Costing and Pricing of Products

Dr. A. Sharada DeviDean of Home ScienceANGRAU, Hyderabad

Costs + Margins = PRICE

“ A price is not merely a function of costs and margins… ”

“…it is an expression of VALUE ”

Definition of the terms

• Cost is the total amount invested by the manufacturer in the product

• Costing is the process of determining the costs of producing and marketing each product in the product line

• Price is the amount that is asked or received in exchange for a product

• Pricing is the process of determining the selling price of goods that are manufactured

Relationship of Cost, Price and Profit

• Manufacturer’s Price = Manufacturing costs + Operating expenses + Profit

• Manufacturer’s Price = Retailer’s Cost

• Retailer’s Price = Retailer’s Cost + Operating expenses + Profit

Pricing Puzzle

4 C’s• CUSTOMER VALUE• COST• CONVENIENCE• COMMUNICATION

4 P’s• PRODUCT• PRICE• PLACE• PROMOTION

Pricing Puzzle

• Production costs• Indirect costs• Advertising costs• Distribution costs• Manufacturer’s

margin• Distributor’s margin• Seller’s margin

Product performance• Usefulness & Quality

Image / Aspirations• Brand Equity

Availability• Distribution Strategy

Service• Before/During & After

sales

Minimize Optimize Maximize

Costs + Margins = PRICE

VALUE

• Physical Differences– Features, performance, durability, conformance,

design, etc…• Availability Differences

– Distribution channels ; Stores, mail-order, internet, etc…

• Service Differences– Delivery, installation, training, consulting,

maintenance, etc…• Price Differences

– Price positioning (Very high / High / Medium / Low / Very Low)

• Image Differences– Symbols, atmosphere, events, media, etc…

The key to drive value is to offer relevant and distinctive product differentiation

• Physical Differences– Levi’s Engineered Jeans (Ergonomic construction,

durability, style)• Availability Differences

– Dell Computer’s customized production, Volkswagen “e.lupo”

• Service Differences– Star Hospitals – Cardiology, critical care

• Image Differences– Audi vs Mercedes, DuPont (Innovation Leader)

Differentiation : Examples

Manufacturing costs• Raw materials• Direct Labour• Factory overheads

Factory overhead• Indirect labour• Factory occupancy costs• Other overheads

Costing helps to determine• The productability of a style with in an established price

range• The profit potential in a style• Whether a style should be added to the line

Income Statement

Net sales = Rs 1,05,00,000 100%Cost of goods sold = Rs 63,00,000 60%Raw material costsDirect labourFactory overhead

Gross Profit margin = Rs 42,00,000 40%Gen operating expenses= Rs 31,00,000 30%Net profit or loss(+ or -) = Rs 10,50,000

10%

Methods of CostingMethods of Costing:

Absorption Costing – Considers all manufacturing costs both variable and non-variable to be product costs that must be allocated to products. Overhead is computed as a percentage of direct labour

Direct Costing – considers only variable costs such as production labour, material costs and sales commission as product costs

Stages of Costing Preliminary Costing – done during product devt before samples are made Cost estimating – final costing prior to production

Materials costingLabour costing

Recosting – done when there is a change in production Actual Costing – determined during production

Stages in the Product Lifecycle

50 100 150 200 250 300

50

100

150

200

250

300Desired Profit

Forecast Profit

Profit

Break-even volume

Income-sales li

ne

LossCost l

ine

Fixed Costs

Inco

me

and

Cost

sCost –Volume – Profit Relationships Break-

even Analysis

0

Volume of sales & Production

Break even volume = Non-variable costsContribution Margin

Break-even Analysis

• What is the break-even volume at the established unit price?

• What is the break-even volume if the price is increased or decreased?

• What is the break-even volume for the alternative methods of producing a product?

• What is the break-even volume for the same product made ‘in house’ or by a contractor?

Pricing Decisions

• INTERNAL FACTORS– Marketing

Objectives• Positioning• Target Group

– Marketing Mix Strategy

• 4 P’s– Costs

• Fixed & Variable– Management

Approach• Responsibility• Perspective

• EXTERNAL FACTORS– Market

• Pure Competition• Monopolistic

Competition– Demand

• Elastic / Inelastic– Competition

• Competitors’ offers• Competitiors’ reactions

– Economy• Buying power

– Government Influence• Laws & Regulations

Effective Pricing Strategy An effective pricing strategy will help to• Meet the profit objectives • Meet or beat the competitors’ prices • Retain or increase the market share • Match the image or reputation of the

business, product or service • Match the offer to market demand

Pricing Strategies

The basic issues considered for developing a pricing strategy are:

• At what profit level will the list prices be set?• Will the prices be cost based or demand based?• Will the firm use price lining and or odd pricing?• What terms will be negotiable as a part of sales

agreement?• Will the firm’s pricing strategy fall within legal

restrictions on pricing?

New-Product Pricing Strategies

Market-skimming pricingMarket-penetration pricing

Market-skimming pricing

Market-skimming pricing is a strategy with high initial prices to “skim” revenue layers from the market

• Product quality and image must support the price• Buyers must want the product at the price• Costs of producing the product in small volume

should not cancel the advantage of higher prices• Competitors should not be able to enter the market

easily

Market-penetration pricing

Market-penetration pricing sets a low initial price in order to penetrate the market quickly and deeply to attract a large number of buyers quickly to gain market share

• Price sensitive market

• Inverse relationship of production and distribution cost

to sales growth

• Low prices must keep competition out of the market

Competitive pricing

Good, better, best pricing Loss leader

Multiple pricing

Optional product pricing

Penetration pricing

Premium pricing

Product bundle pricing

Product line pricing

Pricing Strategies

Competitive pricing - pricing your product(s) based on the prices your competitors have on the same product

Good, better, best pricing - charges more for products that have received more attention

Loss leader- refers to products having low prices placed on them in an attempt to lure customers to the business and to make further purchases

Multiple pricing - seeks to get customers to purchase a product in greater quantities by offering a slight discount on the greater quantity

Optional product pricing - used to attempt to get customers to spend a little extra on the product by purchasing options or extra features

Penetration pricing - used to gain entry into a new market

Premium pricing - employed when the product you are selling is unique and of very high quality, but you only expect to sell a small amount

Product bundle pricing - pricing—used to group several items together for sale

Product line pricing - used when a range of products or services complement each other and can be packaged together to reflect increasing value

Price-Adjustment Strategies

Psychological pricing occurs when sellers consider the psychology of prices and not simply the economics

• Reference prices are prices that buyers carry in their minds and refer to when looking at a given product– Noting current prices– Remembering past prices– Assessing the buying situations

Price-Adjustment Strategies

Promotional pricing is when prices are temporarily priced below list price or cost to increase demand

• Loss leaders• Special event pricing• Cash rebates• Low-interest financing• Longer warrantees• Free maintenance

Price-Adjustment Strategies

Risks of promotional pricing• Used too frequently, and copies by competitors

can create “deal-prone” customers who will wait for promotions and avoid buying at regular price

• Creates price wars

One Final Word

“ A product is not a product unless it sells.Otherwise, it’s just a museum piece…”

Ted Levitt