Managerial Accounting: Pricing Strategies and Approaches, Appunti di Sales management

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PricingPricing

Perfect andDemand-basedimperfectapproachescompetition

Cost-based approaches Marketing-basedapproaches

Imperfect competition Monopoly:^ there is only one seller of a good. Themonopolist^ dominates^ buyers^ and

uses^ its^ market

power to set a profit-maximising price. Oligopoly:^ few companies dominate the market and areinter-dependent: reactions of rivals to changes in priceor output must be taken into account. Example: in theUK Tesco, Asda, Sainsbury’s and Morrisons share 74.4%of the grocery market. Monopolistic competition:

products are similar, but

not identical. No business has total control over themarket price.

Illustration – MonopolisticcompetitionConsider the soap market: there are many different brands ofsoap and they are similar. However in some way each soapproduct tries to differentiate itself from competition like: onemight claim to leave you with soft skin, while the other that ithas clean, fresh scent.Each participant has some control over the market price aslong as consumers are willing to buy the product at the newprice.Other examples of monopolistic^

products are: shampoo

products, toothpaste, oil changes.

What is the optimum price and quantity?

• Managerial AccountingDepartment of FinanceHelena NAFFA, PhD29th September,
• Illustration – Tabular approachXYZ Ltd. is introducing a new product. Machinery is hired to manufacture theproduct at a cost of $200,000 per annum, the maximum capacity is 60,000 unitsper annum. Additional machines can be hired at $80,000 per annum and eachadditional machine increases capacity by 20,000 units per annum. Production islimited to a maximum of 90,000 units because of shortage of space.Variable cost is estimated to be $6 per unit.Estimation of Price-Demand are as follows: Units sold 50,000 60,
• 70,000 80,000 90,000 90,
• Selling price $22 $
• $19 $18 $17 $
• Solution – Tabular approach Price^22
• Variable cost^6
• Contribution^16
• Demand 50,000 60,
• 70,000 80,000 90,
• Total contr. 800,000 840,
• 910,000 960,000 990,
• Fixed cost 200,000 200,
• 280,000 280,000 360,
• Profit 600,000 640,
• 630,000 680,000 630,

Optimum price

MC

The optimum price is $50, when Q=3. At output less than Q=3MR>MC and at output greater than Q=3 MC>MR.

Establishing the optimum price Step (1):^ Establish the linear relationship between price (P) and quantitydemanded (Q): P = a + bQ^ , where „a” – is the intercept and „b” is the gradient of the linePrice(P)

Quantity (Q) P= a+bQa Gradient of lineΔP/ΔQ=b 0

Total cost functionCost equations are usually derived from historical data.For now we assume linear cost functions: y= a+ bx , where: „a”: is the fixed cost per period (intercept)„b”: is the variable cost per unit (gradient)„x” is the activity level (independent variable)„y”: is the total cost (dependent variable)

Suppose that the cost equation is as follows:

y = $5000 + 10x

Total cost

Activity level Fixed cost=a=$^

y (total cost)=5,000+ 10x Variable cost=b= $

( 2)Profit may reflect: !Risk of the product !Competitors mark-ups !Desired profit or ROCE (Return on capital employed) !Type of cost used Profit mark-up:^ is the profit as a percentage of the cost Profit-margin:^ is the profit as a percentage of sellingprice

Customer-based pricingThis pricing^ reflects^ customers’

perceptions^ of

benefits. Examples are: convenience, status. Theproduct is priced to reflect these benefits.The approach relates to costs, however it reflectsthe belief that the greater understanding you haveof customers the better placed you are to price theproduct. Illustration:^ the^ offer^ of

food^ and^ drink^ on^ a

remote beach in a hot country will be perceived bytourists as a significant benefit. So they are morelikely to pay an amount in excess of cost.

Different pricing strategiesCost-plus pricingMarket-skimmingPenetration pricingComplementaryproduct pricing

Product-line pricingVolume discountingPrice discriminationRelevant cost pricing

Market-skimming pricingMarket-skimming means to charge high prices when a product is firstlaunched in order to maximise short-term profitability.Conditions when market-skimming is a suitable strategy:(1)The product is new and different, there is little competition.(2)Products that have a short life-cycle and there is a need to recover costsquickly.(3)Where the strength and sensitivity of demand to price is unknown.(4)A firm with liquidity problems can use market-skimming to generate highcash-flows early on.For sustainable skimming one or more significant barriers to entry must bepresent to deter potential competitors. Examples are: patent protection,brand loyalty.