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1、Pricing Productsand Services,Appendix A,Learning Objective 1,Compute the profit-maximizing price of a product or service using the price elasticity of demands and variable cost.,The Economists Approach to Pricing,Elasticity of Demand,The price elasticity of demand measures the degree to which the un
2、it sales of a product or service is affected by a change in price.,Price Elasticity of Demand,Demand for a product is inelastic if a change in price has little effect on the number of units sold.,ExampleThe demand for designer perfumes sold at cosmetic counters in department stores is relatively ine
3、lastic.,Price Elasticity of Demand,Demand for a product is elastic if a change in price has a substantial effect on the number of units sold.,ExampleThe demand for gasoline is relatively elastic because if a gas station raises its price, unit sales will drop as customers seek lower prices elsewhere.
4、,Price Elasticity of Demand,As a manager, you should set higher (lower) markups over cost when demand is inelastic (elastic),Price Elasticity of Demand,Natural log function,Price elasticity of demand,Price Elasticity of Demand,Suppose the managers of Natures Garden believe that every 10 percent incr
5、ease in the selling price of its apple-almond shampoo will result in a 15 percent decrease in the number of bottles of shampoo sold. Lets calculate the price elasticity of demand. For its strawberry glycerin soap, managers of Natures Garden believe that the company will experience a 20 percent decre
6、ase in unit sales if its price is increased by 10 percent.,Price Elasticity of Demand,For Natures Garden apple-almond shampoo.,Price Elasticity of Demand,For Natures Garden strawberry glycerin soap.,Price Elasticity of Demand,The price elasticity of demand for the strawberry glycerin soap is larger,
7、 in absolute value, than the apple-almond shampoo. This indicates that the demand for strawberry glycerin soap is more elastic than the demand for apple-almond shampoo.,The Profit-Maximizing Price,Under certain conditions, the profit-maximizing price can be determined using the following formula:,Th
8、e Profit-Maximizing Price,Lets determine the profit-maximizing price for the apple-almond shampoo sold by Natures Garden. The shampoo has a variable cost per unit of $2.00.,Price elasticity of demand = -1.71,The Profit-Maximizing Price,Now lets turn to the profit-maximizing price for the strawberry
9、glycerin soap sold by Natures Garden. The soap has a variable cost per unit of $0.40.,Price elasticity of demand = -2.34,The Profit-Maximizing Price,The 75 percent markup for the strawberry glycerin soap is lower than the 141 percent markup for the apple-almond shampoo. This is because the demand fo
10、r strawberry glycerin soap is more elastic than the demand for apple-almond shampoo.,The Profit-Maximizing Price,This graph depicts how the profit-maximizing markup is generally affected by how sensitive unit sales are to price.,The Profit-Maximizing Price,Natures Garden is currently selling 200,000
11、 bars of strawberry glycerin soap per year at the price of $0.60 a bar. If the change in price has no effect on the companys fixed costs or on other products, lets determine the effect on contribution margin of increasing the price by 10 percent.,The Profit-Maximizing Price,Contribution margin will
12、increase by $1,600.,Learning Objective 2,Compute the selling price of a product using the absorption costing approach.,The Absorption Costing Approach,Under the absorption approach to cost-plus pricing, the cost base is the absorption costing unit product cost rather than the variable cost.,Setting
13、a Target Selling Price,Here is information provided by the management of Ritter Company.,Assuming Ritter will produce and sell 10,000 units of the new product, and that Ritter typically uses a 50 percent markup percentage, lets determine the unit product cost.,Setting a Target Selling Price,Ritter h
14、as a policy of marking up unit product costs by 50 percent. Lets calculate the target selling price.,Setting a Target Selling Price,Ritter would establish a target selling price to cover selling, general, and administrative expenses and contribute to profit $30 per unit.,Determining the Markup Perce
15、ntage,The markup percentage can be based on an industry “rule of thumb,” company tradition, or it can be explicitly calculated. The equation to calculate the markup percentage is:,Determining the Markup Percentage,Lets assume that Ritter must invest $100,000 in the product and market 10,000 units of
16、 product each year. The company requires a 20 percent ROI on all investments. Lets determine Ritters markup percentage on absorption cost.,Determining the Markup Percentage,Markup %on absorptioncost,(20% $100,000) + ($2 10,000 + $60,000)10,000 $20,=,Problems with the Absorption Costing Approach,The
17、absorption costing approach assumes that customers need the forecasted unit sales and will pay whatever price the company decides to charge. This is flawed logic simply because customers have a choice.,Problems with the Absorption Costing Approach,Lets assume that Ritter sells only 7,000 units at $3
18、0 per unit, instead of the forecasted 10,000 units. Here is the income statement.,Problems with the Absorption Costing Approach,Lets assume that Ritter sells only 7,000 units at $30 per unit, instead of the forecasted 10,000 units. Here is the income statement.,Absorption costing approach to pricing
19、 is a safeapproach only if customers choose to buy atleast as many units as managers forecastedthey would buy.,Learning Objective 3,Compute the target cost for a new product or service.,Target Costing,Target costing is the process of determining the maximum allowable cost for a new product and then
20、developing a prototype that can be made for that maximum target cost figure. The equation for determining the target price is shown below:,Target cost = Anticipated selling price Desired profit,Reasons for Using Target Costing,Two characteristics of prices and product costs:,The market (i.e., supply
