chapter 8 pricing decisions, analyzing customer profitability, and activity-based pricing slide 8-2
TRANSCRIPT
CHAPTER 8CHAPTER 8CHAPTER 8CHAPTER 8
Pricing Decisions, Analyzing Customer Profitability, and
Activity-Based Pricing
Pricing Decisions, Analyzing Customer Profitability, and
Activity-Based Pricing
Slide 8-2
Pricing DecisionsPricing DecisionsPricing DecisionsPricing Decisions
Pricing decisions often the most difficult decisions that managers face
Pricing Methods: - profit maximizing price using
economic theory - Pricing of special orders - Cost Plus pricing - Target costing - Activity based pricing
Slide 8-3
The Profit Maximizing PriceThe Profit Maximizing PriceThe Profit Maximizing PriceThe Profit Maximizing Price
Economic theory The quantity demanded is a function of
the price that is charged
Generally, the higher the price, the lower the quantity demanded
To calculate profit maximizing price: - Subtract variable costs from price to
obtain the contribution margin - Multiply by the quantity demanded - Subtract fixed costs and estimate
profits - Select the price with the highest profit
Slide 8-4 Learning objective 1: Compute the profit maximizing price for a product or service
The Profit Maximizing PriceThe Profit Maximizing PriceThe Profit Maximizing PriceThe Profit Maximizing Price
Slide 8-5 Learning objective 1: Compute the profit maximizing price for a product or service
Estimates of price and quantity demandedPrice = $6.95, quantity demanded = 20,000Price = $5.95, quantity demanded = 25,000Price = $4.95, quantity demanded = 32,000
Variable cost = $1.50 per unit Fixed cost = $80,000
Find the profit maximizing price
Slide 8-6 Learning objective 1: Compute the profit maximizing price for a product or service
(Price - Variable) X Quantity - Fixed Cost = Profit(6.95 - 1.50) X 20,000 - 80,000 = 29,000 (5.95 - 1.50) X 25,000 - 80,000 = 31,250 (4.95 - 1.50) X 32,000 - 80,000 = 30,400
$5.95 is the profit maximizing price
Pricing Special OrdersPricing Special OrdersPricing Special OrdersPricing Special Orders
Special orders are for goods and services not considered part of a company’s normal business
Price charged will not affect prices charged in normal course of business
Price may deviate from what is common
May charge a price less than full cost
Slide 8-7 Learning objective 2: Perform incremental analysis related to pricing a special order
Pricing Special OrdersPricing Special OrdersPricing Special OrdersPricing Special Orders
Two alternatives: accept or reject Consider incremental revenues and
expenses- Income before special order is the
same for both alternatives, not incremental
- Calculate incremental revenue- Calculate incremental expenses i.e.,
materials, labor and variable overhead
Slide 8-8 Learning objective 2: Perform incremental analysis related to pricing a special order
Special Orders – Premier Lens Special Orders – Premier Lens ExampleExample
Special Orders – Premier Lens Special Orders – Premier Lens ExampleExample
Should Premier Lens accept special order of 20,000 lenses to be sold to Blix Camera for $73 per lens?Below is the full cost of $75 per lens
Slide 8-9 Learning objective 2: Perform incremental analysis related to pricing a special order
Special Orders – Premier Lens Special Orders – Premier Lens ExampleExample
Special Orders – Premier Lens Special Orders – Premier Lens ExampleExample
Perform incremental analysis Fixed costs are not incremental, they
will not change if the order is accepted
Slide 8-10 Learning objective 2: Perform incremental analysis related to pricing a special order
Commonwealth EdisonCommonwealth EdisonCommonwealth EdisonCommonwealth Edison
Slide 8-11 Learning objective 2: Perform incremental analysis related to pricing a special order
Which of the following are relevant for a special order?
