CostInformation

for

Pricing

and

ProductPlanningChapter6CostInformation

for

Pricing

a1RoleOfProductCostsInPricingAndProductMixDecisionsUnderstandinghowtoanalyzeproductcostsisimportantformakingpricingdecisions:ManagersmakedecisionsaboutestablishingoracceptingapricefortheirproductsEvenwhenpricesaresetbythemarketandthefirmhaslittleornoinfluenceonproductprices,managementstillhastodecidethebestmixofproductstomanufactureandsellRoleOfProductCostsInPrici2RoleofProductCostsProductcostanalysisisalsosignificantwhenafirmisdecidinghowbesttodeploymarketingandpromotionresourcesHowmuchcommission(orhowmanyotherincentives)toprovidethesalesforcefordifferentproductsHowlargeadiscounttoofferofflistpricesRoleofProductCostsProductc3Short-termandLong-term

PricingConsiderationsThecostsofmanyresourcesarelikelytobecommittedcostsintheshort-termbecausefirmscannoteasilyalterthecapacitiesmadeavailableformanyproductionandsupportactivitiesForshort-termdecisions,itisimportanttonotewhethersurpluscapacityisavailableforadditionalproduction,orwhethershortagesofavailablecapacitylimitadditionalproductionalternativesShort-termandLong-term

Prici4Short-termandLong-term

PricingConsiderations

Thelengthoftimeafirmmustcommititsproductioncapacitytofillthatorderisimportantbecausealong-termcapacitycommitmenttoamarginallyprofitableordermay:Preventthefirmfromdeployingitscapacityformoreprofitableproductsororders,shoulddemandforthemariseinthefutureForcethefirmtoaddexpensivenewcapacitytohandlefuturesalesincreasesShort-termandLong-term

Prici5Short-termandLong-term

PricingConsiderations

Ifproductionisconstrainedbyinadequatecapacity,managersneedtoconsiderwhetherovertimeproductionortheuseofsubcontractorscanhelpaugmentcapacityintheshorttermInthelongterm,managershaveconsiderablymoreflexibilitytoadjustthecapacitiesofactivityresourcestomatchthedemandfortheminproducingvariousproductsDecisionsaboutwhethertointroducenewproductsoreliminateexistingproductshavelong-termconsequencesShort-termandLong-term

Prici6AbilityToInfluencePrices

Ifthefirmisoneofalargenumberoffirmsinanindustry,andifthereislittletodistinguishtheproductsofdifferentfirmsfromeachother:Suchafirmisapricetaker,anditchoosesitsproductmixgiventhepricessetinthemarketplaceforitsproductsAbilityToInfluencePricesIf7AbilityToInfluencePricesFirmsinanindustrywithrelativelylittlecompetition,whoenjoylargemarketsharesandexerciseindustryleadership,mustdecidewhatpricestosetfortheirproductsFirmsinindustriesinwhichproductsarehighlycustomizedorotherwisedifferentiatedfromeachotheralsoneedtosetthepricesfortheirdifferentiatedproductsSuchfirmsarepricesettersAbilityToInfluencePricesFir8PriceTakersAsmallfirm,orafirmwithanegligiblemarketshareinthisindustry,behavesasapricetakerIttakestheindustrypricesforitsproductsasgivenandthendecideshowmanyunitsofeachproductitshouldproduceandsellPriceTakersAsmallfirm,ora9Short-TermDecisionsforPriceTakersApricetakershouldproduceandsellasmuchasitcanofallproductswhosecostsarelessthanindustrypricesManagersmustdecidewhichcostsarerelevanttotheshort-termproductmixdecisionManagersmayhavelittleflexibilitytoalterthecapacitiesofsomeofthefirm’sresourcesintheshort-runShort-TermDecisionsforPrice10Example-GarmentManufacturerChunlingCompanythatsellsfivetypesofready-madegarmentstodiscountstoressuchasKmartandWal-MartThecompanyisoperatingatfullcapacityandiscontemplatingshort-termadjustmentstoitsproductmixItisnecessaryforthecompanytodetermine:WhatcostswillvarywithproductionlevelsinthisperiodWhatcostswillremainfixedwhenachangeoccursintheproductionmixExample-GarmentManufacturer11Example-GarmentManufacturerThecostsofutilities,plantadministration,maintenance,anddepreciationforthemachineryandplantfacilitywillnotalterwithachangeintheproductmix,becausetheplantisoperatingatfullcapacityVaryingwiththequantityofeachgarmentproducedare:ThecostsofdirectmaterialsThedirectlaborthatispaidonapiece-ratebasisInspectorsarepaidamonthlyfixedsalary,buttheyareemployedasrequiredtosupporttheproductionofdifferentgarmentsExample-GarmentManufacturer12Example-GarmentManufacturer

