Pricing Strategies Quiz

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Questions and Answers

What is a primary advantage of full cost plus pricing?

It allows for detailed competitor analysis.

It adapts easily to market changes.

It can justify selling prices to customers. (correct)

It considers opportunity costs effectively.

Which statement best describes variable cost plus pricing?

It adds a fixed percentage mark-up regardless of costs.

It requires complicated fixed cost calculations.

It ignores demand conditions completely.

It focuses on contribution and sales volume effects. (correct)

What is a limitation of full cost plus pricing?

It is too complex for management to implement effectively.

It requires variable costs to be recalculated frequently.

It encourages aggressive discounting strategies.

It can be inflexible and ignore short-term conditions. (correct)

In opportunity cost pricing, what is the primary focus?

Bidding for one-time special orders. Signup and view all the answers

What type of costs are ignored in variable cost plus pricing?

Fixed costs. Signup and view all the answers

How does full cost plus pricing affect the relationship between supply and demand?

It can lead to a disconnect from supply and demand changes. Signup and view all the answers

Why might retailers choose variable cost plus pricing?

To quickly respond to market changes in demand. Signup and view all the answers

One disadvantage of opportunity cost pricing is that it often fails to account for what?

Competitive pricing strategies. Signup and view all the answers

What should be considered when making bids for additional orders?

Only the additional costs of undertaking the order. Signup and view all the answers

Which condition is NOT mentioned for making a bid?

The bid price should affect future selling prices. Signup and view all the answers

What percentage of a company's customers typically contributes to its profits?

20% Signup and view all the answers

Why might a company choose to retain unprofitable customers?

For customer prestige or potential future profitability. Signup and view all the answers

Which of the following describes a potential qualitative reason to retain unprofitable customers?

Non-monetary benefits such as knowledge or expertise. Signup and view all the answers

What aspect should NOT be affected when making bids at prices above incremental costs?

Future selling price. Signup and view all the answers

Which factor contributes most to identifying less profitable customers?

Frequency of order changes. Signup and view all the answers

What is typically indicated by the relationship between price and quantity demanded according to economic theory?

Higher prices generally lead to lower quantity demanded. Signup and view all the answers

What is the optimum selling price determined by marginal revenue and marginal cost?

The price at which marginal revenue equals marginal cost. Signup and view all the answers

When will capacity be released for use on more profitable opportunities?

When short-term orders are completed. Signup and view all the answers

Which factor is NOT typically included in pricing decisions?

Prices determined by customer negotiations. Signup and view all the answers

What is marking up cost primarily used for in pricing decisions?

To determine the selling price by adding a specific percentage to costs. Signup and view all the answers

What challenge is commonly associated with applying economic theory to pricing decisions?

Estimating accurate demand levels. Signup and view all the answers

What can comparing customer-related costs reveal?

Helpful insights into profitability Signup and view all the answers

How do managers determine the optimal price based on estimated demand?

By analyzing marginal costs and revenues directly. Signup and view all the answers

What role does target costing play in pricing strategies?

It establishes a maximum allowable cost to ensure desired profit margins. Signup and view all the answers

Which of the following statements is true about the two unprofitable customers?

Their customer-related costs are significantly high. Signup and view all the answers

What does measuring customer profitability involve?

Assessing the customer's total contribution margin. Signup and view all the answers

What aspect of customer profitability analysis is emphasized in the content?

Identifying cost structures Signup and view all the answers

What is the most significant reason for the unprofitability of the two customers?

Excessive handling and packaging costs Signup and view all the answers

What role does special packaging play in customer profitability analysis?

It contributes to higher costs. Signup and view all the answers

Which cost is mentioned as part of the comparison for customer-related expenses?

Order processing costs Signup and view all the answers

Why is it important to analyze customer-related costs thoroughly?

To identify opportunities to improve profitability Signup and view all the answers

What is the selling price set at based on the given costs and return?

