Transcript Chapter 8: Analyzing Customer Profitability, And Activity

Chapter 8
Pricing, Analyzing Customer
Profitability, and ActivityBased Pricing
The Profit Maximizing Price
 Economic theory focuses on the
“demand function.”
 Own-price elasticity: the higher the
price, the lower the quantity
demanded.
Pricing Special Orders
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Generally, products are not sold for less than full
cost.
In some cases it may be beneficial to charge a
price less than full cost.
Special order.
 Order
will not affect demand for a firm’s other
products (or current sales).
 Company may be better off charging a price below
full cost.
Pricing Special Orders: Example,
Model A Standard Unit Costs
Direct Material:
Direct Labor:
Variable Overhead:
Fixed Overhead:
Total:
$30
$15
$10
$20
$75
Should Quality Lens Company accept
(or reject) a bid for 20,000 lenses for $73
each? It depends on whether there is
“excess capacity.”
Cost-Plus Pricing
 Cost-Plus Pricing is simple, but limited.
 Ignores demand for product.
 Leads to circular pricing schemes for
manufacturers.
 Ignores own-price elasticity.
Cost Plus Pricing – You try it
Costs are as follows:
Variable Mfg cost: $4/unit
Variable Selling cost:
$2/unit
Fixed Mfg cost:
$100,000/year
Fixed S&A cost:
$50,000/year
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Questions
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What price would need to be charged if volume
is 25,000 units produced and sold and desired
profit is $50,000?
What markup on full cost would be necessary to
earn a profit of $75,000 at a volume of 50,000
units?
What markup on total cost would be necessary
to earn a profit of $100,000 on a volume of
100,000 units?
Target Costing
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Target Costing Process:
 Specify features and price.
 Determine desired profit.
 Target cost = price – desired profit.
 Design to meet the target cost.
Change price and/or features if product
cannot be designed to meet target cost.
Analyzing Customer Profitability
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Customer Profitability System (CPM).
 Indirect costs of servicing customers
assigned to cost pools.
 Returns
 Shipments
 Using cost drivers, costs are
assigned to customers
Customer revenues – product costs indirect costs (above) = customer
profitability.
Activity-Based Pricing
1. Activity-Based Pricing uses the same
information as customer profitability.
2. Also called menu-based pricing.
3. Examples include:
a.
b.
c.
d.
e.
f.
Charge for Internet order: $1.25
Charge for phone, fax or mail order: $4.75
Charge per order line item: $1.00
Delivery charge per mile: $0.40
Per pound packing charge: $0.50
Per item restocking fee: $1.00
Present Value Calculations
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For Chapter 9 we need to be able to present
value a single future payment and a stream of
future payments
The present value of a single future cash flow is
what would have to be deposited now earning
i% interest to have that amount of money in n
periods
The present value of a stream of payments is
what would have to be deposited now to earning
i% so that an equal periodic amount could be
withdrawn each period for n periods, starting in
one period from now
The Tables
We will use the tables in your book on
pages 322 and 323 to do these calulations
 Table 1 shows the present value of a
single payment.
 Table 2 shows the present value of an
annuity (an equal periodic payment)
beginning in one period

Try a couple
How much would have to be deposited
now to have $10,000 in 6 years earning
12%?
 First guess
 Then calculate
 This is the same question as “what is the
present value of $10,000 discounted at
12% for 6 years?”
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Answer
10,000 * PV 6/12%
10,000 * 0.5066 = $5066
Time
0
1
2
3
4
5
6
Amount
$5,066
$5,674
$6,355
$7,117
$7,971
$8,928
$10,000
Factor
1.12
1.12
1.12
1.12
1.12
1.12
1.12
Question 2
What would have to be deposited now to
be able to withdraw $10,000 per year for 8
years earning 9%?
 Or what is the present value of an 8 year
annuity earning 9%?
 Start by guessing
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Answer
First guess?
 Use table 2 and multiply $10,000 by the
factor for 8 years at 9%
 PVA 8/9% = 5.5348
 10,000 * 5.5358 = $55,358
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Interest
Payment
0
Balance
$
55,348
1 $
4,981
$10,000
$
50,329
2 $
4,530
$10,000
$
44,859
3 $
4,037
$10,000
$
38,896
4 $
3,501
$10,000
$
32,397
5 $
2,916
$10,000
$
25,313
6 $
2,278
$10,000
$
17,591
7 $
1,583
$10,000
$
9,174
8 $
826
$10,000
$
(0)