A. Management decisions about what to charge for products and services to achieve profitability 1. Evaluate demand at different prices 2. Manage costs across the value chain and over the products life cycle . !onsider type of mar"et and degree of competition #. Ma$or influences on demand and supply 1. !ustomers %demand& 2. !ompetition %demand and supply& . !osts %supply& !. 'ime hori(on of pricing decisions)dictates which costs are relevant* how costs are managed* and the profit that needs to be earned 1. +hort,run pricing decisions a. 'ime hori(on of less than one year b. More opportunistic)prices decreased when demand wea" and increased when strong c. 'ypes include ad$usting product mi- and output volume in a competitive mar"et 2. .ong,run pricing decisions a. 'ime hori(on of one year or longer b. Price of products in ma$or mar"et with some leeway in setting price c. More costs relevant because can alter in long run d. Earn reasonable rate of return on investment through setting profit margins II. Pricing decisions relative to time hori(on A. +hort run illustration)special order 1. !osts/ necessary information a. E-isting fi-ed manufacturing overhead costs irrelevant because no change b. All direct and indirect variable manufacturing costs related to special order relevant c. All material procurement and process,changeover costs related to special order relevant d. All nonmanufacturing costs unaffected by accepting special order irrelevant e. 0ote that unit costs can mislead 2. !ompetition a. 1ata on capacity conditions)idle or need to reduce product to regular customers b. Minimum price identified . !ustomers a. Price must cover incremental costs b. Price may also need to cover revenues lost on e-isting sales if price lowered c. Price may be set at what mar"et will bear if strong customer demand and limited capacity #. .ong,run time hori(on 1. #asic concepts)strategic decisions a. #uyers typically prefer stable %and predictable& prices over a long time hori(on b. !ompany must "now and manage costs* over the long run* of supplying product to customers 2. !alculation of product costs a. 2ull costs of producing and selling product used to set price in long run using any costing system* such as activity,based costing b. Mar"et,based approach i. As"s/ 3iven what our customers want and how our competition will react to what we do* what price should we charge4 ii. +tarting point for product differentiation industries/ loo" at customers and competitors first* then at cost) must accept prices set by mar"et c. !ost,based approach i. As"s/ 3iven what it costs us to ma"e this product* what price should we charge that will recoup our costs and achieve a re5uired return on investment4 ii. +tarting point for product differentiation industries/ loo" at costs first* then consider customers and competitors d. Mar"et forces of demand and supply always important III. 'arget costing for target pricing)a long,run approach to pricing A. 'arget pricing)a mar"et,based approach 1. 1efinition of target price/ estimated price for product or service that potential customers will pay a. 6nderstanding what customers value b. 6nderstanding how competitors will price competing products 2. Analysis of competitors a. 7hat to "now/ technologies* products* costs* and financial conditions b. 8ow to "now/ customers* suppliers* competitors employees* and reverse engineering . 'arget cost a. #ased on target price and is target price minus target operating income per unit b. Estimated long,run cost per unit of a product or service that enables the company to achieve target operating income per unit when selling at target price c. Includes all future costs* both variable and fi-ed d. Is a target/ something to aim for %lower existing full cost per unit of product& #. Implementing target pricing and target costing 1. +tep 1/ 1evelop a product that satisfies needs of potential customers 2. +tep 2/ !hoose a target price . +tep / 1erive a target cost per unit by subtracting target operating income per unit from the target price 9. +tep 9/ Perform value engineering to achieve target cost a. :alue engineering/ systematic evaluation of all aspects of the value,chain business functions* with ob$ective of reducing costs while satisfying customer needs b. :alue engineering can result in improvements in product design* changes in materials specifications* or modifications in process methods !. !ost,plus pricing and target pricing a. !ost,plus pricing determines prospective prices that balance costs* mar"up* and customer reaction b. 'arget pricing determines product characteristics and target price on basis of customer preferences and e-pected competitor responses c. !ost,plus pricing usually used by providers of uni5ue products and services CHAPTER QUIZ 1. Ma$or influences of competitors* costs* and customers on pricing decisions are factors of a. supply and demand. b. activity,based costing and activity,based management. c. "ey management themes that are important to managers attaining success in their planning and control decisions. d. the value,chain concept. 2. +hort,run pricing decisions include a. pricing a main product in a ma$or mar"et. b. considering all costs in the value,chain of business functions. c. ad$usting product mi- and volume in a competitive mar"et while maintaining a stable price if demand fluctuates from strong to wea". d. pricing for a special order with no long,term implications. . Pritchard !ompany manufactures a product that has a variable cost of P; per unit. 2i-ed costs total P1*<;;*;;;* allocated on the basis of the number of units produced. +elling price is computed by adding a 2;= mar"up to full cost. 8ow much should the selling price be per unit for ;;*;;; units4 a. P9> b. P9.?