a. Total company income before the order
b. Fixed costsc. Incremental revenues and expensesd. Fixed manufacturing overhead
Answer: cIncremental revenues and expenses
Slide 8-12 Learning objective 2: Perform incremental analysis related to pricing a special order
Cost-Plus PricingCost-Plus PricingCost-Plus PricingCost-Plus Pricing
Company estimates product cost and adds a markup to arrive at price which allows for a reasonable profit
Benefits- Simple approach- Guarantees profit if sufficient quantity
can be sold at the specified price
Slide 8-13 Learning objective 3: Explain the cost-plus approach to pricing and why it is inherently circular for manufacturing firms
Cost-Plus PricingCost-Plus PricingCost-Plus PricingCost-Plus Pricing
Limitations What markup percentage to use? Requires considerable judgment and
experimentation Inherently circular for manufacturing
firms:- Need to estimate demand to determine
fixed manufacturing costs - Price affects the quantity demanded
Slide 8-14 Learning objective 3: Explain the cost-plus approach to pricing and why it is inherently circular for manufacturing firms
Cost-Plus PricingCost-Plus PricingCost-Plus PricingCost-Plus Pricing
Slide 8-15 Learning objective 3: Explain the cost-plus approach to pricing and why it is inherently circular for manufacturing firms
Cost-plus pricing:a. Leads to profit maximizationb. Is inherently circular for
manufacturing firmsc. Is difficult to performd. None of the above are correct
Answer: bIs inherently circular for mfg firms
Slide 8-16 Learning objective 3: Explain the cost-plus approach to pricing and why it is inherently circular for manufacturing firms
Target Costing Target Costing Target Costing Target Costing
Slide 8-17 Learning objective 4: Explain the target costing process for a new product
Once a product is designed it is difficult to make changes that reduce costs
- 80% of a product’s costs cannot be reduced once it is designed
- Product features drive costs Target costing
- Integrated approach to determine features, price, costs and design to ensure a profit
Target Costing Target Costing Target Costing Target Costing
Slide 8-18 Learning objective 4: Explain the target costing process for a new product
Target Costing Target Costing Target Costing Target Costing
Slide 8-19 Learning objective 4: Explain the target costing process for a new product
Target costing:a. Requires specification of desired
level of profitb. Adds desired profit to existing costsc. Is used primarily with products
that are already in productiond. Leads to profit maximization
Answer: aRequires specification of desired profit
Slide 8-20 Learning objective 4: Explain the target costing process for a new product
Analyzing Customer Analyzing Customer ProfitabilityProfitability
Analyzing Customer Analyzing Customer ProfitabilityProfitability
Customer Profitability Measurement System (CPM)
Indirect costs of servicing customers are assigned to cost pools: - cost of processing orders
- cost of handling returns
Costs are allocated to specific customers using cost drivers to determine customer profitability
Slide 8-21 Learning objective 5: Analyze customer profitability
Customer profitability is measured as:a. Revenue minus cost of goods soldb. Revenue minus indirect manufacturing
costsc. Revenue minus cost of goods sold minus
indirect service costsd. Revenue minus cost of goods sold minus
indirect manufacturing costs
Answer: cRevenue minus cost of goods sold minus indirect service costs
Slide 8-22 Learning objective 5: Analyze customer profitability
Customer Profitability Customer Profitability Measurement SystemMeasurement SystemCustomer Profitability Customer Profitability Measurement SystemMeasurement System
Slide 8-23 Learning objective 5: Analyze customer profitability
Cost Pools and Cost Drivers to Cost Pools and Cost Drivers to Service CustomersService Customers
Cost Pools and Cost Drivers to Cost Pools and Cost Drivers to Service CustomersService Customers
Slide 8-24 Learning objective 5: Analyze customer profitability
Customer Profitability AnalysisCustomer Profitability AnalysisCustomer Profitability AnalysisCustomer Profitability Analysis
Slide 8-25 Learning objective 5: Analyze customer profitability
CostRevenue Quantity Amount Quantity AmountLess COGS 732,600 727,650 Gross margin (666,000) (661,500) Less indirect costs 66,600 66,150
Internet orders $1.20 /order 165 (198) 0 0Fax orders $4.50 / order 20 (90) 320 (1,440) Line items $0.90 / item 2,500 (2,250) 5,100 (4,590) Miles $0.36 /mile 1,200 (432) 3,300 (1,188) Weight $0.40 / pound 900 (360) 870 (348) Items returned $0.80 / item 210 (168) 910 (728)
Profit 63,102 57,856 Profit as a percent of sales 8.61% 7.95%
Customer 1 Customer 2
Customer Profitability AnalysisCustomer Profitability AnalysisCustomer Profitability AnalysisCustomer Profitability Analysis
Slide 8-26 Learning objective 5: Analyze customer profitability
Delta products has determined the following costs and drivers for the Johnson Brand customer:
Slide 8-27 Learning objective 5: Analyze customer profitability
Cost JohnsonSales 53,800$ Cost of sales 48,420$ Order processing per order 5.00$ 200 ordersLine items per item 8.50$ 120 itemsCustomer service per call 10.00$ 140 callsRelationship management per account 500.00$ 4 accounts
Calculate the profitability of the Johnson Brands customer.
Delta products has determined the profitability of the Johnson Brand customer:
Slide 8-28 Learning objective 5: Analyze customer profitability
JohnsonSales 53,800$ Cost of sales 48,420Order processing $5.00 X 200 = 1,000Line items $8.50 X 120 = 1,020Customer service $10.00 X 140 = 1,400Relationship management $500.00 X 4 = 2,000Loss from customer (40)$
Customers Can Hurt Customers Can Hurt ProfitabilityProfitability
Customers Can Hurt Customers Can Hurt ProfitabilityProfitability
Slide 8-29 Learning objective 5: Analyze customer profitability
Activity-Based PricingActivity-Based PricingActivity-Based PricingActivity-Based Pricing
Customers are presented with separate prices for services they request in addition to the cost of goods purchased- Customers will carefully consider the
services they request- May lead them to impose less cost on
the supplier Also called menu-based pricing
Slide 8-30 Learning objective 6: Explain the activity-based pricing approach
Activity-Based PricingActivity-Based PricingActivity-Based PricingActivity-Based Pricing
Customers are presented with separate prices for services they request in addition to the cost of goods purchased- Customers will carefully consider the
services they request- May lead them to impose less cost on
the supplier Also called menu-based pricing
Slide 8-31 Learning objective 6: Explain the activity-based pricing approach
With activity-based pricing:a. Customers face a menu of prices for
various servicesb. Customers are encouraged to consider
the costs they impose on a supplierc. Customers may be charged less if they
request less product variety in their orders
d. All of the above are correct
Answer: dAll of the above are correct
Slide 8-32
Pricing DecisionsPricing DecisionsPricing DecisionsPricing Decisions
Slide 8-33 Learning objective 6: Explain the activity-based pricing approach
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