Slide 8-1
Prepared by
Debby Bloom-Hill
CMA, CFM
CHAPTER 8
Pricing Decisions, Analyzing
Customer Profitability, and
Activity-Based Pricing
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Pricing Decisions
 Pricing decisions are often the most
difficult decisions that managers face.
 Topics examined in this chapter
include:
 Pricing from the standpoint of economic
theory.
 Pricing of special orders.
 Cost-plus pricing and target costing.
 Measuring customer profitability and
activity based pricing.
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The Profit Maximizing Price
 Economic theory suggests that the
quantity demanded is a function of
the price that is charged.
 Generally, the higher the price, the
lower the quantity demanded.
 If managers can estimate the quantity
demanded at various prices,
determining the optimal price is
straightforward.
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Estimating Demand
 The most difficult part of determining
the profit maximizing price is
determining the demand function.
 A number of approaches can be used:
 Sales managers in various regions
could estimate the total quantity
demanded at various prices.
 The product could be test marketed
with a number of potential customers
at various prices.
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Estimating the Profit
Maximizing Price
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Pricing Special Orders
 Special orders are for goods and
services not considered part of a
company’s normal business.
 Prices charged and sales to existing
customers are not affected.
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Special Orders – Premier Lens
Example
Should Premier Lens accept special order of
20,000 lenses to be sold to Blix Camera for
$73 per lens?
Below is the full cost of $75 per lens
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Special Orders – Premier Lens
Example
 Fixed costs are not incremental, they will
not change if the order is accepted.
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Cost-Plus Pricing
 With a cost plus approach, the
company starts with an estimate of
product cost, typically excluding any
selling or administrative costs.
 Adds a markup to arrive at a price that
allows for a reasonable level of profit.
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Cost-Plus Pricing
 Advantages:
 The cost plus approach is simple to
apply.
 The company will earn a reasonable
profit if a sufficient quantity can be sold
at the specified price.
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Cost-Plus Pricing
 Limitations:
 Determination of an appropriate markup
requires considerable judgment.
 Experimentation with different markups
may be necessary.
 Inherently circular for manufacturing
firms.
 Need to estimate demand to determine the
level of manufacturing capacity (a fixed
cost) required which affects the price, yet
the price affects the quantity demanded.
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Target Costing
 Studies have shown that once a product
is designed, it is difficult to make
changes that reduce costs.
 80% of a product’s costs cannot be
reduced once it is designed.
 Product features drive costs.
 Target costing is an integrated approach to
determine price, costs and design features
to achieve a desired profit.
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Target Costing
 The process begins with an analysis of
competing products.
 This leads to a specification of features
and price attractive to customers.
 The second step is to specify a desired level
of profit.
 Then the engineering department with input
from the cost accounting department
develops a design that can be produced at a
cost which will earn the desired profit.
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Analyzing Customer Profitability
 Customer Profitability Measurement
System (CPM):
 Indirect costs of servicing customers are
assigned to cost pools.
 Examples include cost of processing
orders, handling returns, shipments etc.
 Costs are allocated to specific customers
using cost drivers to determine customer
profitability.
 Subtracting these costs and product costs
from customer revenue yields a measure
of customer profitability.
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Activity-Based Pricing
 Customers are presented with separate
prices for services they request in
addition to the cost of goods
purchased.
 Customers will carefully consider the
services they request.
 May lead them to impose less cost on
the supplier.
 Also called menu-based pricing.
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 © 2010 John Wiley & Sons, Inc. All rights
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