Ifitscapacitywereunlimited,thecompanycouldproducegarmentstofillthemaximumdemandforthemCapacityisconstrained,however,andthereforethecompanymustdecidehowbesttodeploythislimitedresourceThecapacityisfixedintheshort-term,sothecompanymustplanproductiontomaximizethecontributiontoprofitearnedforeveryavailablemachinehourusedExample-GarmentManufacturer13TheImpactOfOpportunityCostsIfthegarmentmanufacturerreceivesaspecialorderrequest,itwouldhavetodecidetheminimumpriceitwouldacceptBecauseitsproductioncapacityislimited,thecompanymustcutbacktheproductionofsomeothergarmenttoenableittoproducethegoodsforthespecialorderGivinguptheproductionofsomeprofitableproductresultsinanopportunitycost,whichequalsthelostprofitonthegarmentsthatthecompanycannolongermakeTheImpactOfOpportunityCost14TheImpactOfOpportunityCosts

ThelostprofitinthiscasewouldbethecontributiononthegoodsitwillnotmakeTheproductwiththelowestcontributionperhourshouldbesacrificedTheprofit(contribution)lostonthoseproductswouldneedtobecoveredbythepriceofthespecialorderTheImpactOfOpportunityCost15Short-TermPricingDecisions

forPriceSettersInmanybusinesses,potentialcustomersrequestthatsuppliersbidapriceforanorderbeforetheydecideonthesupplierwithwhomtheywillplacetheorderShort-TermPricingDecisions

f16DeterminingaBidPrice

Assumethatthefullcostsforthejobareestimatedtobe$28,500Settingthepriceofaproductalsomeansdeterminingamarkuppercentageabovecost,anapproachknownascost-pluspricingCost-pluspricing-themarkuppercentageisdeterminedbyacompany’sdesiredprofitmarginandoverallrateofreturnThecompanyhasdecidedthemarkuppercentageisnormallytobe40%offullcostsDeterminingaBidPriceAssume17DeterminingaBidPriceIfthebidrequestcamefromaregularcustomer,thebidpricewouldhavebeen$39,9001.40x$28,500Butforthisspecialorderfromanewcustomer,whatistheminimumacceptableprice?OneofthecriticalfactorstoconsideristhelevelofavailablesurpluscapacityDeterminingaBidPriceIfthe18AvailableSurplusCapacityThecompany’sincrementalcostsoffillingtheorderwillbe$22,000(material,directlabor,batchrelatedexpenses)Thecostsofsupervisionandbusiness-sustainingsupportactivitieswillnotincreaseifexcesscapacityoftheseresourcesisavailabletomeettheproductionneedsoftheorderThepricethatthecompanyshouldbidmustcovertheincrementalcostsforthejobtobeprofitableThecompanywouldlikelyaddaprofitmarginaboveincrementalcostsandmakethebidpricesomethinghigherthan$22,000,dependingoncompetitiveanddemandconditionsAvailableSurplusCapacityThe19NoAvailableSurplusCapacityIfsurplusmachinecapacityisnotavailable,thecompanywillhavetoincuradditionalcoststoacquiretheneededcapacityCompaniesoftenmeetsuchshort-termcapacityrequirementsbyoperatingitsplantovertimeMoremachinemaintenanceandplantengineeringactivitieswillbenecessaryNoAvailableSurplusCapacityI20NoAvailableSurplusCapacitythecompanyincursadditionalrentalcostsfortheextrauseofmachineswhenitaddsanovertimeshiftAssumemanagementestimatestheorderwouldcause:$5,100ofincrementalsupervisioncosts(includingovertimepremium)$5,400ofincrementalbusiness-sustainingcostsThus,thetotalcostofovertimerequiredtomanufacturecustomizedtoolsfortheorderis$10,500($5100+$5400)NoAvailableSurplusCapacityt21NoAvailableSurplusCapacityTheminimumacceptablepriceinthiscaseis$32,500($22,000+$10,500)TheminimumacceptablepricemustcoverallincrementalcostsNoAvailableSurplusCapacityT22Long-TermPricingDecisions

