Target Pricing

I. Pricing decisions in general

A. Management decisions about what to charge for products and
services to achieve profitability
1. Evaluate demand at different prices
2. Manage costs across the value chain and over the products
life cycle
. !onsider type of mar"et and degree of competition
#. Ma$or influences on demand and supply
1. !ustomers %demand&
2. !ompetition %demand and supply&
. !osts %supply&
!. 'ime hori(on of pricing decisions)dictates which costs are
relevant* how costs are managed* and the profit that needs to be
earned
1. +hort,run pricing decisions
a. 'ime hori(on of less than one year
b. More opportunistic)prices decreased when demand wea" and
increased when strong
c. 'ypes include ad$usting product mi- and output volume in a
competitive mar"et
2. .ong,run pricing decisions
a. 'ime hori(on of one year or longer
b. Price of products in ma$or mar"et with some leeway in
setting price
c. More costs relevant because can alter in long run
d. Earn reasonable rate of return on investment through
setting profit margins
II. Pricing decisions relative to time hori(on
A. +hort run illustration)special order
1. !osts/ necessary information
a. E-isting fi-ed manufacturing overhead costs irrelevant
because no change
b. All direct and indirect variable manufacturing costs
related to special order relevant
c. All material procurement and process,changeover costs
related to special order relevant
d. All nonmanufacturing costs unaffected by accepting special
order irrelevant
e. 0ote that unit costs can mislead
2. !ompetition
a. 1ata on capacity conditions)idle or need to reduce product
to regular customers
b. Minimum price identified
. !ustomers
a. Price must cover incremental costs
b. Price may also need to cover revenues lost on e-isting
sales if price lowered
c. Price may be set at what mar"et will bear if strong
customer demand and limited capacity
#. .ong,run time hori(on
1. #asic concepts)strategic decisions
a. #uyers typically prefer stable %and predictable& prices
over a long time hori(on
b. !ompany must "now and manage costs* over the long run* of
supplying product to customers
2. !alculation of product costs
a. 2ull costs of producing and selling product used to set
price in long run using any costing system* such as
activity,based costing
b. Mar"et,based approach
i. As"s/ 3iven what our customers want and how our
competition will react to what we do* what price should
we charge4
ii. +tarting point for product differentiation industries/
loo" at customers and competitors first* then at cost)
must accept prices set by mar"et
c. !ost,based approach
i. As"s/ 3iven what it costs us to ma"e this product* what
price should we charge that will recoup our costs and
achieve a re5uired return on investment4
ii. +tarting point for product differentiation industries/
loo" at costs first* then consider customers and
competitors
d. Mar"et forces of demand and supply always important
III. 'arget costing for target pricing)a long,run approach to pricing
A. 'arget pricing)a mar"et,based approach
1. 1efinition of target price/ estimated price for product or
service that potential customers will pay
a. 6nderstanding what customers value
b. 6nderstanding how competitors will price competing products
2. Analysis of competitors
a. 7hat to "now/ technologies* products* costs* and financial
conditions
b. 8ow to "now/ customers* suppliers* competitors employees*
and reverse engineering
. 'arget cost
a. #ased on target price and is target price minus target
operating income per unit
b. Estimated long,run cost per unit of a product or service
that enables the company to achieve target operating income
per unit when selling at target price
c. Includes all future costs* both variable and fi-ed
d. Is a target/ something to aim for %lower existing full cost
per unit of product&
#. Implementing target pricing and target costing
1. +tep 1/ 1evelop a product that satisfies needs of potential
customers
2. +tep 2/ !hoose a target price
. +tep / 1erive a target cost per unit by subtracting target
operating income per unit from the target price
9. +tep 9/ Perform value engineering to achieve target cost
a. :alue engineering/ systematic evaluation of all aspects of
the value,chain business functions* with ob$ective of
reducing costs while satisfying customer needs
b. :alue engineering can result in improvements in product
design* changes in materials specifications* or
modifications in process methods
!. !ost,plus pricing and target pricing
a. !ost,plus pricing determines prospective prices that
balance costs* mar"up* and customer reaction
b. 'arget pricing determines product characteristics and
target price on basis of customer preferences and e-pected
competitor responses
c. !ost,plus pricing usually used by providers of uni5ue
products and services
CHAPTER QUIZ
1. Ma$or influences of competitors* costs* and customers on pricing
decisions are factors of
a. supply and demand.
b. activity,based costing and activity,based management.
c. "ey management themes that are important to managers attaining
success in their planning and control decisions.
d. the value,chain concept.
2. +hort,run pricing decisions include
a. pricing a main product in a ma$or mar"et.
b. considering all costs in the value,chain of business functions.
c. ad$usting product mi- and volume in a competitive mar"et while
maintaining a stable price if demand fluctuates from strong to
wea".
d. pricing for a special order with no long,term implications.
. Pritchard !ompany manufactures a product that has a variable cost of
P; per unit. 2i-ed costs total P1*<;;*;;;* allocated on the basis
of the number of units produced. +elling price is computed by
adding a 2;= mar"up to full cost. 8ow much should the selling price
be per unit for ;;*;;; units4
a. P9> b. P9.?< c. P92 d. P<
9. 'he first step in implementing target pricing and target costing is
a. choosing a target price.
b. determining a target cost.
c. developing a product that satisfies needs of potential customers.
d. performing value engineering.
