Pricing & Target Costing

nguyp035's version from 2016-05-18 18:13

Section 1

Question Answer
Prices are determined by the marketsubject to costs that must be covered in the long run
Prices are based on costsubject to reactions of customer and competitors
Cost plus pricingCost + (markup % x cost)
Yield managementpractice of achieving high capacity utilisation through varying prices according to market segments and time of booking - applicable n industries like hotels, airlines
Empty room in hotel represents...lost revenue. Managers will always like to sell all rooms at highest rate but they know there is a tradeoff between high occupancy and high prices
Yield percentage = actual revenue / maximum potential revenue

Section 2

Question Answer
Elasticity of demandmeasures how the volume of sales is affected by a change in price
Limits of profit maximising modelfirms demand and MR curves are difficult to discern - MR and MC paradigm is not valid fr all margins, MC difficult to measure
Problem with economist modelROI will be attained only if the forecasted unit sales is attained

Section 3

Question Answer
Role of accounting - product costs in pricing
Optimal decisionsEconomic pricing model - sophisticated model, info requirements - accounting product cost data - LESS COSTLY
Suboptimal decisionsSimplified decision model and info requirement - MC & MR DATA (Costly)
Best approach = lies in between both of them

Section 4

Question Answer
Cost plus pricingused in monopoly situations (markup = SP-COST) Cost plus pricing = COST + (MARKUP % X COST)
Target costingused on more competitive situations
Absorption costing1) compute the unit product cost 2) mark up must be large enough to cover SG&A expenses and provide an adequate return on investment (ROI)
I.E. find the unit product cost and then have a mark up that covers SG&A expenses and desired profit = target price
ROINet operating profit / Average operating assets (gross margin) = 20%
Absorption cost pricing formulas advantageprice covers all cost, perceived as equitable, comparison to competitor
DisadvantageFull absorption unit price obsecures the distinction between bar and fixed cost

Section 5

Question Answer
Variable cost pricing formulas advantagedo not obscure cost behavior patterns, do not require fixed cost allocation, useful for managers
Fixed cost may be overlooked in pricing decisions, resulting in low prices that are too low to cover total cost

Section 6

Question Answer
Solve for the markup % that will yield the desired return on investment
Step 1) Work out the unit product cost
Step 2)Construct profit statement (less S&G expense + markup) = net operating profit
Step 3)ROI = Net operating profit / average operating assets

Section 7

Question Answer
Strategic pricing
Skimminginitial price high with intent to gradually lower to appeal
Market penetrationinitial low price with intent to gain market share

Section 8

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Target costingMarket research determines the price at which a new product will sell
Management computes a manfac cost that provides acceptable profit margin
Engineers and cost analysts deisgn a product that can be made for allowable cost
Principles of target costingprice led costing, life cycle costs, focus on process design, focus on customer, focus on product design
Target costing is the process of determining a new products maximum cost and developing a prototype that can be profitably made for that figure
Target cost =anticipated selling price - targeted desired profit
Target not just a pricing model - cost management model too
Target costing involves designing to cost and quality targets set by competitive conditions
It takes a longer term perspective by considering the life cycle of a product
Target costing...starts with the price and then determines allowable cost
rather than starting with product and determining cost
Most of the cost is determined at the design stage of the product

Section 9

Question Answer
Life cycle costingdraws on target costing which manages costs rather than just measures them
Once a product has been designed and gone into production, little can be done to reduce cost - 90% of cost can be locked in at preprod stage
Cost incurrence = describes when a resource is sacrificed or forgone to meet a specific objective (R&D, design, mf, marketing, dist)
Locked in cost = cost that have not yet been incurred but which, based on decisions that have already been made will be incurred in the future (difficult to alter)
At design stage most costs e.g. direct material, direct manfac labour, marketing costs ,etc are locked in.
In industries e.g. consultingcosts locked in and incurred at same time (key to lower cost is to improve efficiency and productivity rather than design)
Drawbacks of target and life cycle costingmay be time consuming, too slow for electronics (time to market must be minimised, still need to estimate costs

Section 10

Question Answer
SummaryPricing involves a delicate balancing act - high price means more revenue but slow down sales. > where to set price to maximise is problem > in general the mark up over cost should be highest for products where customers are least sensitive to price > inelastic
Managers often reply on cost plus formula to set prices > In the absorption costing approach, the cost base is absorption costing unit product cost and the mark-up is computed to cover both non-manufacturing costs and to provide an adequate return on investment. > but cost will not be covered and there will not be adequate ROI unless unit sales forecast used in cost plus formula is accurate > if applying the cost plus formula results in a price that is too high > unit sales forecast will not be attained
some companies take different approach to pricing - start with price and then determine allowable cost > companies that use target costing estimates what a new products market price is likely to be based on its anticipated features and prices of products already on market. > they subtract desired profit from estimated market price to arrive at product target cost > the design and development team is given responsibility of ensuring the actual cost of new product does not exceed target cost
A special approach to pricing is required when....goods and services are being transffered between segments or divisions. the overall aim should be to determine a price that maximizes the profit for whole company