CHAPTER12PricingDecisionsandCostManagementPricingandBusinessHowcompaniespriceaproductorserviceultimatelydependsonthedemandandsupplyforitThreeinfluencesondemandandsupply:CustomersCompetitorsCostsInfluencesonDemandandSupplyCustomers–influencepricethroughtheireffectonthedemandforaproductorservice,basedonfactorssuchasqualityandproductfeaturesCompetitors–influencepricethroughtheirpricingschemes,productfeatures,andproductionvolumeCosts–influencepricesbecausetheyaffectsupply(thelowerthecost,thegreaterthequantityafirmiswillingtosupply)TimeHorizonsandPricingShort-runpricingdecisionshaveatimehorizonoflessthanoneyearandincludedecisionssuchas:Pricingaone-time-onlyspecialorderwithnolong-runimplicationsAdjustingproductmixandoutputvolumeinacompetitivemarketLong-runpricingdecisionshaveatimehorizonofoneyearorlongerandincludedecisionssuchas:PricingaproductinamajormarketwherethereissomeleewayinsettingpriceDifferencesAffectingPricing:

LongRunvs.ShortRunCoststhatareoftenirrelevantforshort-runpolicydecisions,suchasfixedcoststhatcannotbechanged,aregenerallyrelevantinthelongrunbecausecostscanbealteredinthelongrunProfitmarginsinlong-runpricingdecisionsareoftensettoearnareasonablereturnoninvestment–pricesaredecreasedwhendemandisweakandincreasedwhendemandisstrongAlternativeLong-RunPricingApproachesMarket-Based:pricechargedisbasedonwhatcustomerswantandhowcompetitorsreactCost-Based:pricechargedisbasedonwhatitcosttoproduce,coupledwiththeabilitytorecoupthecostsandstillachievearequiredrateofreturnMarketsandPricingCompetitiveMarkets–usethemarket-basedapproachLess-CompetitiveMarkets–canuseeitherthemarket-basedorcost-basedapproachNoncompetitiveMarkets–usecost-basedapproachesMarket-BasedApproachStartswithatargetpriceTargetPrice–estimatedpriceforaproductorservicethatpotentialcustomerswillpayEstimatedoncustomers’perceivedvalueforaproductorserviceandhowcompetitorswillpricecompetingproductsorservicesUnderstandingthe

MarketEnvironmentUnderstandingcustomersandcompetitorsisimportantbecause:CompetitionfromlowercostproducershasmeantthatpricescannotbeincreasedProductsareonthemarketforshorterperiodsoftime,leavinglesstimeandopportunitytorecoverfrompricingmistakesCustomershavebecomemoreknowledgeableanddemandqualityproductsatreasonablepricesFiveStepsinDeveloping

TargetPricesandTargetCostsDevelopaproductthatsatisfiestheneedsofpotentialcustomersChooseatargetpriceDeriveatargetcostperunit:TargetPriceperunitminusTargetOperatingIncomeperunitPerformcostanalysisPerformvalueengineeringtoachievetargetcostValueEngineeringValueEngineeringisasystematicevaluationofallaspectsofthevaluechain,withtheobjectiveofreducingcostswhileimprovingqualityandsatisfyingcustomerneedsManagersmustdistinguishvalue-addedactivitiesandcostsfromnon-value-addedactivitiesandcostsValueEngineeringTerminologyValue-AddedCosts–acostthat,ifeliminated,wouldreducetheactualorperceivedvalueorutility(usefulness)customersobtainfromusingtheproductorserviceNon-Value-AddedCosts–acostthat,ifeliminated,wouldnotreducetheactualorperceivedvalueorutilitycustomersobtainfromusingtheproductorservice.ItisacostthecustomerisunwillingtopayforValueEngineeringTerminologyCostIncurrence–describeswhenaresourceisconsumed(orbenefitforgone)tomeetaspecificobjectiveLocked-inCosts(Designed-inCosts)–arecoststhathavenotyetbeenincurredbut,basedondecisionsthathavealreadybeenmade,willbeincurredinthefutureAreakeytomanagingcostswellProblemswithValueEngineeringandTargetCostingEmployeesmayfeelfrustratediftheyfailtoattaintargetsAcross-functionalteammayaddtoomanyfeaturesjusttoaccommodatethewishesofteammembersAproductmaybeindevelopmentforalongtimeasalternativedesignsarerepeatedlyevaluatedOrganizationalconflictsmaydevelopastheburdenofcuttingcostsfallsunequallyondifferentbusinessfunctionsinthefirm’svaluechainCost-Based(Cost-Plus)PricingThegeneralformulaaddsamarkupcomponenttothecostbasetodetermineaprospectivesellingpriceUsuallyonlyastartingpointintheprice-settingprocessMarkupissomewhatflexible,basedpartiallyoncustomersandcompetitorsFormsofCost-PlusPricingSettingaTargetRateofReturnonInvestment:theTargetAnnualOperatingReturnthatanorganizationaimstoachieve,dividedbyInvestedCapitalSelectingdifferentcostbasesforthe“cost-plus〞calculation:VariableManufacturingCostVariableCostManufacturingCostFullCostCommonBusinessPracticeMostfirmsusefullcostfortheircost-basedpricingdecisions,because:AllowsforfullrecoveryofallcostsoftheproductAllowsforpricestabilityItisasimpleapproachLife-CycleProduct

BudgetingandCostingProductLife-CyclespansthetimefrominitialR&Donaproducttowhencustomerserviceandsupportarenolongerofferedonthatproduct(orphaned)Life-CycleProduct

BudgetingandCostingLife-CycleBudgetinginvolvesestimatingtherevenuesandindividualvalue-chaincostsattributabletoeachproductfromitsinitialR&DtoitsfinalcustomerserviceandsupportLife-CycleCostingtracksandaccumulatesindividualvalue-chaincostsattributabletoeachproductfromitsinitialR&DtoitsfinalcustomerserviceandsupportImportantConsiderationsfor

Life-CycleBudgetingNonproductioncostsarelargeDevelopmentperiodforR&DanddesignislongandcostlyManycostsarelockedinattheR&Danddesignstages,evenifR&DanddesigncostsarethemselvessmallOtherImportantConsiderationsinPricingDecisionsPriceDiscrimination–thepracticeofchargingdifferentcustomersdifferentpricesforthesameproductorserviceLegalimplicationsPeak-LoadPricing–thepracticeofchargingahigherpriceforthesameproductorservicewhenthedemandforitapproachesthephysicallimitofthecapacitytoproducethatproductorserviceTheLegalD