Pricing, Analyzing Customer Profitability, and Activity-Based Pricing

1
Chapter 8

• Pricing, Analyzing Customer Profitability, and
  Activity-Based Pricing

2
The Profit Maximizing Price

• Economic theory focuses on the demand function.
• Own-price elasticity the higher the price, the
  lower the quantity demanded.

3
Pricing Special Orders

• Generally, products are not sold for less than
  full cost.
• In some cases it may be beneficial to charge a
  price less than full cost.
• Special order.
• Order will not affect demand for a firms other
  products (or current sales).
• Company may be better off charging a price below
  full cost.

4
Pricing Special Orders Example, Model A Standard
Unit Costs
Direct Material 30 Direct Labor 15 Variable
Overhead 10 Fixed Overhead 20 Total 75
Should Quality Lens Company accept (or reject) a
bid for 20,000 lenses for 73 each? It depends on
whether there is excess capacity.
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Cost-Plus Pricing

• Cost-Plus Pricing is simple, but limited.
• Ignores demand for product.
• Leads to circular pricing schemes for
  manufacturers.
• Ignores own-price elasticity.

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Cost Plus Pricing You try it

• Costs are as follows
• Variable Mfg cost 4/unit
• Variable Selling cost 2/unit
• Fixed Mfg cost 100,000/year
• Fixed SA cost 50,000/year

7
Questions

• What price would need to be charged if volume is
  25,000 units produced and sold and desired profit
  is 50,000?
• What markup on full cost would be necessary to
  earn a profit of 75,000 at a volume of 50,000
  units?
• What markup on total cost would be necessary to
  earn a profit of 100,000 on a volume of 100,000
  units?

8
Target Costing

• Target Costing Process
• Specify features and price.
• Determine desired profit.
• Target cost price desired profit.
• Design to meet the target cost.
• Change price and/or features if product cannot be
  designed to meet target cost.

9
Analyzing Customer Profitability

• Customer Profitability System (CPM).
• Indirect costs of servicing customers assigned to
  cost pools.
• Returns
• Shipments
• Using cost drivers, costs are assigned to
  customers
• Customer revenues product costs - indirect
  costs (above) customer profitability.

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Activity-Based Pricing

• Activity-Based Pricing uses the same information
  as customer profitability.
• Also called menu-based pricing.
• Examples include
• Charge for Internet order 1.25
• Charge for phone, fax or mail order 4.75
• Charge per order line item 1.00
• Delivery charge per mile 0.40
• Per pound packing charge 0.50
• Per item restocking fee 1.00

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Present Value Calculations

• For Chapter 9 we need to be able to present value
  a single future payment and a stream of future
  payments
• The present value of a single future cash flow is
  what would have to be deposited now earning i
  interest to have that amount of money in n
  periods
• The present value of a stream of payments is what
  would have to be deposited now to earning i so
  that an equal periodic amount could be withdrawn
  each period for n periods, starting in one period
  from now

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The Tables

• We will use the tables in your book on pages 322
  and 323 to do these calulations
• Table 1 shows the present value of a single
  payment.
• Table 2 shows the present value of an annuity (an
  equal periodic payment) beginning in one period

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Try a couple

• How much would have to be deposited now to have
  10,000 in 6 years earning 12?
• First guess
• Then calculate
• This is the same question as what is the present
  value of 10,000 discounted at 12 for 6 years?

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Answer

• 10,000 PV 6/12
• 10,000 0.5066 5066

Time Amount Factor
0 5,066 1.12
1 5,674 1.12
2 6,355 1.12
3 7,117 1.12
4 7,971 1.12
5 8,928 1.12
6 10,000 1.12
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Question 2

• What would have to be deposited now to be able to
  withdraw 10,000 per year for 8 years earning 9?
• Or what is the present value of an 8 year
  annuity earning 9?
• Start by guessing

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Answer

• First guess?
• Use table 2 and multiply 10,000 by the factor
  for 8 years at 9
• PVA 8/9 5.5348
• 10,000 5.5358 55,358

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Interest Payment Balance
0 55,348
1 4,981 10,000 50,329
2 4,530 10,000 44,859
3 4,037 10,000 38,896
4 3,501 10,000 32,397
5 2,916 10,000 25,313
6 2,278 10,000 17,591
7 1,583 10,000 9,174
8 826 10,000 (0)