Cost based pricing rules
Download
1 / 67

Cost Based Pricing Rules - PowerPoint PPT Presentation


  • 140 Views
  • Uploaded on
  • Presentation posted in: General

Cost Based Pricing Rules. Ted Mitchell. Pricing Two Views. 1. We give you a good price Price Is Relative To Competition 2. We ask for this in exchange Price = Product + Place + Promotion Price Is A Reflection of Value. There are Price Setters and Price Takers.

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha

Download Presentation

Cost Based Pricing Rules

An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -

Presentation Transcript


Cost Based Pricing Rules

Ted Mitchell


Pricing Two Views

1. We give you a good price

Price Is Relative To Competition

2. We ask for this in exchange

Price = Product + Place + Promotion

Price Is A Reflection of Value


There are Price Setters and Price Takers

A basic idea of marketing is to make your product sufficiently better than your competitors’ product from the customer’s point of view and not to be a price taker.


Pricing Goals

  • Profit

    • long run, short run

  • Sales Revenue (Growth)

  • Market Share (Penetration)

  • Unit Sales Volume (Learning Curve)


Pricing Goals Cont’d

  • Image Maintenance

  • Cash Flow (survival)

  • Competitive Pricing (Stability, Price leader, price taker

    • Avoid price competition


Basics C’s for Pricing

Costs of making the product, etc.

Customer Demand

Competitors


Pricing Methods (Formulas)

  • Cost Based Methods

  • Demand Based Methods

  • Competitive Based (Going Rate, Bidding) Pricing


Cost Based Pricing Is Most Important


Why Cost Based PricingFour Reasons

1 Fair

2 Easy to Calculate

3 Industry Stability

4 “guarantee a profit”


Types of Cost Based Methods

  • Cost Plus (profit)

  • Traditional Markup (Discount rate)

  • Target Return on Investment

  • Discounts & Allowances


Some Costing Is Crude

  • Direct Materials plus

  • Direct Labor plus

  • 300% of Direct Labor (to cover Fixed Costs) plus

  • A 50% Markup plus

  • Competitive adjustment plus

  • What the customer will bear


  • Pricing Formulas Tend To Be The Same Across An Industry

  • Reduces Price Competition


Price Formula Comes From The Basic Profit Formula

Z = (P - V)Q - F


The Basic Cost BasedPricing Formula is

Price Formula Comes From The Basic Profit Formula

Z = (P - V)Q - F


Calculate the Price

Knowing Cost and Profit Targets


The Variable Cost Is Crucial In The Idea Of Pricing Down The Learning Curve


Learning Curve

Variable Cost Per Unit Is Reduced As Experience In Its Production Is Learned


Learning Curve

V

Production Experience


Learning Curve

V

Production Experience


Learning Curve

V

Cumulative


Forecasting Future Variable Cost Is A Very Important Part Of Modern Pricing Strategy!


Variable Cost Is Not Unit Cost

UNIT COST COMBINES

AVERAGE FIXED COSTS

AND VARIABLE COSTS


Basic Cost BasedPricing Formula is

Substitute Unit Cost


Example

“We charge what it costs to make each unit plus a standard approved markup of 10% for our profit.”


Example

“We charge what it costs to make each unit plus a standard approved markup of 10% for our profit.”

Unit Cost is considered the cost to make each unit in a pricing formula


Profit is being measured as a percentage of sales revenue.

Substitute


Profit is being measured as a percentage of sales revenue.

Substitute


Simplify

Substitute


Example

“We charge what it costs to make each unit plus a standard approved markup of 10% for our profit.”


Classic Cost Plus Formula Is

P = Unit Cost + x% of Final Price

P = Unit Cost + x(P)

P - xP = Unit Cost

(1-x)P = Unit Cost

P = Unit Cost

(1- x)


Classic Cost Plus Formula Is

Note: we use unit cost and a target profit margin

P = Unit Cost + x% of Final Price

P = Unit Cost + x(P)

P - xP = Unit Cost

(1-x)P = Unit Cost

P = Unit Cost

(1- x)


Types of Cost Based Formulas

  • Cost Plus (Profit)

  • Traditional Markup Pricing

    (Discount rate)

  • Target Return on Investment

  • Discounts & Allowances


Markup Pricing

  • Very Popular with Retailers

  • It uses the purchase cost of the merchandise which is the Variable cost.

  • The Target Markup which includes the fixed costs and the target profit.


