PRICING

DECISION

nsam2019 1
PRICING DECISION
•Each product or service must have a
price that customers willing to pay
•Pricing is important in maximizing a
firm's value
•Price sets has direct impact on the
revenue and profitability of a firm

nsam2019 2
IMPACTS OF PRICING
• Setting low price:
§ May attract more buyers
§ But unit profit will relatively lower

• Setting high price:

§ Has higher unit profit
§ But it might drive out your customers,
thus affecting sales quantity

nsam2019 3
FACTORS INFLUENCING
PRICE SETTING

• Firm’s Policy & Objectives

• Cost Structure
• Competitors’ Price
• Economic Conditions
• Government Regulations
• Business Ethics

nsam2019 4
FACTORS : FIRM’S POLICY &
OBJECTIVES
• It is important to consider company’s
policy & objectives before deciding on
what price to set for the product
• If one of the firm's objectives is “to offer
affordable prices to wide range of
customers”, thus the company should
considers setting low prices for its
products and services.

nsam2019 5
FACTORS : COST STRUCTURE &
PRODUCTION COSTS

• Set price by estimating unit production

cost plus some mark-up
• Useful to ensure production costs are
covered by the price set
• Firms may set a lower price if they
manage to produce their products at
lower costs

nsam2019 6
FACTORS :
COMPETITORS’ PRICES
• It is common to refer to competitors’
prices in setting selling price
• This is to ensure product’s
competitiveness in term of price
• Various pricing strategies: skimming,
penetration, defensive, predatory &
prestige pricing

nsam2019 7
FACTORS :
• Economic Conditions >
• during inflation, setting high price will not
help firms to attain more profits
• Government Regulations >
• ceiling price set by government need to be
observed
• Business Ethics >
• taking too much profit by setting too high
price is unethical as it oppresses the
customers

nsam2019 8
Some common pricing strategies use by
Companies are:
§ Penetration pricing strategies
§ Defensive strategy
§ Predatory strategy
§ Skimming pricing strategies
§ Premium (prestige) pricing strategies
§ Economy pricing strategies
§ Bundle pricing Strategies
§ Psychological pricing strategies

nsam2019 9
 PRICING STRATEGIES
•Penetration strategy – firm lower the price
than those of the competitors to penetrate
the market
•Defensive strategy – firm reduces its price
when competitors reduced their prices
•Predatory pricing – firm lower their price to
drive out new competitors from the market

nsam2019 10
 PRICING STRATEGIES
•Prestige pricing – firm set high price as its
product is intended to have a top-of-the-
line image.
•Skimming pricing – set high price for a new
product when no other competitors in
market

nsam2019 11
•Psychological pricing is the practice of
setting prices slightly lower than rounded
numbers, in the belief that customers do not
round up these prices, and so will treat them as
lower prices than they really are. eg setting
the price of a gadget at RM19.99, rather than
RM20.
•Bundle pricing selling a package or set of goods or
services for a lower price than they would charge
if the customer bought all of them separately. eg
value meals at restaurants and cable TV channel
plans.
•Economy pricing in which a low price is assigned
to a product with decreased production costs

nsam2019 12
PRICING METHODS
•COST-BASED PRICING
• Price is Set Based On Costs Plus Some
Percentage of Profit
• SP = Cost + Mark-up (%)

• MINIMUM PRICING

nsam2019 13
COST-BASED PRICING

•Depend on how much firm wants them to

be covered by the selling price
•Costs may include:
• Variable production costs only
• All variable costs
• Total (full) production costs, or
• Total production plus non-production
costs

nsam2019 14
MINIMUM PRICING

The lowest price that a firm could charge

for each unit sold
The price can just cover incremental cost
of producing the unit and the
opportunity cost of the resourced used
(when firm has scarce resources)
Minimum SP = VC of the
product + specific FC + any
opportunity cost
nsam2019 15
Poser Enterprise produces frozen currypuff in
packets of 10 pieces. The cost data related to
each packet is as follow:

RM/packet
Direct material costs 2.15
Direct labour costs 1.25
Variable factory overhead 0.90
Fixed factory overhead 0.75
Variable selling & other costs 0.55

nsam2019 16
 RM/packet
Direct material costs 2.15
Direct labour costs 1.25
Variable factory overhead 0.90
Fixed factory overhead 0.75
Variable selling & other costs 0.55

Determine for Poser Ent:

1. the Minimum SP
2. SP at variable production cost + 25% mark-up
3. SP at full costs
4. SP at full production cost + 20% mark up
5. SP at full cost + 20% margin

nsam2019 17
Poser Ent:
1. Minimum SP: UVC + Spec. FC + OC:

RM
Direct material Costs 2.15
Direct labour costs 1.25
Variable factory overhead 0.90
Variable selling costs 0.55
Unit Variable Costs: 4.85
Opportunity cost: 0.00
Minimum Price: 4.85

nsam2019 18
Poser Ent:
SP = Variable Production Costs + 25% mark-up
RM
Direct material Costs 2.15
Direct labour costs 1.25
Variable factory overhead 0.90
Total Production costs: 4.30
+ 25% mark-up 1.075
Selling Price: 5.375

nsam2019 19
SP at Full Costs
RM
Direct material Costs 2.15
Direct labour costs 1.25
Variable factory overhead 0.90
Fixed Factory overhead 0.75
Variable selling costs 0.55

