Factors and Model Influences the Pricing Decision
The product pricing decision is a critical issue for most managers, yet the amount of concentration given to this important area is often much less than is provided to other marketing decisions. One cause for the lack of concentration is that several believe price setting is a mechanical procedure requiring the administration to use financial tools, such as spreadsheets, to construct their case for setting price levels. While financial tools are broadly utilized to help in setting price, marketers must consider several other issues when arriving at the price for which their product will sell. In this part I will focus why price is significant and what issues affect the pricing decision.
The concept of a 'price' is a global concept. In fact, there are several methods to express the concept of 'price'. Some of the terms are; evaluation, bill, charge, cost, dues, responsibility, expenditure, fee, interest, levy, honorarium, tithe, premium, rate, retainer, tax, wage, tariff, toll and tuition. I'm sure if you spend a little time you can consider of many more. No matter what you select to call the 'price' you will price for your product or service there are a number of issues to consider when deciding exactly how much you should charge. There is range of issues that should be considered when determining a charge for your service or product. The last price for a product may be affected by several issues which can be classified into two main categorizes; Internal Factors and External Factors.
When setting price, marketers must take into consideration many issues, declared in the following, which are the result of firm decisions and actions.
Marketing decisions are guided by the general goals of the firm. While we will talk about this in more detail when we cover marketing policy in a later tutorial, for now it is significant to appreciate that all marketing decisions, containing price, work to help get firm goals. Corporate goals can be wide-ranging and contain various objectives for various functional areas (e.g., goals for production, human capital, etc). While pricing decisions are affected by several kinds of objectives set up for the marketing functional area, there are four important objectives in which price execute a central role. In most conditions only one of these goals will be pursued, though the marketer may have various objectives for various products. The four main marketing goals influencing price contain:
- Return on Investment (ROI)
- Market Share
- Cash Flow
- Maximization of Profits
Marketing policy concerns the decisions marketers make to assist the firm satisfy its objective market and achieve its business and marketing goals. Price, obviously, is one of the key marketing mix decisions and since all marketing mix decisions must work jointly, the last price will be affected by how other marketing decisions are made. For example, marketers selling high quality products would be anticipated to price their products in a range that will add to the perception of the product being at a high-level. It should be noted that not all firms view price as a key selling aspect. Some companies, for instance those seeking to be viewed as market leaders in product quality, will deemphasize price and focus on a policy that highlights non-price advantages (e.g., quality, durability, service, etc.). Such non-price rivalry can assist the firm eliminate potential price wars that often break out between competitive companies that pursue a market share objective and utilize price as a key selling aspect.
For several for-profit firms, the starting point for setting a product's price is to first decide how much it will price to get the product to their consumers. Obviously, whatever price consumer pay must exceed the cost of making a good or delivering a service otherwise the firm will lose money. When analyzing price, the marketer will consider all costs required to get the product to market containing those related with production, marketing, distribution and firm management (e.g., office expenditure). These expenses can be divided into two main groups, Fixed Cost and Variable Cost. Determining individual unit cost can be a difficult procedure. While variable costs are often decided on a per-unit basis, applying fixed costs to individual products is less straightforward. Generally, a firm will assign fixed cost to individual products if the firm can clearly relate the cost with the product, such as evaluating the cost of operating production machinery based on how much time it takes to produce each item.
There are a number of affecting issues which are not controlled by the firm, but will affect pricing decisions. Understanding these issues need the marketer conduct study to monitor what is occurring in each market the firm serves since the impact of these issues can differ by market.
Elasticity of Demand
Marketers should never relax on their marketing decisions. They must frequently use market study and their own decision to decide whether marketing decisions require to be adjusted. When it comes to adjusting price, the marketer must realize what impact a change in price is likely to have on target market requirement for a product. Understanding how price alters effect the market needs the marketer have a company comprehension of the concept economists call elasticity of demand, which associates to how purchased quantity changes as prices alter.
Possibly the most apparent external issues that impact price setting, are the anticipations of consumers and channel partners. As we talked about, when it comes to making a buy decision consumers evaluate the general "value" of a product much more than they evaluate the price. When determining on a price marketers need to conduct consumer research to decide what "price points" are acceptable. Pricing beyond these price points could dishearten consumers from buying.
Competitive and Other Products
Marketers will indubitably look to market rivals for points out of how price should be set. For several marketers of customer products researching competitive pricing is comparatively easy, specifically when Internet search tools are utilized. Price analysis can be somewhat more complex for products sold to the business market since final price may be influenced by a number of issues containing if competitors enable consumers to bargain their final price.
Marketers must be alert of rules that affect how price is set in the markets in which their products are sold. These rules are primarily regime enacted meaning that there may be lawful ramifications if the regulations are not pursued. Price rules can come from any level of regime and vary broadly in their needs. Lastly, when selling beyond their home market, marketers must identify that local rules may make pricing decisions unlike for each market. This is specifically a concern when selling to global markets where failure to consider rules can lead to severe penalties. As a result marketers must have a clear knowledge of rules in each market they work.
