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Unformatted text preview: Module 20
Pricing and Other Product Management Decisions
©Cambridge Business Publishers, 2009 The Value Chain The set of valueproducing activities that stretches from basic raw materials to the final consumer All entities along the value chain depend on the final customer’s perception of the value and cost of a product or service
Goal of every organization is to maximize the value, while minimizing the cost of a product or service to final customers Each product or service has a separate value chain ©Cambridge Business Publishers, 2009 Three Levels of the Value Chain The value chain for the paperboard cartons used to package beverages shows three levels with each successive level showing more detail. Exhibit 20.1 ©Cambridge Business Publishers, 2009 First level: Business entities Refining the value chain into processes helps management understand how entities within the chain add and incur costs Second level: Processes Collections of related activities intended to achieve a common purpose Third level: Activities The units of work
©Cambridge Business Publishers, 2009 Three Levels of the Value Chain Value Chain Perspective Fosters focus on core competencies Relationships with suppliers often begin to represent an extended family Creates a competitive advantage Suppliers can focus on efficient, lowcost manufacturing Manufacturer can focus on marketing and product development ©Cambridge Business Publishers, 2009 Fosters supplierbuyer partnerships Buyers deal with a reduced number of suppliers Relationships involve sharing customer and other data (internal processes) Value Chain Perspective Common value chain is studied Often process modifications are made to reduce overall costs and share increased profits Virtual integration is the use of information technology and partnerships to allow entities along a value chain to act as if they are one economic entity.
©Cambridge Business Publishers, 2009 SupplierBuyer Partnership Example
JC Penney has a partnership with TAL, a company in China that manufactures shirts. TAL monitors JC Penney’s shirt inventory in individual stores remotely, orders inventory replacements, and within a couple of days produces and ships the shirts directly to a specific JC Penney store. Source: Hirsch, Steve. E-Management - Suppliers Become Closer Partners © International Trade Centre, International Trade Forum, Issue 3/2005. ©Cambridge Business Publishers, 2009 The Pricing Decision Important and complex decision for management Directly affects the salability and profitability of individual products or services Two pricing theories
Economic approaches Costbased approaches ©Cambridge Business Publishers, 2009 Economic Approaches to Pricing Provide a useful framework for thinking about pricing decisions Based on cost and revenue functions Marginal revenue The varying increment in total revenue derived from the sale of an additional unit Marginal cost The varying increment in total cost required to produce and sell an additional unit of product Despite their conceptual merit, economic
models are seldom used for pricing decisions. ©Cambridge Business Publishers, 2009 CostBased Approaches to Pricing Cost has traditionally been the most important consideration in pricing because Cost data are available. Costbased prices are defensible. Feasible for setting prices in a short period of time Managers can argue they represent a fair profit Revenues must exceeds costs if the firm is to remain in business. Long run selling price must exceed the full cost of each unit ©Cambridge Business Publishers, 2009 CostBased Pricing for a New Product
Begin with market research
Exhibit 20.3 Proposed price Proposed price should be evaluated based on competition and what customers are willing to pay. ©Cambridge Business Publishers, 2009 Known data are entered into the profit formula
Example: Lawn Chopper mows lawns and has an annual facilities cost totaling $110,000. Each lawn mowed costs $18. Management desires to achieve an annual profit of $25,000 at an annual volume of 4,000 lawns. Profit = Total revenues – Total costs $25,000 = (Price × 4,000) – ($110,000 + [$18 × 4,000]) Price = $51.75 per lawn A price of $51.75 per lawn will allow Lawn Chopper to achieve its desired profit totaling $25,000. ©Cambridge Business Publishers, 2009 CostBased Pricing in SingleProduct Companies CostBased Pricing in MultipleProduct Companies Desired profits are obtained for entire company Standard procedures are established for determining initial selling prices of each product Typically include Cost assigned to the product or services Plus a markup to cover unassigned costs and to provide a profit ©Cambridge Business Publishers, 2009 Possible cost bases for markups based on behavior and function Pricing Bases in MultipleProduct Companies
Direct materials costs Variable manufacturing costs Variable manufacturing, selling, and administrative costs Full manufacturing costs ©Cambridge Business Publishers, 2009 Markup on Cost Base
General approach to developing a markup is to recognize that the markup must be large enough to provide for costs not included in the base, plus a profit
