Three influences on demand and supply:
Customers,Competitors,Costs
Customers
Influences price through their effect on the demand for a product or service, based on factors such as the features of a product and its quality.
Competitors
Companies must always be aware of the actions of their competitors. Competitors�influence price through their pricing schemes, product features, and production volume
Costs
Costs influence prices because they affect supply. THe lower the cost of producing a product, the greater the quantity of product the company is willing to supply.
Short-run pricing decisions
Have a time horizon of less than one year and include decisions such as:
Pricing a one-time-only special order with no long-run implications
Adjusting product mix and output volume in a competitive market
Long-run pricing decisions
Have a time horizon of one year or longer and include decisions such as:
Pricing a product in a major market where there is some leeway in setting price
Differences Affecting Pricing: Long Run vs. Short Run
Costs that are often irrelevant for short-run policy decisions, such as fixed costs that cannot be changed, are generally relevant in the long run because costs can be altered in the long run.
Profit margins in long-run pricing decisions are often set to
Costing and Pricing for the long run
Long run pricing is a strategic decision to build long-run relationships with customers based on stable and predictable prices. A stable price reduces the need for continous monitoring the prices, improves planning, and build long-run buyer-seller relatio
Alternative Long-Run Pricing Approaches
1. Market-based 2. Cost-based, which is also called cost-plus.
Market-based:
Price charged is based on what customers want and how competitors react. asking this question: "GIven what our customers want and how our competitors will react to what we do, what price should we charge" Based on this price, managers control costs to ear
Cost-based Approach
price charged is based on what it costs to produce, coupled with the ability to recoup the costs and still achieve a required rate of return.
LESS COMPETITIVE MARKETS
Market-based o Cost-based Approach
COMPETITIVE MARKETS
Market-based
Noncompetitive markets�
Use cost-based approaches
Market-based
Starts with a target price
Target price�estimated price for a product or service that potential customers will pay
Estimated on customers perceived value for a product or service and how competitors will price competing products or services
Understanding customers and competitors is important because:
Competition from lower cost producers has meant that prices cannot be increased.
Products are on the market for shorter periods of time, leaving less time and opportunity to recover from pricing mistakes.
Customers have become more knowledgeable and deman
Five Steps in Developing Target Prices and Target Costs
1.Develop a product that satisfies the needs of potential customers.
2.Choose a target price.
3.Derive a target cost per unit:
Target price per unit minus target operating income per unit
4.Perform cost analysis.
5.Perform value engineering to achieve tar
Value Engineering
is a systematic evaluation of all aspects of the value chain, with the objective of reducing costs while improving quality and satisfying customer needs.
How to implement Value Engineering
Managers must distinguish value-added activities and costs from non-value-added activities and costs.
Value-added costs�
a cost that, if eliminated, would reduce the actual or perceived value or utility (usefulness) customers obtain from using the product or service.
Non-value-added costs�
a cost that, if eliminated, would not reduce the actual or perceived value or utility customers obtain from using the product or service. It is a cost the customer is unwilling to pay for.
Cost incurrence
�describes when a resource is consumed (or benefit foregone) to meet a specific objective
Locked-in costs (designed-in costs)�
are costs that have not yet been incurred but, based on decisions that have already been made, will be incurred in the future
Key Steps in value-engineering
1. Understanding customer requirements, value-added and non-value added costs. 2. Anticipating how costs are locked in before they are incurred 3. Using cross-functional teams to redesign products and processes to reduce costs while meeting customer needs
Cost-Based (Cost-Plus) Pricing
The general formula adds a markup component to the cost base to determine a prospective selling price.
Usually, it is only a starting point in the price-setting process.
Markup is somewhat flexible, based partially on customers and competitors.
Forms of Cost-Plus Pricing
1.Setting a target rate of return on investment: the target annual operating return that an organization aims to achieve, divided by invested capital - Total Assets, that is, long term assets plus current assets.
2.Selecting different cost bases for the
Common Business Practice
Most firms use full cost for their cost-based pricing decisions, because:
It allows for full recovery of all costs of the product
It allows for price stability
It is a simple approach
Important Considerations for Life-Cycle Budgeting
Nonproduction costs are large.
Development period for R&D and design is long and costly.
Many costs are locked in at the R&D and design stages, even if R&D and design costs are themselves small
Other Important Considerations in Pricing Decisions
Price discrimination�the practice of charging different customers different prices for the same product or service
Legal implications
Peak-load pricing�the practice of charging a higher price for the same product or service when the demand for it approach
The Legal Dimension of Price Setting
1. Price discrimination is illegal if the intent is to lessen or prevent competition for customers. Is the practice of charging different customers different prices for the same product or service.
Predatory pricing is deliberately lowering prices below c