Chapter 9 - Pricing External Sales Some of the many factors...

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Pricing External Sales Some of the many factors that can affect pricing decisions include: a. Pricing Objectives: Gain market share Achieve a target rate of return b. Environment: Political reaction to prices Patent or copyright protection c. Demand: Price sensitivity Demographics d. Cost Considerations: Fixed and variable costs Short-run or long-run In most cases, a company does not set prices. Instead, the price is set by the competitive market (laws of supply and demand). These companies are called price takers and price taking often happens when the product is not easily differentiated from competing products, such as farm products (corn or wheat) or minerals (coal or sand). Companies can set prices: (1) where the product is specially made for a customer; (2) when there are few or no other producers capable of manufacturing a similar item; or (3) when a company can effectively differentiate its product or service from others. Target Costing Once a company has identified its segment of the market, it does market research to determine the target price . The target price is the price that the company believes would place it in the optimal position for its target audience. Once the company has determined the target price, it can determine its target cost by setting a desired profit. The difference between the target price and the desired profit is the target cost of the product. The target cost includes all product and period costs necessary to make and market the product. Cost-Plus Pricing When the price is set by the company, price is commonly a function of the product or service. Cost-plus pricing involves establishing a cost base and adding to this cost base a mark-up to determine a target selling price. The size of the mark-up (the "plus") depends on the desired operating income or return on investment (ROI) for the product line, product, or service. The cost-plus pricing formula is expressed as follows: Target selling price = Cost + (Mark-up Percentage X Cost) 6b682aa64eb3a12ba010637fe8e9a1a25002ec2b 1
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The cost-plus approach has a major advantage: it is simple to calculate. However, the cost model does not give consideration to the demand side that is, will the customers pay the price? In addition, sales volume plays a large role in determining per unit costs. The lower the sales volume, the higher the price a company must charge to meet its desired ROI (because fixed costs are spread over fewer units and, therefore, the fixed costs per unit increases). Instead of using both fixed and variable costs to set prices, some companies simply add a mark-up to their variable costs. Using variable costing as the basis avoids the problem of using poor cost information related to fixed cost per unit computations.
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Chapter 9 - Pricing External Sales Some of the many factors...

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