< c. P92 d. P< 9. 'he first step in implementing target pricing and target costing is a. choosing a target price. b. determining a target cost. c. developing a product that satisfies needs of potential customers. d. performing value engineering. <. 'he best opportunity for cost reduction is a. during the manufacturing phase of the value chain. b. during the product@process design phase of the value chain. c. during the mar"eting phase of the value chain. d. during the distribution phase of the value chain. 'he following data apply to 5uestions A and ?. Each month* 8addon !ompany has P2?<*;;; total manufacturing costs %2;= fi-ed& and P12<*;;; distribution and mar"eting costs %A= fi-ed&. 8addons monthly sales are P<;;*;;;. A. 'he mar"up percentage on full cost to arrive at the target %e-isting& selling price is a. 2<=. b. ?<=. c. B;=. d. 2;=. ?. 'he mar"up percentage on variable costs to arrive at the e-isting %target& selling price is a. 2;=. b. 9;=. c. B;=. d. AA 3 2 =. B. .ong,run pricing a. needs to cover only incremental costs. b. only utili(es the mar"et,based approach to pricing and not the cost,based approach. c. is a strategic decision. d. strives for fle-ible pricing that can respond to temporary changes in demand. >. 2or long,run pricing decisions* using stable prices has the advantage of a. minimi(ing the need to monitor competitorsC prices fre5uently. b. reducing the need to change cost structures fre5uently. c. reducing competition. d. helping build buyer,seller relationships. 1;. 'arget pricing a. is used for short,term pricing decisions. b. is one form of cost,based pricing. c. estimate is based on customers perceived value of the product. d. relevant costs are all variable costs. 11. 'o understand how competitors might price competing products a company a. needs to understand the competitors technologies and financial conditions. b. may get information from suppliers that service the competitor. c. may use reverse engineering. d. may do all of the above. 12. 'he department usually in the best position to identify customers needs is the a. production department. b. sales and mar"eting department. c. design department. d. distribution department. 1. Delevant costs for target pricing are a. variable manufacturing costs. b. variable manufacturing and variable nonmanufacturing costs. c. all fi-ed costs. d. all future costs* both variable and fi-ed. 19. Place the following steps for the implementation of target costing in order/ A E 1erive a target cost # E 1evelop a target price ! E Perform value engineering 1 E 1etermine target operating income a. # 1 A ! b. # A 1 ! c. A 1 # ! d. A # ! 1 1<. 'o design costs out of products is a goal of a. cost,plus pricing. b. target costing. c. "ai(en costing. d. pea",load costing. 1A. All of the following are true regarding target costing EF!EP' a. improvements are implemented in small incremental amounts. b. customer input is essential to the target costing process. c. input is re5uested from suppliers and distributors. d. a "ey goal is to minimi(e costs over the products useful life. 1?. All of the following are associated with target costing EF!EP' a. value engineering. b. the mar"up component. c. all value,chain business functions. d. cross,functional teams. 1B. 7hen target costing and target pricing are used together* a. the target cost is established first* then the target price. b. the target cost is the estimated long,run cost that enables a product or service to achieve a desired profit. c. the focus of target pricing is to undercut the competition. d. target costs are generally higher than current costs. 1>. 'he product strategy in which companies first determine the price at which they can sell a new product and then design a product that can be produced at a low enough cost to provide ade5uate operating income is referred to as a. cost,plus pricing. b. target costing. c. "ai(en costing. a. full costing. After conducting a mar"et research study* +chult( Manufacturing decided to produce a new interior door to complement its e-terior door line. It is estimated that the new interior door can be sold at a target price of PA;. 'he annual target sales volume for interior doors is 2;*;;;. +chult( has target operating income of 2;= of sales. 2;. 7hat are target sales revenues4 a. P>A;*;;; b. P2*;;;*;;; c. P1*2;;*;;; d. none of the above 21. 7hat is the target operating income4 a. P29;*;;; b. P;;*;;; c. P1>2*;;; d. P1B;*;;; 22. 7hat is the target cost4 a. P>;;*;;; b. P>A;*;;; c. P1*2A;*;;; d. P1*;;B*;;; 2. 7hat is the target cost for each interior door4 a. P9B b. P<B c. PA; d. P9< +heltars ': currently sells small televisions for P1B;. It has costs of P19;. A competitor is bringing a new small television to mar"et that will sell for P1<;. Management believes it must lower the price to P1<; to compete in the mar"et for small televisions. Mar"eting believes that the new price will cause sales to increase by 1;=* even with a new competitor in the mar"et. +heltars sales are currently 1;;*;;; televisions per year. 29. 7hat is the target cost if target operating income is 2<= of sales4 a. P?.<; b. P9<.;; c. P112.<; d. P1<.;; 2<. 7hat is the change in operating income if mar"eting is correct and only the sales price is changed4 a. P1*1;;*;;; b. P;;*;;; c. P%1*1;;*;;;& d. P%2*>;;*;;;& 2A. 7hat is the target cost if the company wants to maintain its same income level* and mar"eting is correct4 a. P112.<; b. P11.A9 c. P12.9 d. P19;.;;