forPriceSettersTherelevantcostsfortheshort-termspecialorderpricingdecisiondifferfromthefullcostsofthejobMostfirmsrelyonfull-costinformationreportswhensettingpricesLong-TermPricingDecisions

fo23UseofFullCostsinPricingEconomicjustificationforusingfullcostsforpricingdecisionsinthreetypesofcircumstances:Manycontractsforthedevelopmentandproductionofcustomizedproductsandmanycontractswithgovernmentalagenciesspecifythatpricesshouldequalfullcostsplusamarkup,andpricessetinregulatedindustriesarebasedonfullcostsWhenafirmentersintoalong-termcontractualrelationshipwithacustomertosupplyaproduct,ithasgreatflexibilityinadjustingthelevelofcommitmentforallresourcesUseofFullCostsinPricingEc24UseofFullCostsinPricing

Mostactivitycostswilldependontheproductiondecisionsunderthelong-termcontract,andfullcostsarerelevantforthelong-termpricingdecisionInmanyindustries,firmsmakeshort-termadjustmentsinprices,oftenbyofferingdiscountsfromlistpricesinsteadofrigidlyemployingafixedpricebasedonfullcostsWhendemandfortheirproductsislow,thefirmsrecognizethegreaterlikelihoodofsurpluscapacityintheshorttermUseofFullCostsinPricingM25UseofFullCostsinPricingTheyadjustthepricesoftheirproductsdownwardtoacquireadditionalbusinessbasedonthelowerincrementalcoststheyincurwhensurpluscapacityisavailableWhendemandfortheirproductsishigh,theyrecognizethegreaterlikelihoodthattheexistingcapacityofactivityresourcesisinadequatetosatisfyallofthedemandTheyadjustthepricesupwardbasedonthehigherincrementalcoststheyincurwhencapacityisfullyutilize,therebyrationingtheavailablecapacitytothehighestprofitopportunityUseofFullCostsinPricingTh26FluctuatingPrices

