CHAPTER 14

The market (i.e., supply and demand) determines price:

 Customers’ perceived value for a product or service

 How competitors will price competing products or services

(Competitor Analysis)

Target

Price

Target

Target Costing for Target Pricing

Four steps:

1) Develop a product that satisfies the needs of potential customers.

2) Choose a target price.

3) Derive a target cost per unit by subtracting target operating income per unit

from the target price.

4) Perform value engineering to achieve target cost

Target cost = Target price – Target operating income per unit

Value engineering:

A systematic evaluation of all aspects of the value chain, with

the objective of reducing costs and achieving a quality level that satisfies

customers.

to implement value engineering, managers must distinguish value-added

activities and costs from non-value-added activities and costs

Value-added costs: if eliminated, would reduce the actual or perceived value or

utility (usefulness) customers experience from using the product or service.

 Non-value-added costs: if eliminated, would not reduce the actual or perceived

value or utility (usefulness) customers gain from using the product or service.

Full cost is determined first and adds a markup

Full cost is determined first and adds a markup

Simple and easy to understand

 Less consideration of customers or competitors

 Because a markup is added, cost-based pricing is often called cost-

plus pricing, where the plus refers to the markup component.

Cost Price

Selling Price = Full cost + Markup

Determination of the Markup Percentage

 A markup percentage can be based on an industry “rule of thumb,”

company tradition, or it can be explicitly calculated based on a target

rate of return on investment.

 The markup must be high enough to cover all costs and to provide an

adequate return on investment.

Target Pricing

The target-pricing approach reduces the need to go back and forth

among prospective cost-plus prices, customer reactions, and design

modifications.

 Target-pricing first determines product characteristics and target price

on the basis of customer preferences and expected competitor

responses and then computes a target cost.

Cost-plus Pricing

 The selling prices computed under cost-plus pricing are prospective

prices.

Non-cost Factors in Pricing Decisions

 Predatory pricing

 Collusive pricing

Predatory pricing—

when a company deliberately prices below its

costs in an effort to drive competitors out of the market to restrict supply

and then recoups its losses by raising prices or enlarging demand

 Ex) Netflix lower subscription fee  Increase market share

 Both type of pricing violate U.S. Antitrust Laws and are illegal

Collusive pricing—

when companies in an industry conspire in their

pricing and production decisions to achieve a price above the

competitive price and so restrain trade

 Ex) The Organization of the Petroleum Exporting Countries (OPEC)

controlling oil price

Price discrimination

is the practice of charging different customers different

prices for the same product or service.

 Price discrimination is permissible if differences in prices can be justified

by differences in costs.

 Price discrimination is illegal only if the intent is to lessen or prevent

competition.

 Ex) Museum tickets for children vs adults; Movie tickets in morning vs

weekend

 Peak-load pricing

is the practice of charging a higher price for the same

product or service when demand approaches the physical limit of the

capacity to produce that product or service.

 Ex) Uber price during Christmas Eve midnight

International pricing

is a form of price discrimination where prices charged

in different countries may vary much more than the costs of delivering the

product because of differences in customers’ purchasing power in those

different countries.