Pricing Decisions and Profitability Analysis

Chapter 12

Introduction

Pricing decisions are management decisions about what to charge for the products and services that companies deliver.

To maximise operating profit, companies produce and sell units as long as the revenue from an additional unit exceeds the cost of producing it.

Learning Objectives

Discuss the three major influences on pricing decisions

Distinguish between short-run and long-run pricing decisions

Describe the target-costing approach to pricing

Distinguish between cost incurrence and locked-in costs

Describe the cost-plus approach to pricing

Describe two pricing practices in which non-cost factors are important when setting price

Explain how life-cycle product budgeting and costing assist in pricing decisions

Discuss why revenues can differ across customers purchasing the same product

Apply the concept of cost hierarchy to customer costing

Show how customer-profitability reports can be prepared to highlight differences across customers in their profitability

Learning Objective 1: Discuss the three major influences on pricing decisions

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.

Three influences on pricing

Customers

Competitors

Costs

Customers 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.

Competitors influence prices through their 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.

Costs influence prices because they affect supply. The lower the cost relative to the