Becausedemandconditionsfluctuateovertime,pricesalsofluctuatewithdemandconditionsovertimeMosthotelsofferspecialweekendratesthatareconsiderablylowerthantheirweekdayratesManyamusementparksofferlowerpricesonweekdayswhendemandisexpectedtobelowAirfaresbetweenNewYorkandLondonarehigherinsummer,whenthedemandishigher,thaninwinter,whenthedemandislowerLong-distancetelephoneratesarelowerintheeveningsandontheweekendswhenthedemandislowerFluctuatingPricesBecausedem27FluctuatingPricesAlthoughfluctuatingshort-termpricesarebasedontheappropriateincrementalcosts,overthelongtermtheiraveragetendstoequalthepricebasedonthefullcoststhatwillberecoveredinalong-termcontractMostfirmsusefullcost-basedpricesastargetprices,givingsalesmanagerslimitedauthoritytomodifypricesasrequiredbytheprevailingcompetitiveconditionsFluctuatingPricesAlthoughflu28TheMarkupRateJustaspricesdependondemandconditions,markupsincreasewiththestrengthofdemandMarkupsalsodependontheelasticityofdemandMarkupsalsofluctuatewiththeintensityofcompetitionTheMarkupRateJustasprices29TheMarkupRateFirmsdecideonmarkupsforstrategicreasons:AfirmmaychoosealowmarkupforanewproducttopenetratethemarketandwinovermarketsharefromanestablishedproductofacompetingfirmManyinternetbusinesseshaveadoptedthestrategyofsettinglowpricestobuildthebusiness,acquireabrandname,buildaloyalcustomerbase,andgarnermarketshareFirmssometimesemployaskimmingpricestrategywhereinitiallyahigherpriceischargedtocustomerswhoarewillingtopaymorefortheprivilegeofpossessingthelatesttechnologicalinnovationsTheMarkupRateFirmsdecideon30Long-TermDecisionsforPriceTakersDecisionstoaddanewproductortodropanexistingproductfromtheportfolioofproductsusuallyhavesignificantlong-termimplicationsforafirm’scoststructureProduct-sustainingcostsarerelevantcostsforsuchdecisionsBatch-relatedcostsarealsolikelytoalterifachangeoccursintheproductmixeitherinfavoroforagainstproductsmanufacturedinlargebatchesLong-TermDecisionsforPrice31ProfitIncreaseisNotAutomaticDroppingproductswillhelpimproveprofitabilityonlyifthemanagers:Eliminatetheactivityresourcesnolongerrequiredtosupportthediscontinuedproduct,orRedeploytheresourcesfromtheeliminatedproductstoproducemoreoftheprofitableproductsthatthefirmcontinuestoofferCostsresultfromcommitmentstosupplyactivityresourcesTheydonotdisappearautomaticallywiththedroppingofunprofitableproductsOnlywhencompanieseliminateorredeploytheresourcesthemselveswillactualexpensesdecreaseProfitIncreaseisNotAutomat32SummaryManagersusecostinformationtoassisttheminpricingandinproductmixdecisionsThemannerinwhichtheyusecostinformationinmakingthesedecisionsdependonwhetherthefirmisamajororminorentityinitsindustryTheroleofcostinformationalsodependsonthetimeframeinvolvedinthedecisionSummaryManagersusecostinfor33EconomicAnalysisofthePricingDecisionAppendix6-1EconomicAnalysisofthePrici34QuantityDecision

Introductorytextbooksineconomicsusuallyanalyzetheprofitmaximizationdecisionbyafirmintermsofthechoiceofaquantitytoproduce.Inturn,thequantitychoicedeterminesthepriceoftheproductinthemarketplaceEconomistspresentthequantitychoiceintermsofequatingmarginalrevenueandmarginalcostQuantityDecisionIntroductory35QuantityDecision

Thefirmchoosesthequantitylevel,andthemarketdemandconditionsdeterminethecorrespondingpriceThefirmthatmustchooseaprice,notaquantity,toannouncetoitscustomersCustomersreacttothepriceannouncedanddeterminethequantitythattheydemandThepricedecisionanalysisusesdifferentialcalculustoanalyzethefirm’spricingdecisionQuantityDecisionThefirmcho36PricingDecision

Totalcosts,C,expressedintermsofitsfixedandflexiblecostcomponentsare:C=f+vQ,Wherefisthecommittedcost,vistheflexiblecostperunit,andQisthequantityproducedinunitsQuantityproducedisassumedtobethesameasquantitydemandedThedemand,Q,isrepresentedasadecreasinglinearfunctionofthepriceP:Q=a–bPAhighervalueofbrepresentsademandfunctionthatismoresensitive(elastic)topricePricingDecisionTotalcosts,37PricingDecision

AnincreaseofadollarinthepricedecreasesdemandbybunitsAhighervalueofareflectsagreaterstrengthofdemandforthefirm’sproduct.Foranygivenprice,P,thedemandisgreaterwhentheparameter,a,hasahighervalueThetotalrevenue,R,isgivenbytheprice,P,multipliedbythequantitysold,Q.Algebraically,wewritethis:

