Pricing Decisions, Including Target Costing
and Transfer Pricing
0REVIEWING THE CHAPTER
Objective 1: Identify the objectives and rules used to establish prices of goods and services,
and relate pricing issues to the management process.
A company’s long-term objectives should include a pricing policy. Possible pricing
objectives include (a) identifying and adhering to short-run and long-run pricing strategies,
(b) maximizing profits, (c) maintaining or gaining market share, (d) setting socially
responsible prices, (e) maintaining a minimum rate of return on investment, and (f) being
Pricing strategies depend on many factors and conditions. Identifying the market being
served and meeting the needs of that market are of primary importance. Companies that
make standard products for a competitive market have different pricing strategies from
firms that make products to customers’ specifications.
For a company to stay in business, the selling price of its product or service must (a) be
competitive with the competition’s price, (b) be acceptable to the customer, (c) recover all
costs incurred in bringing the product or service to market, and (d) return a profit. If a
manager deviates from any of these four selling rules, there must be a specific short-run
objective that accounts for the change. Breaking these pricing rules for a long period will
force a company into bankruptcy.
Pricing issues are addressed at each step of the management process. When managers plan,
they must decide how much to charge for each product or service. During the performing
step, the product or service is sold at the specified price or on the auction market. When
managers evaluate performance, they review sales to determine which pricing strategies
were successful and which failed. To communicate about performance inside the
organization, managers prepare analyses of actual and targeted prices and profits.
When making and evaluating pricing decisions, managers must consider many factors, some
relating to the market and others to internal constraints. Factors related to the market include
the demand for the product, customer needs, competition, and the quantity and quality of
competing products or services. Internal constraints include the cost of the product or
service, the desired return on investment, the quality and quantity of materials and labor,
and the allocation of scarce resources.
Objective 2: Describe economic pricing concepts, including the auction-based pricing
method used on the Internet.
The economic approach to pricing is based on microeconomic theory. A product’s total
revenue and total costs are plotted against units produced. Initially, because of fixed costs,
the cost line is above the revenue line, illustrating a loss. When enough products are
produced and sold to cover both variable and fixed costs, the lines cross, illustrating a profit.
However, the lines are destined to cross again. Price competition will eventually bend the