<. 'he best opportunity for cost reduction is
a. during the manufacturing phase of the value chain.
b. during the product@process design phase of the value chain.
c. during the mar"eting phase of the value chain.
d. during the distribution phase of the value chain.
'he following data apply to 5uestions A and ?.
Each month* 8addon !ompany has P2?<*;;; total manufacturing costs %2;=
fi-ed& and P12<*;;; distribution and mar"eting costs %A= fi-ed&.
8addons monthly sales are P<;;*;;;.
A. 'he mar"up percentage on full cost to arrive at the target
%e-isting& selling price is
a. 2<=. b. ?<=. c. B;=. d. 2;=.
?. 'he mar"up percentage on variable costs to arrive at the e-isting
%target& selling price is
a. 2;=. b. 9;=. c. B;=. d. AA
3
2
=.
B. .ong,run pricing
a. needs to cover only incremental costs.
b. only utili(es the mar"et,based approach to pricing and not the
cost,based approach.
c. is a strategic decision.
d. strives for fle-ible pricing that can respond to temporary
changes in demand.
>. 2or long,run pricing decisions* using stable prices has the
advantage of
a. minimi(ing the need to monitor competitorsC prices fre5uently.
b. reducing the need to change cost structures fre5uently.
c. reducing competition.
d. helping build buyer,seller relationships.
1;. 'arget pricing
a. is used for short,term pricing decisions.
b. is one form of cost,based pricing.
c. estimate is based on customers perceived value of the
product.
d. relevant costs are all variable costs.
11. 'o understand how competitors might price competing products a
company
a. needs to understand the competitors technologies and
financial conditions.
b. may get information from suppliers that service the
competitor.
c. may use reverse engineering.
d. may do all of the above.
12. 'he department usually in the best position to identify customers
needs is the
a. production department.
b. sales and mar"eting department.
c. design department.
d. distribution department.
1. Delevant costs for target pricing are
a. variable manufacturing costs.
b. variable manufacturing and variable nonmanufacturing costs.
c. all fi-ed costs.
d. all future costs* both variable and fi-ed.
19. Place the following steps for the implementation of target costing
in order/
A E 1erive a target cost
# E 1evelop a target price
! E Perform value engineering
1 E 1etermine target operating income
a. # 1 A !
b. # A 1 !
c. A 1 # !
d. A # ! 1
1<. 'o design costs out of products is a goal of
a. cost,plus pricing.
b. target costing.
c. "ai(en costing.
d. pea",load costing.
1A. All of the following are true regarding target costing EF!EP'
a. improvements are implemented in small incremental amounts.
b. customer input is essential to the target costing process.
c. input is re5uested from suppliers and distributors.
d. a "ey goal is to minimi(e costs over the products useful
life.
1?. All of the following are associated with target costing EF!EP'
a. value engineering.
b. the mar"up component.
c. all value,chain business functions.
d. cross,functional teams.
1B. 7hen target costing and target pricing are used together*
a. the target cost is established first* then the target price.
b. the target cost is the estimated long,run cost that enables a
product or service to achieve a desired profit.
c. the focus of target pricing is to undercut the competition.
d. target costs are generally higher than current costs.
1>. 'he product strategy in which companies first determine the price
at which they can sell a new product and then design a product
that can be produced at a low enough cost to provide ade5uate
operating income is referred to as
a. cost,plus pricing.
b. target costing.
c. "ai(en costing.
a. full costing.
After conducting a mar"et research study* +chult( Manufacturing
decided to produce a new interior door to complement its e-terior door
line. It is estimated that the new interior door can be sold at a
target price of PA;. 'he annual target sales volume for interior doors
is 2;*;;;. +chult( has target operating income of 2;= of sales.
2;. 7hat are target sales revenues4
a. P>A;*;;;
b. P2*;;;*;;;
c. P1*2;;*;;;
d. none of the above
21. 7hat is the target operating income4
a. P29;*;;;
b. P;;*;;;
c. P1>2*;;;
d. P1B;*;;;
22. 7hat is the target cost4
a. P>;;*;;;
b. P>A;*;;;
c. P1*2A;*;;;
d. P1*;;B*;;;
2. 7hat is the target cost for each interior door4
a. P9B
b. P<B
c. PA;
d. P9<
+heltars ': currently sells small televisions for P1B;. It has costs
of P19;. A competitor is bringing a new small television to mar"et
that will sell for P1<;. Management believes it must lower the price
to P1<; to compete in the mar"et for small televisions. Mar"eting
believes that the new price will cause sales to increase by 1;=* even
with a new competitor in the mar"et. +heltars sales are currently
1;;*;;; televisions per year.
29. 7hat is the target cost if target operating income is 2<= of
sales4
a. P?.<;
b. P9<.;;
c. P112.<;
d. P1<.;;
2<. 7hat is the change in operating income if mar"eting is correct and
only the sales price is changed4
a. P1*1;;*;;;
b. P;;*;;;
c. P%1*1;;*;;;&
d. P%2*>;;*;;;&
2A. 7hat is the target cost if the company wants to maintain its same
income level* and mar"eting is correct4
a. P112.<;
b. P11.A9
c. P12.9
d. P19;.;;