Markup on cost base = Costs not included in the base + Desired profit Costs included in the base ©Cambridge Business Publishers, 2009 Variable Cost Basis Example
Lawn Chopper has total assets of $320,000. Management desires an annual return of 9% on total assets. Fixed costs and expenses total $50,000, and variable costs and expenses total $180,000. Estimated variable costs per unit equals $15. Desired annual profit = 9% × $320,000 = $28,800 Markup on Variable Costs $50,000 + $28,800 $180,000
©Cambridge Business Publishers, 2009 = 0.438 Selling price = $15 + ($15 × 0.438) = $21.57 Full Manufacturing Cost Basis Example
Lawn Chopper’s fixed costs and expenses total $50,000, of which $10,000 are selling and administrative costs. Total variable costs and expenses are $180,000, with $30,000 of this amount selling and administrative costs. Estimated variable costs per unit equals $15, of which $1 is selling and administrative costs. Desired annual profit = 9% × $320,000 = $28,800 Markup on Full Manufacturing Cost $10,000 + $30,000 + $28,800 = 0.362 $190,000 Selling price = $14 + ($14 × 0.362) = $19.07 Selling and administrative costs must be covered. ©Cambridge Business Publishers, 2009 CostBased Pricing for Special Orders
Used to bid on unique projects If the project requires The desired profit on the special order or project should allow for an adequate return on the additional investment Dedicated assets, or Acquisition of new fixed assets, or An investment in employee training ©Cambridge Business Publishers, 2009 Critique of CostBased Pricing If costbased pricing does not have accurate cost assignments, some products could be priced too high and others too low. The higher the portion of unassigned costs, the greater is the likelihood of over or underpricing individual products. Costbased pricing assumes goods or services are relatively scarce and, generally, customers who want a product are willing to pay the price. In a competitive environment, costbased approaches increase the time and cost of bringing new products to market. ©Cambridge Business Publishers, 2009 Starts with determining what customers are willing to pay for a product or service Then subtracts a desired profit on sales to determine the allowable cost of the product or service Allowable cost = Target cost of product or service Target Costing Cost is communicated to the target costing team Team must design a product that meets customer price, function, and quality requirements while providing the desired profit
©Cambridge Business Publishers, 2009 Reflects the belief that costs are best managed by decisions made during product development Helps orient employees toward the final customer Reinforces the notion that all departments within the organization and through the value chain must work together Target Costing and Cost Management ©Cambridge Business Publishers, 2009 Target Costing in a Competitive Environment
Exhibit 20.4 ©Cambridge Business Publishers, 2009 Target costing keeps the customer's function, quality, and price requirements in the forefront at all times. Design for manufacturers Encouraging Design for Production Target costing forces product design engineers to explicitly consider the costs of manufacturing and servicing a product while it is being designed Examples Placing a side access panel in an appliance for easy access for repairs Using standardsize parts to reduce inventory Using molded parts to avoid assembling ©Cambridge Business Publishers, 2009 Eliminates the evaluation of marketability of a product at a costplus price and having to recycle the design though several departments Involving vendors makes the vendors aware of the necessity of meeting a target cost Time Reduction to Introduce Products Facilitates concurrent engineering of components to be produced outside the organization and reduces time to obtain components ©Cambridge Business Publishers, 2009 Pros and Cons of Target Costing
Exhibit 20.5 ©Cambridge Business Publishers, 2009 A costing approach focused on continuous improvement Calls for establishing cost reduction targets for products or services Begins where target costing leaves off Often found in companies that have adopted a lean production philosophy
Successful world class companies use Kaizen to avoid complacency. Kaizen Costing ©Cambridge Business Publishers, 2009 Benchmarking A systematic approach to identifying best practices to help an organization take action to improve performance Typically deals with Target costs for a product, service or operation Customer satisfaction Quality Benchmarking is no Inventory levels longer regarded as Inventory turnover spying. Cycle time Productivity ©Cambridge Business Publishers, 2009 Provides measurements in setting goals Can lead to dramatic innovations Can help overcome resistance to change Typical benchmarking steps
1. 2. 3. 4. 5. 6. Benchmarking Decide what to benchmark Plan the benchmark project Understand your own performance Study others Learn from the data Take action ©Cambridge Business Publishers, 2009 Appendix A: Quality Costs You are not responsible for this material. ©Cambridge Business Publishers, 2009 ...
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This note was uploaded on 11/08/2010 for the course ACC 5056 taught by Professor J.goslinga during the Spring '10 term at University of Florida.
- Spring '10