Introduction to pricing methods and policies

1. Price decisions
and profitability analysis
Management Accounting
Mukhtar Mankeyev
21 Feb 2013

2. INTRODUCTION TO THE ARTICLE
 Accounting information is an important input to
pricing decision;
 Setting of prices depend on organization’s business
and production strategy: customized, differentiated,
etc.;
 It is important to operate right cost information to
make a price decision;
 Accounting information play a big role in determining
the selling prices;
 Main theoretical solution to pricing decision is
derived from economic theory, BUT it’s only for
theoretical understanding.
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3. PRICE TAKERS AND SETTERS
There are two types of companies:
1. Price takers
2. Price setters
Four different situations to determine product pricing:
1. A price setting firm facing short-run pricing decisions;
2. A price setting firm facing long-run pricing decisions;
3. A price taker firm facing short-run product-mix
decisions;
4. A price taker firm facing long-run product-mix decisions.
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4. SHORT-RUN PRICING DECISION
Companies bidding for a one-time special order in
competition with other suppliers
ONLY incremental costs should be taken into account:
- extra materials required to fulfil the order;
- any extra part-time labour, overtime or other labour costs;
- extra energy and maintenance costs for machinery equipment and
equipment required to complete the order.
NOTE: Batch, product and service-sustaining activities
resources usually already been acquired and in most cases
no extra costs on the supply of activities are likely to be
incurred
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5. LONG-RUN PRICING DECISION
Three approaches of long-run pricing decision:
1. Pricing customized products;
2. Pricing non-customized products;
3. Target costing for pricing non-customized products.
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6. PRICING CUSTOMIZED PRODUCTS
In the long-run firms Product/Service should
can adjust the supply of be priced to cover all of
virtually all of their the resources that are
activity resources committed to it
Full cost and long-run cost – the sum of the cost of all those
resources committed to a product in the long-term
Facility-sustaining Shouldn’t be allocated to products
costs are incurred to for most decision (arbitrary).
support the Such costs must be covered by
organization as a sales revenues, and for pricing
whole and not for purposes their allocation can be
individual (customized) justified as long as they are
products separately reported
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7. PRICING NON-CUSTOMIZED PRODUCTS
Applicable to make a pricing decision for large and
unknown volumes of a single product
The unit cost calculation indicates the break-even
selling price at each sales volume required to cover
the cost of the resources committed at that particular
volume
Management MUST assess the likelihood of selling the
specified volumes at the designated prices and choose
the price which they consider has the highest
probability of generating at Mukhtar Mankeyev specified sales
7
least the

8. PRICING NON-CUSTOMIZED PRODUCTS
USING TARGET COSTING
Stages of target costing:
1. Determine the target price which customers will be prepared to
pay;
2. Deduct a target profit margin from the target price to determine the
target cost;
3. Estimate the actual cost of the product;
4. If estimated actual cost exceeds the target cost investigate ways of
driving down the actual cost to the target.
Most suited for setting prices for non-customized and high
sales volume products
Important mechanism for managing the cost of the future
products
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9. COST-PLUS PRICING
Method using for price setting when impossible to estimate demand and
where cost is used as the starting point to determine the selling price
Mark-up Cost-plus
Cost base $ percentage, selling price,
% $
1 Direct variable costs 200 150 500
2 Direct non-variable costs 100
3 Total direct costs 300 70 510
4 Indirect costs 80
5 Total cost (excluding higher level 380 40 532
sustaining costs)
6 Higher level sustaining costs 60
7 Total costs 440 20 528
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10. PRICING POLICIES
1. Price-skimming policy: attempt to
exploit those sections of the market that
are relatively insensitive to price
changes.
2. Penetration pricing policy: based on
concept of charging low prices initially
with the intention of gaining rapid
acceptance of the product.
3. Product life cycle: consisting of four
stages as introductory, growth, maturity
and decline.
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11. CUSTOMER PROFITABILITY ANALYSIS
 Provides important information that can be used to
determine which classes of customers should be
emphasized or
de-emphasized and the price to charge for customer
services;
 Identifies the characteristics of high cost and low cost to
serve customers and shows how customer profitability can
be increased;
 Can be used to rank customers by order of profitability
based on Pareto analysis.
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12. Thank you for attention!
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