R=PQ=P(a–bP) =aP–bP2Theprofit,Π,ismeasuredasthedifferencebetweentherevenue,R,andthecost,C:PricingDecisionAnincreaseo38PricingDecision

Π=R-C =PQ-(f+vQ) =P(a-bP)-F-v(a-bP) =aP-bP2-F-va+vbPTofindtheprofit-maximizingprice,P*,wesetthefirstderivativeofprofitPwithrespecttoPequaltozero: dΠ/dP=A–2bP+vb=0Thisequationimplies: P*=(a+vb)/2b=a/2b+v/2PricingDecision Π=R-C39Long-TermBenchmarkPricesThissimpleeconomicanalysissuggeststhatthepricedependsonlyonv,theflexiblecostperunitAmorecomplexanalysisthatconsiderssimultaneouslythepricingdecisionandthelong-termdecisionsofthefirmtocommitresourcestofacility-sustaining,product-sustaining,andotheractivitycapacitiesindicatesthatthecostsofthesecommittedresourcesdoplayaroleinthepricingdecisionThecostsofthesecommittedactivityresourcesappeartobecommittedcostsintheshort-term,buttheycanbechangedinthelong-termLong-TermBenchmarkPricesThis40Long-TermBenchmarkPrices(2of2)Thepricesthatafirmsetsandadjustsintheshortterm,basedonchangingdemandconditions,fluctuatearoundalong-termbenchmarkprice,pL,thatreflectstheunitcostsoftheactivityresourcecapacities: pL

=a/2b+(v+m)/2m=f÷Xisthecostperunitofnormalcapacity,X,offacility-sustainingactivitiesthedegreeofpricefluctuationsaroundthebenchmarkpriceincreaseswiththeproportionofcommittedcostspricesappearmorevolatileincapital-intensiveindustrieswherealargeproportionofcostsareforfacility-sustainingactivitiesLong-TermBenchmarkPrices(241CompetitiveAnalysis(1of3)Inasituationwhenotherfirmscompeteinthesameindustrywithproductsthataresimilarbutnotidenticaltoeachother,somecustomersmayswitchtheirdemandtoacompetingsupplierifthecompetitorreducesitspriceConsidertwofirms,AandB,andrepresentthedemand,QA,forfirmA’sproductasafunctionofitsownprice,PA,andtheprice,PB,setbyitscompetitor:QA=a–bPA+ePBThedemandforfirmA’sproductfallsbybunitsforeachdollarincreaseinitsownprice,butincreasesbyeunitsforeachdollarincreaseinthecompetitor’sprice,becausefirmAgainssomeofthemarketdemandthatfirmBlosesCompetitiveAnalysis(1of3)I42CompetitiveAnalysis(2of3)Theprofit,PA,forfirmAisrepresentedbythefollowing:ΠA=PAQA-(f+vQA)ΠPA(a-bPA+ePB)-f-v(a-bPA+ePB)Profitmaximizationrequiresthis: dπ

A÷dPA=a-2bPA+ePB+vb=0Therefore,theprofit-maximizingpricePA0giventheotherfirm’spricePBis: PA0=(a+vb+ePB)÷2bThepricingdecisionthusdependsonwhatthecompetitor’spriceisexpectedtobeCompetitiveAnalysis(2of3)T43CompetitiveAnalysis(3of3)Ifthefirmexpectsitscompetitortobehaveasitdoesandexpectsittochoosethesamepriceasitsown,thenwesetPA=PB=P*intheequation

a-2bPA1+ePB+vb=0toobtain:a-2bP*+eP*+vb=0P*

=a+vb/2b-eThispriceistheequilibriumprice,becausenofirmcanincreaseitsprofitsbychoosingadifferentpriceprovidedtheotherfirmmaintainsthesamepriceP*CompetitiveAnalysis(3of3)I44CostInformation

