Analysing Strategic Pricing and Product Profitability

Strategic importance of pricing and profitability decisions:

• Price is the only marketing mix that generate money, which affects revenue growth and buyer behaviour.
• Heavily influence to long-term and short term decisions of corporate strategy, which directly affects the creation of shareholder and customer values.
• Major consideration of repositioning the company's competitive landscape, customer perceives about the company's products/services, which includes tangible/intangible attributes.

Pricing approaches:

• Economic Approaches
• Based on laws of supply and demand --> to increase sales need to decrease sales price, thus marginal revenue will decrease as sales volume increase.
• Therefore, it's argued that profits can be increased by increasing sales to the point where marginal revenues equal marginal costs (point of maximum profit: break even point)
• Problems: 
• Difficult to predict demand, up/down trends of uncertainty.
• There're some other business considerations that more important than profit maximisation, for example: gives subsidise price to poor community in order to obey regulation and be a responsible corporation citizen, added price due to funding ecological sustainable process or first mover market penetrations that require lower prices to introduce new product/process.

• Cost-based Approaches
  

• Common approach --> based on % mark-up on identified costs.
• However, the price set still need to be acceptable by customers and also must consider the competitor's reaction to price as well.
• Pricing Process:
• Determine customer wants --> 
• Design product to meet customer wants (step 2)
• Determining manufacturing or service procedures // determine necessary raw materials   --> 
• Determine price (predict selected costs, add mark-up for other costs, add additional mark-up to achieve desired profit) -->
• Evaluate the resulting price:
• If acceptable, manufacture and sell.
• If unacceptable, redesign --> back step 2.
• Determining the mark-up price:
• Variable Cost Approach : 
• Avoids possible misinterpretation of fixed cost behaviour.
• most useful in determining short-term pricing decisions.
• Absorption cost approach:
• Full manufacturing cost
• Fairness in calculating mark-up.
• Activity based approach
• Drawbacks:
• Relies on accurate cost assignment.
• Assumes that customers are willing to pay the price set.
• Can increase the time and cost of bringing new product to market.

• Target Costing Approaches

 

• Customer oriented approach to costing/pricing --> start with what customer is willing to pay and design a product to meet the price.
• Target Cost = Sales Price - Acceptable Profit Margin
• Strength:
• Proactive approach to cost management --> pricing toward meeting customer needs
• Encourage design for manufacture --> To meet the requirements of functionality, quality and price of customers perspectives, thus the company must consider cost of manufacturing and servicing of a product.
• Reduce time to market --> break down barriers and meet directly to customer
• Minimise non-value-adding activities --> reduction or elimination in the activity/process selection to meet target costs requirements.
• Advantageous for products with short-life cycles --> encourages effective planning and design, less opportunity to make continuous improvements.
• Drawbacks:
• Detailed cost data required --> to choose the best activity alternatives
• Required more cooperation and coordination between functional units --> may be problematic if there are cultural/political tensions between functional areas.

• In seeking greater profitability, managers may be attempted to use pricing to gain unethical advantages over competitors, such as:
• Predatory pricing --> reducing prices (to a low level) with the intentions of forcing competitors out of the market.
• Price discrimination --> different prices, discounts, services or payments terms are offered to different customers for the same goods/services.
• Resale price maintenance --> when a supplier dictates the minimum resale price
• Price-fixing contracts --> fixing, controlling, or maintaining prices between competitors.
• To control: Trade Practices Act 1974, and Australian Competition and Customer Commissions (ACCC)

Pricing for Internal Customers -- Transfer Pricing

• To accomodate the growth of internal customers and to make divisions accountable --> management must consider how transfer goods to internal customers should be reported
• Internal value assigned to a product/services provided by one division to another.
• Methods to charge price"
• Market Price:
• used when there is an established (and competitive) market price for the good/service transferred.
• Compare to outside sales, managers may choose to remove their selling expenses.
• free to source requirements from outsider.
• Variable Costs:
• appropriate methods if company has excess capacity.
• However, the supplying divisions could not report profit from transfers made/loss equal to fixed costs.
• Absorption Cost plus mark-up
• include all variable and fixed manufacturing costs.
• avoids problems due to fixed costs from supplying division.
• allows for recovery of unallocated costs
• Considerations: individual divisions may attempt to maximise their own performances, but this may be to detriments overall corporate performances.

Profitability Analysis

• Cost-Volume-Profit (CVP) Analysis
• Contribution Income Statement