Business Decision Analysis - Pricing Stragetgy and CVP Analysis PDF

Pricing Strategy - price is the amount a customer will have to pay for a product or service. Price is the very center of business revenue Price x Volume = Revenue How do we “SET” the Price? 1. Cost-based method 2. Competition-based method 3. Customer-based method...

Pricing Strategy - price is the amount a customer will have to pay for a product or service. Price is the very center of business revenue Price x Volume = Revenue How do we “SET” the Price? 1. Cost-based method 2. Competition-based method 3. Customer-based method Cost-based pricing method Cost-based pricing method - the prices are determined by analyzing other factors like consumer demand or the cost of production A cost-based approach to pricing is appropriate when a company sells a differentiated product Cost-based Pricing/cost-based approach - something that is unique or differentiated Companies would likely use a cost-based approach to setting prices when it is unique (for example; a pharmaceutical company selling a patented drug) 1. Marking up the pierce based on Variable Cost Absorption Cost (COGS) Total Cost 2. Price Death Spiral 3. Target Costing based on the market The cost markup formula Cost x (1+ Mark-up%) = Price 1. Which cost to use? The “One” CVP Formula 1. Using Variable Cost Formula Sales Price (Volume) - VC Rate (Volume) - TFC = Profit Variable Cost (1+ Mark-up%) (Volume) - VC Rate (Volume) - TFC = Profit 𝑃𝑟𝑜𝑓𝑖𝑡 + 𝑡𝑜𝑡𝑎𝑙 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 Mark-up % = 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 (𝑣𝑜𝑙𝑢𝑚𝑒) 𝑃𝑟𝑜𝑓𝑖𝑡 + 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡 𝑡𝑜 𝑐𝑜𝑣𝑒𝑟 2. The Cost MarkupFormula = 𝑀𝑎𝑟𝑘𝑢𝑝 𝑐𝑜𝑠𝑡 𝑏𝑎𝑠𝑖𝑠 𝑥 𝑉𝑜𝑙𝑢𝑚𝑒 Variable Cost - Mark up cost basis is = variable cost Absorption Cost (COGS) - Mark-up cost basis is = COGS - Production Cost per unit (exclude admin) Total Cost- Mark-up cost basis is = total cost  Note: Should be per unit cost per unit x volume 𝑟𝑒𝑠𝑒𝑙𝑙 𝑝𝑟𝑖𝑐𝑒 − 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑐𝑜𝑠𝑡 Mark- up % = 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑐𝑜𝑠𝑡 Target Selling Price = cost + (Mark-up percentage x cost) Target Cost = (Customer Willing to Pay x Required Profit) = Desired Profit = Customer Willing to Pay - Desired Profit = Target Cost Price Taker - control over the price Price Setter - walang choice kundi sundin yung market Cost Plus Target rate of return pricing, price are set by adding a mark-up based on the cost of the product and the desired return on investment Cost plus pricing starts with the cost and adds a makeup Prices are set in such a ways as to earn a target rate of return on the investment made in a product It is appropriate for sellers selling a fairly unique product with few available substitutes Companies using cost plus target rate of return pricing are PRICE SETTER Target costing starts with desired profit to determine its ability to offer the product at a certain price A company starts with the price customers are willing to pay for a good or service Determines whether the company can offer the product or services at a certain price. PRICE TAKER companies If the company determines the market price for the product and then the desired profit, which leads to the target cost. Target cost is the difference between the market price of a product and a company’s desired profit for that product Setting Prices using a target costing approach - The target costing formula is a variation - Can be used to calculate required variable costs - Can be used to calculate the required absorption cost Traditional pricing is based on the premise that price equals cost plus profit margin; target costing implies that cost equals competitive price minus profit margin - Target pricing is a pricing strategy that focuses on setting a price point for a product or service that will appeal to customers and still provide a reasonable profit for the business. Target Costing based on the market Price Maker - Cost x (1 + Mark-up%) = Price Variable Cost = 4.45 x 1.1671 = 4.96 Absorption = 2.855 x 1.7404 = 4.96 Full Cost = 4.72 x 1.0508 = 4.96 Price Taker - Price / (1 + Mark-up%) = Cost Market Price Target Cost Original Cost Reduce Cost Variable Cost = 3.95/ 1.1671 = 3.38 4.25 0.87 Absorption = 3.95/1.7404 = 2.27 2.85 0.58 Full Cost = 3.95/1.0508 = 3.76 4.75 0.96 Variable Cost Method - retailers almost use always the VC method because they think in terms of buying something and selling it again which is the core variable cost of the organization. - They take what they bought and mark it up and then they sell it Absorption Cost Method - often used by a company that is publicly traded that has a GAAP or an IFRS reporting standard since they have a big emphasis of production cost due to the use of income statement’s COGS Total Cost or Full Cost Method - a technique that oil and natural gas companies use to capitalize on all expenses related to the discovery and production of wells, even if they're unsuccessful. When using this method of accounting, these companies don't immediately report a failed well as a loss Death Spiral - the term death spiral refers to the repeated elimination of a manufacturer's products which will result in spreading the fixed manufacturing overhead costs to fewer products Cost plus target rate of return pricing - involves setting prices in such a way as to earn a target rate of return on the capital invested in the product Cost plus pricing - base prices on the cost incurred to produce and deliver the product Competition-Based Pricing Competition-Based Pricing - competitive pricing definition is setting your prices about the prices of your competitors. It involves setting prices based on the price of similar products - We do market-based pricing in stocks when estimating the value of stocks. - A food-products company selectable salt - A office supply company selling ball pens - A consumer goods company selling napkins.  1. The classic demand & supply economics model 2. Price Demand Elasticity 3. The four economic market structures The classic demand & supply economics model The classic demand & supply economics model the theory that prices are determined by the relationship between supply and demand. If the supply of a good or service outstrips the demand for it, prices will fall. If demand exceeds supply, prices will rise. Elastic demand is one in which the change in quantity demanded due to a change in price is large. - If the value is greater than 1, demand is elastic Inelastic demand is one in which the change in quantity demanded due to a change in price is small. If the formula creates an absolute value greater than 1, the demand is elastic. - If the value is less than 1, demand is inelastic. Perfectly elastic demand is a demand where any price increase would cause the quantity demanded to fall to zero, and reducing the price of a good or service will not increase sales. Perfectly inelastic demand is an economic condition in which a change in the price of a product or a service has no impact on the quantity demanded or supplied because the elasticity of demand or supply is equal to zero. Price Demand Elasticity In a market-based pricing strategy, we used elasticity Elasticity Coefficient - A measure of the responsiveness of the quantity of a product taken in the market to price changes. ELASTICITY OF DEMAND 1. E >1 - product is elastic - Affect quantity demand - An elastic demand is one in which the change in quantity demanded due to a price change is large. 2. E = 1 - unitary (unit elastic) - When proportionate or percentage change in quantity demanded is exactly equal to proportionate or percentage change in price, then demand is said to be unitary elastic. For instance, a 10% fall in the price of a commodity leads to a 10% rise in demand for that commodity. 3. E