Lecture 1_Pricing, Target Costing and Customer Profitability Analysis

Lecture Overview

  • Topic: Pricing, Target Costing, and Customer Profitability Analysis

  • Course: C39MT Management Accounting, Techniques, and Decisions

  • Institution: Heriot-Watt University, Business School

Introduction to Pricing Decisions

  • Definition: Management decisions about product/service pricing.

  • Objective: Maximize operating profit by producing/selling as long as revenue from an additional unit exceeds production cost.

Learning Objectives

  • Pricing Influences: Understand three major influences on pricing decisions.

  • Pricing Decisions: Differentiate between short-run and long-run pricing.

  • Target Costing: Describe the target-costing approach to pricing.

  • Cost Concepts: Distinguish between cost incurrence and locked-in costs.

  • Cost-Plus Pricing: Explain the cost-plus approach to pricing.

  • Non-Cost Factors: Discuss pricing practices where non-cost factors are important.

  • Life-Cycle Pricing: Explain how life-cycle budgeting/costing assists pricing decisions.

  • Customer Profitability: Analyze why revenues differ among customers.

  • Cost Hierarchy: Apply cost hierarchy concepts to customer costing.

  • Profitability Reports: Prepare customer-profitability reports to highlight differences in profitability.

Major Influences on Pricing Decisions

Key Influencers

  • Customers: Affect pricing through demand; prices too high may deter purchases.

  • Competitors: Their actions may necessitate price adjustments; substitute goods can influence demand.

  • Costs: Impact supply; lower costs lead to higher quantity supply willingness.

Short-Run vs. Long-Run Pricing Decisions

Time Horizon

  • Short-Run Decisions: Less than one year; e.g., pricing for special orders.

  • Long-Run Decisions: More than one year; pricing in major markets with price-setting flexibility.

Considerations

  • Fixed costs relevant in long-run, often irrelevant in short-run.

  • Profit margins in long-run set for reasonable ROI.

Target-Costing Approach

  • Target Price: The price customers are willing to pay, based on competitors' input.

  • Target Costs: Target sales price per unit minus target operating profit per unit.

  • Steps:

    • Develop a product based on customer needs.

    • Choose a target price.

    • Derive a target cost.

    • Perform value engineering to meet target costs.

Cost Concepts

Cost Incurrence

  • Describes costs associated with resource sacrifice to achieve objectives.

Locked-in Costs

  • Upcoming costs based on previous decisions, hard to alter.

Cost-Plus Pricing Approach

  • Formula: Cost base + Mark-up component = Selling price.

  • Target operating profit: Calculated as a percentage of investment.

Other Non-Cost Factors in Pricing Decisions

Price Discrimination

  • Charging different prices for the same product depending on the customer.

Peak-Load Pricing

  • Higher prices during peak demand to maximize revenue.

Life-Cycle Budgeting

  • Evaluates revenues and costs over the entire product lifecycle.

  • Essential for accurate financial forecasting before production begins.

Customer Profitability Analysis

  • Details factors affecting customer profitability including revenue differences due to discounting.

  • Importance of effectively analyzing profitability to retain high-value customers.