for

Pricing

and

ProductPlanningChapter6CostInformation

for

Pricing

a45RoleOfProductCostsInPricingAndProductMixDecisionsUnderstandinghowtoanalyzeproductcostsisimportantformakingpricingdecisions:ManagersmakedecisionsaboutestablishingoracceptingapricefortheirproductsEvenwhenpricesaresetbythemarketandthefirmhaslittleornoinfluenceonproductprices,managementstillhastodecidethebestmixofproductstomanufactureandsellRoleOfProductCostsInPrici46RoleofProductCostsProductcostanalysisisalsosignificantwhenafirmisdecidinghowbesttodeploymarketingandpromotionresourcesHowmuchcommission(orhowmanyotherincentives)toprovidethesalesforcefordifferentproductsHowlargeadiscounttoofferofflistpricesRoleofProductCostsProductc47Short-termandLong-term

PricingConsiderationsThecostsofmanyresourcesarelikelytobecommittedcostsintheshort-termbecausefirmscannoteasilyalterthecapacitiesmadeavailableformanyproductionandsupportactivitiesForshort-termdecisions,itisimportanttonotewhethersurpluscapacityisavailableforadditionalproduction,orwhethershortagesofavailablecapacitylimitadditionalproductionalternativesShort-termandLong-term

Prici48Short-termandLong-term

PricingConsiderations

Thelengthoftimeafirmmustcommititsproductioncapacitytofillthatorderisimportantbecausealong-termcapacitycommitmenttoamarginallyprofitableordermay:Preventthefirmfromdeployingitscapacityformoreprofitableproductsororders,shoulddemandforthemariseinthefutureForcethefirmtoaddexpensivenewcapacitytohandlefuturesalesincreasesShort-termandLong-term

Prici49Short-termandLong-term

PricingConsiderations

Ifproductionisconstrainedbyinadequatecapacity,managersneedtoconsiderwhetherovertimeproductionortheuseofsubcontractorscanhelpaugmentcapacityintheshorttermInthelongterm,managershaveconsiderablymoreflexibilitytoadjustthecapacitiesofactivityresourcestomatchthedemandfortheminproducingvariousproductsDecisionsaboutwhethertointroducenewproductsoreliminateexistingproductshavelong-termconsequencesShort-termandLong-term

Prici50AbilityToInfluencePrices

Ifthefirmisoneofalargenumberoffirmsinanindustry,andifthereislittletodistinguishtheproductsofdifferentfirmsfromeachother:Suchafirmisapricetaker,anditchoosesitsproductmixgiventhepricessetinthemarketplaceforitsproductsAbilityToInfluencePricesIf51AbilityToInfluencePricesFirmsinanindustrywithrelativelylittlecompetition,whoenjoylargemarketsharesandexerciseindustryleadership,mustdecidewhatpricestosetfortheirproductsFirmsinindustriesinwhichproductsarehighlycustomizedorotherwisedifferentiatedfromeachotheralsoneedtosetthepricesfortheirdifferentiatedproductsSuchfirmsarepricesettersAbilityToInfluencePricesFir52PriceTakersAsmallfirm,orafirmwithanegligiblemarketshareinthisindustry,behavesasapricetakerIttakestheindustrypricesforitsproductsasgivenandthendecideshowmanyunitsofeachproductitshouldproduceandsellPriceTakersAsmallfirm,ora53Short-TermDecisionsforPriceTakersApricetakershouldproduceandsellasmuchasitcanofallproductswhosecostsarelessthanindustrypricesManagersmustdecidewhichcostsarerelevanttotheshort-termproductmixdecisionManagersmayhavelittleflexibilitytoalterthecapacitiesofsomeofthefirm’sresourcesintheshort-runShort-TermDecisionsforPrice54Example-GarmentManufacturerChunlingCompanythatsellsfivetypesofready-madegarmentstodiscountstoressuchasKmartandWal-MartThecompanyisoperatingatfullcapacityandiscontemplatingshort-termadjustmentstoitsproductmixItisnecessaryforthecompanytodetermine:WhatcostswillvarywithproductionlevelsinthisperiodWhatcostswillremainfixedwhenachangeoccursintheproductionmixExample-GarmentManufacturer55Example-GarmentManufacturerThecostsofutilities,plantadministration,maintenance,anddepreciationforthemachineryandplantfacilitywillnotalterwithachangeintheproductmix,becausetheplantisoperatingatfullcapacityVaryingwiththequantityofeachgarmentproducedare:ThecostsofdirectmaterialsThedirectlaborthatispaidonapiece-ratebasisInspectorsarepaidamonthlyfixedsalary,buttheyareemployedasrequiredtosupporttheproductionofdifferentgarmentsExample-GarmentManufacturer56Example-GarmentManufacturer

