PRICING
3 METHODS OF PRICING
MINIMUM
PRICING
FULL COST
PRICING Sales Price = Total
MARGINAL COST Variable Cost
Sales Price = Full Cost + % PLUS OR
Mark-up (CONTRIBUTION) *For a special order:
PRICING Min. Price= Total
relevant cost
of making the
Sales Price = Marginal Cost + special order
Profit Margin --------------------------
No. Of SO units
a) FULL COST PRICING – A TRADITIONAL APPROACH
Full cost may be:
i) fully absorbed production cost only
ii) total cost = production cost + non-production cost (administration cost
+ selling and distribution cost)
Advantages of full cost pricing:
1. Cheap
2. Simple to operate
3. Pricing decisions are standardised – can delegate to lower management
4. Ensure all costs are covered
5. Ensure a reasonable rate of return is earned.
6. Enable to justify its price
Disadvantages of full cost pricing:
1. In short-term, it is inflexible
2. Ignore opportunity costs
3. Fail to allow for competition
4. Different basis for charging overheads will result if a different sales
price is used. Failure to apportion overhead fairly will result a product
being overpriced or underpriced.
5. Fail to distinguish between relevant and irrelevant costs.
6. Ignore demand and therefore fails to recognise the impact of price
clasticity of demand in its pricing policy. This led to underpricing of
products.
7. The level of activity are based on budgeted volume of sales. In other
words, price has already been assumed to arrive at the selling price.
b. MARGINAL COST PLUS OR CONTRIBUTION PRICING
Sales Price = Marginal Cost + Profit
Marginal cost may be either marginal cost of production or marginal cost of
sales.
Especially used for short-term decision making.
Advantages of marginal cost plus pricing:
1. Simple and easy method to use.
2. Mark-up can be adjusted to reflect demand conditions.
3. Draws management attention to contribution, and the effects of higher or
lower sales volume on profit.
4. Ideal for spare capacity.
5. Enable to penetrate new market more easily.
6. Can be more competitive in the existing market.
7. Survive in trade depression.
8. Surplus or obsolete stock can be disposed off.
Disadvantages of marginal cost plus pricing:
1. Do not ensure that sufficient attention is paid to demand conditions,
competitors prices and profit maximisation.
2. Ignore fixed overhead – fixed overhead may not be covered in the long
run.
3. Once charged low prices, a customer may expect further reduction in
the long run.
4. If the price set is too low, a customer can resell the products to existing
customers, thus affecting customers’ goodwill.
5. Cut throat pricing can lead to price wars.
6. If too many low priced contrcats are accepted, the business may end up
making losses/unacceptablely low profits.
7. Future more profitable contracts may be lost.
c. MINIMUM PRICING
Sales price = Variable cost + Specific Fixed Cost + Opportunity Cost
Minimum price would lead the business no better or worse off than if it did not
sell the products.
When to use minimum pricing:
1. to clear stocks
2. entertain special order
3. close down business
4. force competitor to close down
5. utilise excess capacity
6. compete with competitors in short run
7. operating under distress
8. when faced with sharp competition on particular orders under a
competitive bidding situation
FACTORS TO BE CONSIDERED IN PRICING DECISIONS
1. Overall firm’s objective
2. Cost structure of the
product
3. Consumer demand
4. Competition
5. Product life cycle
6. Legal influences
7. Economic situation
8. Social responsibility
9. Relative position of the
firm
10. Level of activity
11. Availability of
PRICING FOR NEW PRODUCTS
Market Skimming Market Penetration
Pricing Pricing
High price strategy - Charged a low price
Aims to gain high unit - Shorten the product
profits very early in life cycle
The product’s life
When to use?
When to use?
1. product is new and 1. to discourage new
different. entrance into the mkt
2. strength of demand 2. demand is highly elastic
is unknown.