We remember that

  • The target markup for a target profit was

  • Mp* = (F+Z)/ R

  • We consider Mp*(R) = F+Z and substitute into

  • PQ - vQ = F+Z

  • PQ - vQ = Mp*(R)

  • and substitute R = PQ

  • (P-V)Q = Mp*PQ

  • P-V = Mp*P

  • P-Mp*P = V

  • P = V / (1-Mp*) is markup pricing


Another Way

  • Consider the breakeven price with a target profit

  • P = V +(F+Z)/Q

  • Divide both sides by P

  • (1/P)P = V/P + (F+Z)/PQ

  • Where (F+Z)/PQ = Mp = Target markup

  • 1 = V/P +Mp

  • (1-Mp)P = V

  • P = V/(1-Mp)


When you have a target markup, The Markup Pricing Formula Is


Markup Pricing

  • Remember the markup pricing is to cover the total contribution needed to cover the Fixed Costs and the Target Operating Profit!


Types of Cost Based Formulas

  • Cost Plus (Profit)

  • Traditional Markup Pricing

    (Discount rate)

  • Target Return on Investment

  • Discounts & Allowances


Calculating A Price From A Cost Based Formula Is EasierIf They Give You A Target Return or Profit Z in dollars


Then You Get to Substitute For The Profit, Z, and Solve


Example: Target Profit Pricing FormulaA Expected Profit of 15% ROI


Example: Target Profit Pricing FormulaA Expected Profit of 15% ROI


Example: Target Profit Pricing FormulaA Expected Profit of 15% ROI


Target Returns (Profits)Where Do They Come From?


Sources of Targets

  • 1 Deciding What Seems Fair

  • 2 Wanting A Better Return Than Last Year

  • 3 Establishing What They Believe They Can Get

  • 4 Estimated Cost Of Capital

  • 5 Wanting To Stabilize Prices


Types of Cost Based Formulas

  • Cost Plus (Profit)

  • Traditional Markup Pricing

    (Discount rate)

  • Target Return on Investment

    • Weakness Of Cost Based

  • Discounts & Allowances


Basic Cost Based Pricing Formula is


Basic Cost Based Pricing Formula is

Where Does The Q Come From?


Q Can Come From

  • Target Level Of Desired Production

    Percent Of Normal Capacity

  • Sales Forecasts


Cost Structure is Very Important

Total Cost

Dollars

Fixed Cost

Quantity Produced


#1 Percentage Of Normal Capacity

Often Becomes The Bases

For Expected Sales = Q!

Total Cost

Dollars

Fixed Cost

85% of Capacity


#2 Forecasting The Quantity That Will Be Sold From Simple Projections Of Past Sales Is Popular

Time


To Cost Based Pricing You Need To Know

Variable cost , Fixed cost, Target Profit, & Estimate of Future Sales

or Production = Q


The Fundamental Weakness OfCost Based Pricing Is


The Fundamental Weakness OfCost Based Pricing Is

Using An Expected

Sales Forecast, Q,

To Select The Price


Why?

Because Price is Key Factor in Causing Sales

Revenue = f(Price, Promotion, Place, Product)

Price Causes Sales!


Remember

  • The Expected Quantity Of Sales Should NOT Set The Price.

  • The Price Determines The Quantity!


Remember

  • The Expected Quantity Of Sales Should NOT Set The Price.

You Need Sales Estimates Based On The Demand At The Planned Price (i.e. Demand Based Pricing)


Types of Cost Based Formulas

  • Cost Plus (Profit)

  • Traditional Markup Pricing

    (Discount rate)

  • Target Return on Investment

    • Weakness Of Cost Based

  • Discounts & Allowances


Discounts & Allowances

  • Cash Discounts

  • Trade Discounts

  • Quantity Discount

  • Rebates (Cumulative)


Discounts & Allowances

Everything Is A Percentage Off Catalog List Prices

Importance Of Catalog And Pricing Sheet Updates


Cash Discount

3% /10 net 30

  • Encourage prompt payment

  • Reduce cost of credit

  • Industry standard


Trade Or Functional Discount

Straight Percentage Off List

  • Pay For The Functions A Middleman Performs

    • Class A or B Distributor

    • OEM

    • Educational

    • Government


Quantity Discount

  • Must Be Offered To All Customers

  • Must Demonstrate Cost Saving Being Passed On


Rebates & Allowances

  • Cumulative

  • Competitive Rebates (software)

  • Seasonal

  • Advertising Allowances

  • Case Allowances


Shipping Costs

  • FOB origin

  • FOB Destination

    • Phantom Freight

    • Postage Stamp Pricing


Cost Based Pricing Does

  • Not Guarantee Demand

  • Not Guarantee A Net Profit

  • Not Simplify e.g. Managers Confused About Costs

    • Unit cost versus variable cost

    • Sunk costs vs fixed cost

    • Discretionary


ad
  • Login