MARKETING DECISIONS

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CHAPTER 5

• MARKETING DECISIONS

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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

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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.

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Perfect Competition
Price , , , Dkr.
Horizontal Demand Curve The Market Price Is Given
X
Demand
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Perfect Competition
Price , , , Dkr.
Marginal cost
Capacity limit
X
Demand
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Marginal Cost

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

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Marginal Revenue

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

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Imperfect Competition

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

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Imperfect Competition
Price , , , Dkr.
Demand curve is falling from the left to the
right, given the same market conditions. Higher
price means fewer units sold.
X
Demand
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Imperfect Competition
Price , , , Dkr.
MC
Demand Curve
MR
X
Demand
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Price Elasticity

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

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Influences on Pricing

• Several factors interact to shape the market in
  which managers make pricing decisions
• Legal requirements,
• Competitors actions, and
• Customer demands.

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Legal Requirements

• Pricing decisions must be made within
  constraints imposed by law.

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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.

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Discriminatory Pricing

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

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Competitors Actions

• Competitors usually react to the price changes
  of their rivals.

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Competitors Actions

• Many companies will gather information regarding
  a rivals capacity, technology, and operating
  policies. In this way, managers make more
  informed predictions of competitors reactions to
  a companys prices.

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Customer Demands

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

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Role of Costs in Pricing Decisions

• The exact role costs play in pricing decisions
  depends on both the market conditions and the
  companys approach to pricing.

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Role of Costs in Pricing Decisions

• Two pricing approaches used by companies are
• cost-plus pricing and
• target costing.

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Mark-up

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

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Target Sales Price

• Cost plus is often the basis for target prices.
• The size of the plus depends on target
  (desired) operating incomes.

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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.

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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.

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Relationships of Costs to Same Target Selling
Prices

• TARGET SALES PRICE 20.00
• Variable costs
• Manufacturing 12.00
• Selling and administrative 1.10
• Unit variable costs 13.10
• Fixed costs
• Manufacturing 3.00
• Selling and administrative 2.90
• Unit fixed costs 5.90
• Full costs 19.00
• Target operating income 1.00

• Mark-up as a percentage of variable manufacturing
  costs
• (20.00 - 12.00) 66.67
• 12.00

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Relationships of Costs to Same Target Selling
Prices

• TARGET SALES PRICE 20.00
• Variable costs
• Manufacturing 12.00
• Selling and administrative 1.10
• Unit variable costs 13.10
• Fixed costs
• Manufacturing 3.00
• Selling and administrative 2.90
• Unit fixed costs 5.90
• Full costs 19.00
• Target operating income 1.00

• Mark-up as a percentage of total variable costs
• (20.00 - 13.10) 52.67
• 13.10

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Relationships of Costs to Same Target Selling
Prices

• TARGET SALES PRICE 20.00
• Variable costs
• Manufacturing 12.00
• Selling and administrative 1.10
• Unit variable costs 13.10
• Fixed costs
• Manufacturing 3.00
• Selling and administrative 2.90
• Unit fixed costs 5.90
• Full costs 19.00
• Target operating income 1.00

• Mark-up as a percentage of full costs
• (20.00 - 19.00) 5.26
• 19.00

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Relationships of Costs to Same Target Selling
Prices

• TARGET SALES PRICE 20.00
• Variable costs
• Manufacturing 12.00
• Selling and administrative 1.10
• Unit variable costs 13.10
• Fixed costs
• Manufacturing 3.00
• Selling and administrative 2.90
• Unit fixed costs 5.90
• Full costs 19.00
• Target operating income 1.00

• Mark-up as a percentage of absorption costs
  (12.00 3.00)
• (20.00 - 15.00) 33.33
• 15.00

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Full Cost

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

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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.

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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.

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Kaizen Costing

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

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Target Costing and Cost-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.

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Target Costing and Cost-Plus Pricing Compared

• Assume the following data apply
• The estimated current manufacturing cost is
  154.
• ITT Automotives 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.

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Target Costing and Cost-Plus Pricing Compared

• BID PRICE USING COST-PLUS PRICING
• Bid Price Cost 154
• Cost .7
• Bid Price 220

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Target Costing and Cost-Plus Pricing Compared

• This bid of 220 would most likely be rejected
  by Ford because the market price is only 200.
• ITT Automotives pricing approach would lead to
  a lost opportunity.

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Target Costing and Cost-Plus Pricing Compared

• BID PRICE USING TARGET- COSTING
• Target Cost Market Price 200
• x Cost x .7
• Target Cost 140
• Bid Price Market Price 200

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Target Costing and Cost-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 products life.