21、 and demand) determines price. Most of the cost of a product is determined in the design stage.,Target costing was developed in recognition of these two characteristics.,Reasons for Using Target Costing,Target costing was developed in recognition of the two characteristics shown on the previous scre
22、en. More specifically, Target costing begins the product development process by recognizing and responding to existing market prices.,Reasons for Using Target Costing,Target costing focuses a companys cost reduction efforts in the product design stage of production.,Target Costing,Handy Appliance fe
23、els there is a niche for a hand mixer with certain features. The Marketing Department believes that a price of $30 would be about right and that about 40,000 mixers could be sold. An investment of $2,000,000 is required to gear up for production. The company requires a 15 percent ROI on invested fun
24、ds. Let see how we determine the target cost.,Target Costing,Each functional area within Handy Appliance would be responsible for keeping its actual costs within the target established for that area.,End of Appendix A,Appendix B,Profitability Analysis,Absolute Profitability,Absolute profitability me
25、asures the impact on the organizations overall profits of adding or dropping a particular segment such as a product or customer without making any other changes.,Computing Absolute Profitability,For an Existing SegmentCompare the revenues that would be lost fromdropping that segment to the costs tha
26、t would be avoided.,For a New SegmentCompare the additional revenues from addingthat segment to the costs that would be incurred.,Learning Objective 1,Compute the profitability index and use it to select from among possible actions.,Relative Profitability,Relative profitability is concerned with ran
27、king products, customers, and other business segments to determine which should be emphasized in an environment of scarce resources.,Relative Profitability,Managers are interested in ranking segments if a constraint forces them to make trade-offs among segments.In the absence of a constraint, all se
28、gments that are absolutely profitable should be pursued.,Relative Profitability,Profitability Index,Management of Matrix, Inc. developed the following information concerning its two segments:,Project Profitability Index,The project profitability index is used when a company has more long-term projec
29、ts with positive net present values than it can fund.,From Chapter 14,Project Profitability Index,The net present value of the project goes in the numerator since it represents the incremental profit from the segment.,From Chapter 14,Project Profitability Index,The investment funds are theconstraint
30、, so the amount of investmentrequired by a project goes in the denominator.,From Chapter 14,Quality Kitchen Design: An Example,Quality Kitchen Design: An Example,If managementonly has 46 hours available,which projects should be accepted?,Ranking Based on Profitability Index,Ranking Based on Profitab
31、ility Index,Learning Objective 2,Compute and use the profitability index in volume trade-off decisions.,Volume Trade-Off Decisions,Volume trade-off decisions need to be made when a company must produce less than the market demands for some products due to the existence of a constraint.,Volume Trade-
32、Off Decisions,Volume trade-off decisions need to be made when a company must produce less than the market demands for some products due to the existence of a constraint.,Volume Trade-Off Decisions Example,Matrix, Inc. produces the following three products:,Volume Trade-Off Decisions Example,Matrix,
33、Inc. produces the following three products:,A total of 2,700 minutes,Volume Trade-Off Decisions Example,Matrix, Inc. produces the following three products:,A total of 2,700 minutes,If only 2,200 minutes of machine constrainttime are available, which products shouldbe produced in what quantities?,Fir
34、st we calculate the profitability index for each product.,Volume Trade-Off Decisions Example,Volume Trade-Off Decisions Example,Next we prepare the optimal production plan.,Maximum contribution is $8,600 per week.,Volume Trade-Off Decisions Example,Last, we compute the total contribution marginearne
35、d under the optimal production plan.,Learning Objective 3,Compute and use the profitability index in other business decisions.,Sales Commissions,Sales commissions are based on gross selling price. If you were a salesperson at Matrix, which product would you prefer to sell?,RX200,Sales Commissions,Ho
36、wever, RX200 is the least profitable product,given the current machine constraint. It might bea better idea to base sales commissions on theprofitability index for each product.,Pricing New Products,The price of a new product should cover at least the variable cost of producing it plus the opportuni
37、ty cost of displacing the production of existing products to make it.,Pricing New Products,Matrix, Inc. is planning to introduce a new product WR6000. The variable cost of production is $30 per unit and requires six minutes of constrained machine time per unit.What is the minimum selling price Matri
38、x should charge for product WR6000?,Pricing New Products,The first step is to recognize that the price ofWR6000 must cover its $30 variable cost per unit.,Pricing New Products,The second step is to recognize that producing WR6000 will require displacing production of RX200, VB30, or SQ500.,Since RX2
39、00 has the lowest profitability indexof $3 per minute it should be displaced first.,Pricing New Products,The third step is to compute the opportunity cost per unit associated with displacing production of RX200 ($18 per unit).,$3perminute,6minutesper unit,Pricing New Products,$30,+,The fourth step is to add the variable cost per unit ($30) to the opportunity cost per unit ($18) to arrive at the minimum selling price ($48).,$3perminute,6minutesper unit,$48,End of Appendix B,