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Understanding Cost and Pricing Decisions: Key Concepts and Analysis Techniques

This chapter delves into various aspects of cost and pricing decisions crucial for businesses. It covers the perspectives of buyers, competitors, suppliers, and sellers on costs, and introduces essential cost concepts such as direct, indirect, common costs, and opportunity costs. Moreover, it explores cost behavior determinants and their implications for profitability, emphasizing the importance of break-even analysis. By highlighting decision-making strategies to manage costs and revenues, this chapter serves as a valuable guide for optimizing pricing strategies and achieving financial stability.

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Understanding Cost and Pricing Decisions: Key Concepts and Analysis Techniques

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  1. Chapters 10 Cost and Pricing Decision

  2. Whose Cost? • Buyer’s cost – value analysis. • Competitor’s cost – competitor’s staying power and floor of retaliation. • Supplier’s cost – ability to develop and maintain a cost advantage. • Seller’s cost – pre-priced early in the R&D process; important to establish the price floor

  3. Cost Concepts • Direct cost – traceable and attributable directly to the product. • Indirect traceable cost – using some objective logic. • Common or general cost – can not be objectively traced to a product. • Opportunity cost – marginal income forgone by choosing one alternative over another; cost of not choosing the best alternative. • Cash and non-cash cost – Costs that lead to out of pocket or cash outlays or book-keeping (depreciation or amortization) enties. Cash flow = net income + depreciation + depletion + amortization

  4. Cost Behavior • Determinants of cost behavior – intrinsic and extrinsic. • Issue of recovering cost – full cost recovery; partial cost recovery based on contribution; hierarchy • Direct product, customer or sales territory cost. • Number 1 plus desired contribution to the costs of product, customer groups and sales region. • Number 1 and 2 plus contribution to the division, cost center, or total organization.

  5. Elements of profitability • Price per unit (Pi) • Cost: Variable cost per unit (VCi) and Fixed cost per period (FC) • Volume produced and sold (Qi) • Dollar sales mix of the offering.

  6. Break-Even Analysis • Decisions that convert costs from variable to fixed or vice versa. • Decision that reduce or increase costs. • Decision that increase sales volume or revenue. • Decision to change selling price.

  7. Break-Even Analysis BEQ = FC / (P-VC) 1 BEQ = Break even sales quantity FC = Fixed cost per period P = Price VC = direct variable cost per unit. BES = FC/PV 2 BES = Break even in sales revenue PV = profit volume or PV ratio PV = (P-VC)/P 3 Profit = (sales revenue x PV) – Fixed cost 4 PV = (Target profit +Fixed expense)/Sales revenue 5

  8. Break-Even Analysis Some limitations: • Variable costs remain proportional to volume at all output levels. • Costs are relevant over a limited range of volume.

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