Ifitscapacitywereunlimited,thecompanycouldproducegarmentstofillthemaximumdemandforthemCapacityisconstrained,however,andthereforethecompanymustdecidehowbesttodeploythislimitedresourceThecapacityisfixedintheshort-term,sothecompanymustplanproductiontomaximizethecontributiontoprofitearnedforeveryavailablemachinehourusedExample-GarmentManufacturer57TheImpactOfOpportunityCostsIfthegarmentmanufacturerreceivesaspecialorderrequest,itwouldhavetodecidetheminimumpriceitwouldacceptBecauseitsproductioncapacityislimited,thecompanymustcutbacktheproductionofsomeothergarmenttoenableittoproducethegoodsforthespecialorderGivinguptheproductionofsomeprofitableproductresultsinanopportunitycost,whichequalsthelostprofitonthegarmentsthatthecompanycannolongermakeTheImpactOfOpportunityCost58TheImpactOfOpportunityCosts

ThelostprofitinthiscasewouldbethecontributiononthegoodsitwillnotmakeTheproductwiththelowestcontributionperhourshouldbesacrificedTheprofit(contribution)lostonthoseproductswouldneedtobecoveredbythepriceofthespecialorderTheImpactOfOpportunityCost59Short-TermPricingDecisions

forPriceSettersInmanybusinesses,potentialcustomersrequestthatsuppliersbidapriceforanorderbeforetheydecideonthesupplierwithwhomtheywillplacetheorderShort-TermPricingDecisions

f60DeterminingaBidPrice

Assumethatthefullcostsforthejobareestimatedtobe$28,500Settingthepriceofaproductalsomeansdeterminingamarkuppercentageabovecost,anapproachknownascost-pluspricingCost-pluspricing-themarkuppercentageisdeterminedbyacompany’sdesiredprofitmarginandoverallrateofreturnThecompanyhasdecidedthemarkuppercentageisnormallytobe40%offullcostsDeterminingaBidPriceAssume61DeterminingaBidPriceIfthebidrequestcamefromaregularcustomer,thebidpricewouldhavebeen$39,9001.40x$28,500Butforthisspecialorderfromanewcustomer,whatistheminimumacceptableprice?OneofthecriticalfactorstoconsideristhelevelofavailablesurpluscapacityDeterminingaBidPriceIfthe62AvailableSurplusCapacityThecompany’sincrementalcostsoffillingtheorderwillbe$22,000(material,directlabor,batchrelatedexpenses)Thecostsofsupervisionandbusiness-sustainingsupportactivitieswillnotincreaseifexcesscapacityoftheseresourcesisavailabletomeettheproductionneedsoftheorderThepricethatthecompanyshouldbidmustcovertheincrementalcostsforthejobtobeprofitableThecompanywouldlikelyaddaprofitmarginaboveincrementalcostsandmakethebidpricesomethinghigherthan$22,000,dependingoncompetitiveanddemandconditionsAvailableSurplusCapacityThe63NoAvailableSurplusCapacityIfsurplusmachinecapacityisnotavailable,thecompanywillhavetoincuradditionalcoststoacquiretheneededcapacityCompaniesoftenmeetsuchshort-termcapac