Selling Price: 5.60

nsam2019 20
SP at Full Production Cost + 20%
Mark-up
RM
Direct material Costs 2.15
Direct labour costs 1.25
Variable factory overhead 0.90
Fixed Factory overhead 0.75
Total Production costs: 5.05
+ 20% mark-up 1.01
Selling Price: 6.06

nsam2019 21
SP at Full Cost plus 20% Margin

RM
Direct material Costs 2.15
Direct labour costs 1.25
Variable factory overhead 0.90
Fixed Factory overhead 0.75
Variable Selling costs 0.55
Total Production costs: (80%) 5.60
+ 20% margin 1.40
Selling Price: (RM5.60 ÷ 80%) 7.00
nsam2019 22
Target Costing & Target
Pricing
nsam2019 23
TARGET COSTING & TARGET PRICE
• Is a system of profit
planning
and cost managemen
t
• A system of goal
management that de
termine
the life cycle at which
the
proposed product mu
st be
produced in order to
generate a desired le
vel of
profit

SMA - nsam 24
TARGET COSTING
• The costing method in
which the product price
will be established first
and the cost of
manufacturing will be
considered later
• Target cost = Target
Selling Price – Target
Profit
• Thus, Target Price =
Target Cost + Target Profit
SMA - nsam 25
 The characteristics of TC
• The costing that focus on
customers
• Emphasis on cost reduction at
the early stage of product
development
• Considers the whole product
life cycle
• Involve the whole value of
supply chain

SMA - nsam 26
PROCESS IN TARGET COSTING

• Review the market to

establish the appropriate
target selling price
• Determine target profit
margin
• Determine the target cost
• Determine the current cost
to achieve cost reduction
objective
SMA - nsam 27
How to set target price?
Fossa Auto Berhad (FAB) is considering production of
compact hybrid car, which will be known as the
Fabelez. All key competitors produce a small model,
which are aimed at the same market segment. The
average price of these cars in the market is RM50,000.
Total cost of producing a unit of Fabelez has been
estimated at RM45,750. FAB’s shareholders require a
mark-up of 25% on all retail car sales.

Required: Calculate the expected selling price of Fabelez

using:
1. traditional mark-up pricing; explain what will
happen if production goes ahead at this point.
2. target costing; determine the target profit and cost.

SMA - nsam 28
 Fossa Auto Berhad
The expected selling price of Fabelez
using:

1. traditional mark-up pricing: mark-up

25%
• SP = RM45,750 x 125% =
RM57,187.50
• If production goes ahead at this
point, selling at this price, FAB is
losing its competitiveness in the
market.
SMA - nsam 29
 Fossa Auto Berhad
2. In target costing, SP should be set at
RM50,000 or lower.
• Mark-up = 25% on TC; thus profit
margin = 25%/125% = 20% on SP
• Target profit margin = 20% x
RM50,000 = RM10,000
• Target cost = 80% x RM50,000 =
RM40,000
• Cost reduction required: RM45,750
– RM40,000 = RM5,750

SMA - nsam 30
How to reduce costs to achieve
the target costs?
• Cross-functional team:
• A team is set up to manage
target costing
• team members are
responsible to find ways to
cut cost
• Value Engineering:
• Find creative new ways of
achieving the cost reduction
target
SMA - nsam 31
Target costing vs
traditional costing
Target costing Traditional costing
Price is determined Dominated by standard costing
based on the Product is developed first, then
external market expected standard cost is being
analysis determined
Use proactive Use a reactive approach where
approach as price is it considers all production costs
determine first and & other operating costs to
then the total costs determine the selling price
SMA - nsam 32
Target costing vs
traditional costing
Target costing
A desired profit margin is
deducted from the target
selling price to arrive at
the target cost
Product may need to be
redesigned to achieve
target cost.
SMA - nsam
Traditional costing
Profit is allocated and added
to the total costs to
determine the selling price
It is difficult to change the
product as they are already
launched to the market
33
Target costing vs
traditional costing

Target costing Traditional costing

More efficient and focus Cost reduction is only
in keeping costs low as done after product is
costs are determined already developed i.e.
during product planning during manufacturing
& development process, therefore cost
reduction is more
difficult to achieve
SMA - nsam 34
 Target costing vs
traditional costing

Target costing Traditional costing

The price set is based on Price is set based on
the the amount costs incurred to
customer willing to pay produce and sell the
and the features product after adding
prefered by them, thus some profit margin,
it is more competitive in making the price less
the market competitive

SMA - nsam 35
Limitations of Target Costing:
• Unrealistic target costs set
can be very difficult or
impossible to be achieved by
the management
• Workforce would be
demotivated if unable to
achieve unrealistic target
• May lead to dysfunctional
behaviour among the
managers

SMA - nsam 36
nsam2019 37