3. the firm has 3. the firm wishes to
liquidity problems. shorten the earlier
4. the products are stage of product life cyclelikely
to be bought once 4. there are significantly
economies of scale
Example:
Given cost information for a unit of Product X
RM
Direct material 150
Direct labour 115
Manufacturing OH:
Variable 60
Fixed 35
Selling& Dist:
Variable 15
Fixed 8
Admin – fixed 5
Required:
Calculate the selling price of product X if the company adopts the following pricing
policy:
a) Full Total Cost plus mark up 20%
b) Full Manufacturing Cost plus mark up 20%
c) Total Marginal (Variable) Cost plus mark up 20%
d) Total Marginal (Variable) Manufacturing Cost plus mark up 20%
e) Minimum price
Solution:
a b c d e
150 150 150 150 150
Direct material
115 115 115 115 115
Direct labour
60 60 60 60 60
Manufacturing OH – variable
35 35
Manufacturing OH – fixed
15 - 15 15
Selling& Dist – variable
8 -
Selling& Dist – fixed
5 -
Admin – fixed
388 360 340 325 340
TOTAL COST (100%)
77.60 72 68 65
PROFIT (20%)
465.60 432 408 390 340
SELLING PRICE (120%)
TUTORIAL QUESTIONS
PRICING DECISIONS
QUESTION 1
Fibre Scan Sdn Bhd manufactures three products known as Lexmark, Canon and
Fastrex. The following information has been given to you for the month of April
2006.
Lexmark Canon Fastrex
Forecast demand 50 150 200
Raw material per unit RM100 RM150 RM80
Direct labour hours
(at RM3 per hr) 5 8 2
Additional information:
1. Variable overhead is 10% of total cost of materials and labour
2. Fixed overhead is to be allocated to the products at 150% of total direct labour
cost.
3. Selling price is calculated by adding 20% of total cost.
Required:
a. Calculate the selling price per unit for each product.
b. Calculate the new selling price if the company uses 45% mark-up on variable
cost.
c. Give and explain two (2) strategies for new products pricing.
QUESTION 2
Tyco Appliance Company has developed a new air conditioning system that will be
sold during the year. Cost data for the system are as follows:
Maximum capacity : 3,200 units
Production and sales : 3,000 units
Standard cost per unit: RM
Direct materials 480
Direct labour 240
Variable manufacturing overheads 160
Variable selling and administrative expenses 112
Fixed manufacturing overheads 864,000
Fixed selling and administrative expenses 532,500
Currently, the company uses a pricing formula of full production cost plus 50%. A
new hired accountant of the company, however, suggests that the price should be set
at 225% of total variable costs.
Required:
a. Determine the selling price per unit of the air conditioning based on:
i. full production cost
ii. total variable costs
b. A special order of 400 units of air conditioning have been received from Giant
Hypermarket. Tyco Appliance Company is unable to increase its labour hours
to work for the special order and has to cut its normal sales units as alternative.
Determine the minimum selling price per unit for the special order if the
company adopts the current pricing method for its normal sales.
QUESTION 3
The following cost structure relates to product Zest for the year 2005 where the
normal production and sales volume were 1,000 units.
Product Zest RM
Cost per unit:
Direct materials 500
Direct labour 350
Variable overhead 150
Fixed overhead 300
Variable selling and distribution overhead 400
Fixed selling and distribution overhead 350
--------
Total unit cost 2,050
=====
Selling price per unit 2,255
=====
Additional information:
i. The pricing policy used was the full cost plus method.
ii. It is expected that for next year (year 2006) either sales volume will increase by
10% at the present selling price, or if the present selling price increase by 4% the
sales volume will increase by 2%.
Required:
a. List and explain briefly 4 factors to be considered in a pricing decision.
b. What is the minimum selling price per unit of product Zest?
c. Which selling price can give the better net profit and to be suggested for the year
2006?
d. What is the new profit mark-up percentage if the selling price in part (c) is
used?
