price elasticity.

Influences on Pricing
Several factors interact to shape the market in which managers make pricing decisions: Legal requirements, Competitors¶ actions, and Customer demands.

Legal Requirements
Pricing decisions must be made within constraints imposed by law.

Predatory Pricing
Predatory pricing involves establishing prices so low that competitors are driven out of the market. The predatory pricer then has no significant competition and can raise prices dramatically.

Discriminatory Pricing
Discriminatory pricing is charging different prices to different customers for the same product or service.

Competitors¶ Actions
Competitors usually react to the price changes of their rivals.

Competitors¶ Actions
Many companies will gather information regarding a rival¶s capacity, technology, and operating policies. In this way, managers make more informed predictions of competitors¶ reactions to a company¶s prices.

Customer Demands
More than ever before, managers are recognizing the needs of customers. Pricing is no exception.

Role of Costs in Pricing Decisions
The exact role costs play in pricing decisions depends on both the market conditions and the company¶s approach to pricing.

Role of Costs in Pricing Decisions
Two pricing approaches used by companies are cost-plus pricing and target costing.

MarkMark-up
Mark-up is the amount by which price exceeds cost.

Target Sales Price
Cost plus is often the basis for target prices. The size of the ³plus´ depends on target (desired) operating incomes.

Target Sales Price
Target prices can be based on a host of different mark-ups that are in turn based on a host of different definitions of cost. Thus, there are many ways to arrive at the same target price.

Target Sales Price
There are four popular mark-up formulas for pricing:
(1) as a percentage of variable manufacturing costs, (2) as a percentage of total variable costs, (3) as a percentage of full costs, and (4) as a percentage of absorption costs.

Relationships of Costs to Same Target Selling Prices
TARGET SALES PRICE Variable costs Manufacturing Selling and administrative Unit variable costs Fixed costs Manufacturing Selling and administrative Unit fixed costs Full costs Target operating income $ 20.00 $ 12.00 1.10 $ 13.10 $ 3.00 2.90 $ 5.90 $ 19.00 $ 1.00

Mark-up as a percentage of variable manufacturing costs:

($20.00 - $12.00) = 66.67% $12.00

Relationships of Costs to Same Target Selling Prices
TARGET SALES PRICE Variable costs Manufacturing Selling and administrative Unit variable costs Fixed costs Manufacturing Selling and administrative Unit fixed costs Full costs Target operating income $ 20.00 $ 12.00 1.10 $ 13.10 $ 3.00 2.90 $ 5.90 $ 19.00 $ 1.00

Mark-up as a percentage of total variable costs:

($20.00 - $13.10) = 52.67% $13.10

Relationships of Costs to Same Target Selling Prices
TARGET SALES PRICE Variable costs Manufacturing Selling and administrative Unit variable costs Fixed costs Manufacturing Selling and administrative Unit fixed costs Full costs Target operating income $ 20.00 $ 12.00 1.10 $ 13.10 $ 3.00 2.90 $ 5.90 $ 19.00 $ 1.00

Mark-up as a percentage of full costs:

($20.00 - $19.00) = 5.26% $19.00

Relationships of Costs to Same Target Selling Prices
TARGET SALES PRICE Variable costs Manufacturing Selling and administrative Unit variable costs Fixed costs Manufacturing Selling and administrative Unit fixed costs Full costs Target operating income $ 20.00 $ 12.00 1.10 $ 13.10 $ 3.00 2.90 $ 5.90 $ 19.00 $ 1.00

Mark-up as a percentage of absorption costs ($12.00 + $3.00):

($20.00 - $15.00) = 33.33% $15.00

Full Cost
Full cost or fully allocated cost means the total of all manufacturing costs plus the total of all selling and administrative costs.

Target Costing
Target costing is a cost management tool for making cost reduction a key focus throughout the life of a product. A desired, or target, cost is set before the product is created or even designed.

Value Engineering
Value engineering is a cost-reduction technique, used primarily during design, that uses information about all value-chain functions to satisfy customer needs while reducing costs.

Kaizen Costing
Kaizen costing is the Japanese word for continuous improvement during manufacturing.

Target Costing and CostCost-Plus Pricing Compared
Suppose that ITT Automotive receives an invitation to bid from Ford on the anti-lock braking systems (ABS) to be used in a new model car.

Target Costing and CostCost-Plus Pricing Compared
Assume the following data apply:
The estimated current manufacturing cost is $154. ITT Automotive¶s desired gross margin rate is 30% on sales, which means that actual cost should make up 70% of the price. The highly competitive market conditions have established a sales price of $200 per unit.

Target Costing and CostCost-Plus Pricing Compared
BID PRICE USING COST-PLUS PRICING: Bid Price = Cost = $154 Cost % .7 Bid Price = $220

Target Costing and CostCost-Plus Pricing Compared
This bid of $220 would most likely be rejected by Ford because the market price is only $200. ITT Automotive¶s pricing approach would lead to a lost opportunity.

Target Costing and CostCost-Plus Pricing Compared
BID PRICE USING TARGETCOSTING: Target Cost = Market Price = $200 x Cost % x .7 Target Cost = $140 Bid Price = Market Price = $200

Target Costing and CostCost-Plus Pricing Compared
The target cost is $140, so a required cost reduction of $14 per unit is necessary. The target-costing group would work with product and process engineers and suppliers to determine if the average unit cost could be reduced by $14 over the product¶s life.