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