Pricing Decision

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Introduction Pricing Decisions and Cost Management
Pricing decisions are management decisions about what to charge for the products and services that companies deliver. To maximize operating income, companies produce and sell units as long as the revenue from an additional unit exceeds the cost of producing it.

Managerial Accounting, 11/e, by Ray Garrison, Eric Noreen, Peter Brewer. 2006, Mc Graw Hill

Major Influences on Pricing Decisions
1 Customers 2 Competitors 3 Costs

The three major influences on pricing decisions

The price of a product or service is the outcome of the interaction between the demand for the product or service and its supply.

Major Influences on Pricing Decisions
1 Customers influence prices through their

Major Influences on Pricing Decisions
2 Competitors influence prices through their

effect on demand. Companies must always examine pricing decisions through the eyes of their customers. Too high a price may cause customers to reject a company’s product.

actions. Alternative or substitute products of a competitor may affect demand and force a business to lower its prices. Fluctuations in the exchange rates of different countries’ currencies also affect pricing decisions.

© 2000 Prentice Hall Business Publishing Cost Accounting: A Managerial Emphasis, 10/e Horngren/Foster/Datar

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Major Influences on Pricing Decisions
3 Costs influence prices because they affect

supply. The lower the cost relative to the price, the greater the quantity of product the company is willing to supply.

Short-run and long-run pricing decisions

Time Horizon of Pricing Decisions
Most pricing decisions are either short run or long run. Short-run decisions typically have a time horizon of less than a year. – Pricing a one-time-only special order – Adjusting product mix and output volume

Time Horizon of Pricing Decisions
Long-run decisions involve a time horizon of a year or longer. – Pricing a product in a major market where price setting has considerable leeway

Time Horizon of Pricing Decisions
Two key differences when pricing for the long run relative to the short run: 1 Costs that are often irrelevant for short-run pricing decisions (fixed costs) are often relevant in the long run. 2 Profit margins in long-run pricing decisions are often set to earn a reasonable return on investment.

Costing and Pricing for the Short Run
The Reinado Corporation operates a plant with a monthly capacity of 500,000 cases of tomato sauce. Reinado is presently producing 300,000 cases per month. Del Valle has asked Reinado and two other companies to bid on supplying 150,000 cases each month for the next four months.

© 2000 Prentice Hall Business Publishing Cost Accounting: A Managerial Emphasis, 10/e Horngren/Foster/Datar

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Costing and Pricing for the Short Run
Cost Per Case Variable manufacturing $38 Variable marketing and distribution 13 Fixed manufacturing 14 Fixed marketing and distribution 15 Total $80

Costing and Pricing for the Short Run
If Reinado makes the extra 150,000 cases, the existing total fixed manufacturing overhead ($4,200,000 per month) would continue, plus an additional $165,000 of fixed overhead will be incurred per month. Total fixed marketing and distribution costs will not change. What price should Reinado bid?

Costing and Pricing for the Short Run
Relevant Costs Variable manufacturing $38.00 Fixed manufacturing 1.10 Total $39.10 $165,000 ÷ 150,000 = $1.10 Any bid above $39.10 will improve Reinado’s profitability in the short run.

Costing and Pricing for the Short Run
Suppose that Reinado believes that Del Valle will sell the tomato sauce in Reinado’s current markets but at a lower price than Reinado. Relevant costs of the bidding decision should include revenues lost on sales to existing customers.

Costing and Pricing for the Long Run
Taquisha Computer Corporation manufactures two brands of computers: Simple Computer (SC) and Complex...
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