£20 Signup and view all the answers

How might price sensitivity affect customer behavior regarding cinema ticket prices?

Frequent attendees may be less affected by price changes. Signup and view all the answers

What is a potential consequence of a company increasing its product price?

Intermediaries might raise their selling price to maintain margins. Signup and view all the answers

Which factor might cause consumers to perceive a higher-priced product as better quality?

The price difference between two alternatives. Signup and view all the answers

In a price war, what is likely to happen among petrol retailers?

Prices will generally decrease as competition heightens. Signup and view all the answers

What represents the real increase in price when considering inflation?

The nominal price change minus inflation. Signup and view all the answers

What typically happens to pub prices following an increase by breweries after a budget announcement?

They often increase by a larger amount. Signup and view all the answers

What drives customers to either hold off a purchase or hasten it concerning expected price changes?

Anticipation of fluctuating prices. Signup and view all the answers

What must a price setting firm consider when making a bid for a short-term special order?

The incremental cost of undertaking the order Signup and view all the answers

Which of the following is NOT a condition that must be met when a price setting firm bids for a short-term order?

The bid price should cover fixed costs Signup and view all the answers

What distinguishes price takers from price setters?

Price takers have no control over product prices Signup and view all the answers

In the context of pricing decisions, what role does cost information serve for price setters?

It is vital for making pricing decisions Signup and view all the answers

What outcome do firms aim for when they optimize their pricing strategies?

Maximizing long-term profits Signup and view all the answers

Which of the following is a situation a price taker firm would NOT face?

Bidding for special orders Signup and view all the answers

Which factor should a price setting firm avoid affecting by its short-term bids?

Future pricing strategies Signup and view all the answers

What type of pricing strategy is typically used for customized products in long-run pricing decisions?

Cost-plus pricing Signup and view all the answers

Study Notes

Lecture 6: Pricing Decisions & Profitability Analysis

Learning Outcomes: By the end of this unit, students will be able to explain how organizations set prices, other factors that impact pricing, marking up costs, target costing, and measuring customer profitability.

Pricing Decisions

Pricing decisions are often the most challenging for managers.
Pricing decisions include:
- Profit maximization based on economic theory
- Pricing of special orders
- Cost markup and target costing
- Measuring customer profitability and activity-based pricing

Economic Theory

Economic theory suggests that the quantity demanded is a function of the price.
The price reflects the relationship between supply and demand.
Higher prices generally lead to lower demand.
Accurate demand estimations enable straightforward calculation of optimal prices.
Optimal prices occur where marginal revenue equals marginal cost.
An example is given where market factors determine a widget costs £5, suggesting buyers are willing to forego other utilities for £5 and the seller considers this a fair price.

Economic Theory (continued)

The optimal selling price is where marginal revenue (benefit from demand) equals marginal cost (additional cost of production).
The additional revenue earned by producing the last unit should equal the additional cost (£34) in this example.

Problems with Applying Economic Theory

Accurate demand estimations are difficult and expensive.
Estimating cost functions for different product levels at various output levels is challenging.
Demand is affected by factors beyond price.
Firms may prioritize other goals beyond profit maximization.

Role of Cost Information in Pricing Decisions

Price takers have limited control over prices. For them, cost information is critical to output and product mix decisions.
Price setters have more pricing discretion. Cost information is critical for setting prices.
Companies can be both price takers and price setters for different products or services.
Four different pricing scenarios are presented.

A Price Setting Firm Facing Short-Run Pricing Decisions

This applies where companies bid for one-time special orders.
Only consider incremental costs associated with the order.
Most costs are non-incremental because the opportunity is short-term.
bids must exceed incremental costs.
Meeting the following conditions will allow for successful bids:
- Available capacity to fill the order.
- No effect on future pricing or expectation of repeat business due to current bids.
- Use of any unused capacity for short periods in order to obtain more profitable opportunities.

A Price Setting Firm Facing Long-Run Pricing Decisions

Three scenarios are to be considered regarding long-term pricing:
- Pricing of customized products using cost-plus pricing
- Pricing of non-customized products using cost-plus pricing or demand estimates.
- Pricing of non-customized products using Target costing.
For a firm adjusting its supply of resources, prices should cover all committed resources

Cost-Plus vs. Target Costing

Cost-plus pricing is often used by companies selling customized products where demand prediction is difficult: -Price = cost + markup -A short term pricing decision compared to a long term pricing decision. -Predicting prices of other companies is helpful.
- The markup can be adjusted to match changes in sales demand.

Pricing Customized Products Using Cost-Plus Pricing

An accurate costing system is necessary to avoid accepting unprofitable work or losing profitable work due to inaccurate costs.
Full cost (long run cost) + markup price is calculated when determining the selling price.
Cost assignment for pricing should be based on direct cost tracing and cause-and-effect assignments and cost allocations.
Activity based costing (ABC) improves understanding of cost behavior for negotiating price and order size.

Advantages of Cost-Plus Pricing

Price stability is often a result of cost-plus pricing.
This type of pricing takes demand into account by adjusting the target markup.
It is a simple pricing model.
It is often difficult to apply sophisticated techniques to pricing of hundreds of products/ services.

Criticisms of Cost-Plus Pricing

Cost-plus pricing ignores customer demand.
Cost-plus pricing does not guarantee enough revenue to exceed total costs.
Cost-plus pricing models may lead to incorrect decisions if budgeted activities are used to determine unit costs.
Cost-plus pricing models have the issue of circular reasoning, as volume estimates are needed to determine unit costs, which in turn, influences the total price.

Cost-Plus vs. Target Costing (Part 2)

Price-taking firms primarily selling non-customized products should use target costing.
Target costing is the reverse of cost-plus pricing – the target selling price is the starting point.

Cost-Plus vs. Target Costing (Part 3)

Four stages are involved in target costing:
- Determining the target price customers will pay
- Deducting a target profit margin from the target price
- Estimating accurate costs associated with the product.
- Investigating cost reduction methods if the estimated costs exceed the target cost.

A Price-Taker Firm Facing Short-Run Product-Mix Decisions

Short-term pricing decisions occur when opportunities exist to take on business at a market-determined selling price.
Necessary costs are used in the same way price-setting firms' strategies require in short-term pricing decisions.
Short-term capacity contraints determine how the product mix is prioritized. Maximizing contribution per limiting factor is a determining factor in this model.
In long run models, a firm may be able to change the capacity for resources and therefore the calculation for profit/revenue associated with products/services must consider all necessary resources.
Periodic profitability analysis allows a firm to ensure that only profitable products or services are offered to the market.
Profitability analysis can help with identifying actions/attention needed.

Customer Profitability Analysis

The analysis of the costs and profit associated with specific customers.
Some customers are less profitable than others for various reasons.
- Frequent changes in order quantity
- Special customer needs
- Customers difficult to satisfy
Studies indicate that only 20% of customers contribute to overall profit.
Important factors to consider when keeping unprofitable customers include:
- Customer prestige
- Potential future profitability for the customer.
- Loss leader function necessary for penetrating the market
- Non-monetary benefits such as valuable knowledge or skill from customers.

Customer Profitability Analysis (Part 2)

Examining customer-related costs can identify profitable/unprofitable customers.
Example of costs is shown for customer 102 and 114.

Pricing Policies

Discussion of various pricing strategies, including market skimming pricing, market-penetration pricing, full cost-plus pricing, variable cost-plus pricing, and opportunity cost pricing.

Reading List

Drury & Tayles (2023), Cost and Management Accounting, 12th Edition, Chapter 10.

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Description

Test your understanding of various pricing strategies such as full cost plus, variable cost plus, and opportunity cost pricing. This quiz explores the advantages, limitations, and practical implications of these methods in business decision-making. Perfect for students and professionals in finance and marketing sectors.