The Role of Standard Costing and Variance Analysis
A standard cost is a cautiously predetermined expected unit cost. Standard costing is a control method which evaluates standard costs & incomes with actual results to attain differences which are utilized to stimulate enhanced performance. The setting of standards for various components of cost requires a detailed research of various features. The standards are set in a different way for producing, administrative and selling expenditures. Enhanced techniques are utilized for setting these standards. The determination of producing costs will need time and motion research for labor and useful material control tools for materials. Similar studies will be required for finding other expenditures. All these studies will make it possible to reduce inefficiencies at various steps. The significant role that standard costing play into organization is:
- To help in setting budgets & assessing managerial performance.
- To execute as a control tool by establishing standards, highlighting (via variance analysis) activities that do not match to plan & therefore changing administration to those are as that may be out of control & in need of corrective action.
- To allow the principal of "administration by exemption" to be practiced a standard cost, when established, is an average anticipated unit cost. Because it is only an average, actual results will differ to some extent above & below the average differences should only be reported where the variation between actual & standard is important.
- To provide a prediction of future expenses to be utilized in decision-making citation.
- To value stocks and cost production for cost counting purposes it is and alternative way of assessment to techniques like FIFO, LIFO or replacement costing.
- To motive workers and administration by the provision of challenging objectives.
- To provide direction on enhancement of effectiveness.
A standard cost implies that a standard or objective exists for every single component that participate in the product; the kinds, usage and prices of materials & parts, the grades, rates of pay & times for the labor engaged the production techniques, devices and so on. The standard cost for every part of the product is recorded on a standard cost card; instance standard costs may be utilized in both marginal and absorption costing procedures. The accountability for setting standard costs should be shared between managers capable to provide the vital information about levels of anticipated. Effectiveness, prices & overhead costs. Standard costs are generally revised once a year (to enable for the new overheads budget, increase in prices, & any alters in anticipated efficiency of materials usage or of labor). Nevertheless they may be revised more frequency if conditions are altering speedily.
A significant part of standard costing is a variance analysis which breaks down the difference between actual cost and standard costs into different elements (volume difference, material cost difference, labor cost difference, etc.) so manager can realize why costs were diverse from that was planned and take right action to correct the condition.
Variance analysis is utilized to analyze the cost and profit of the business. Profit variance analysis highlights the economic issues responsible for the difference between evaluated and actual profits, and leads to concentrate inspection. Cost variance analysis goes deeper into the variations between planned and actual levels of both costs and incomes. It would highlight the cost effects of such issues as increased raw material prices, lower labor output or fall in sales volumes or selling prices. It then becomes feasible to examine the specific developments that caused these.
Meaningful control becomes feasible when you have particular standards to evaluate performance, and judge whether performance was up to the mark or otherwise. Budgetary control executed this task in an elementary manner by setting budgets and evaluating actual against the budgets. Managers were alerted by reports that pointed out a difference between the two. Standard cost variance analysis has refined this procedure into a fine-tuned method. In addition to pointing out that there is a variation between estimates and actual, it analyzes the reasons for the variance. The value of the method is improved further by using cautiously developed standards of performance, such as raw material usage per unit of production, prices to be paid for the raw materials and to be charged for sales, and so on.
Setting an inclusive set of standards is the first step. Standards are laid down for selling prices, raw material prices, sales volumes, material usage, labor output, labor hours, variable overheads, fixed overheads and all other relevant and assessable issues. Performance is recorded in sufficient detail to enable detailed analysis. For instance, materials utilized, labor hours worked, machine down times and production achieved during every batch run will be recorded.
Standard costing and discrepancy analysis can provide high value insights into cost behavior. These insights can, in turn, assist the firms compete better. For instance, it will know just how low it can go in negotiating prices under a comparison. Less informed rivals might bid too low and later find that they will have to suffer important losses at that price. It is significant to concentrate on important differences. Concentrating on small cost differences can waste managerial time and produce little results. Variation analysis is a refined tool that can monitor expenses and revenues on a continuing basis. It can highlight deviations from standards and concentrates managerial attention on critical areas. The result will be less wasted effort and ongoing enchantments in business results.
Advantages and Disadvantages of Activity Based Costing (ABC)
Activity-based costing (ABC) is a costing model that recognizes activities in a company and assigns the cost of each activity resource to all products and services according to the actual use by each: it assigns more indirect costs overhead into direct costs. In this method a company can exactly estimate the cost of its individual products and services for the purposes of recognizing and reducing those which are unbeneficial and lowering the prices of those which are overpriced. In a business organization, the Activity-based costing method assigns an organization's resource costs through activities to the products and services given to its consumers. It is commonly used as a device for understanding product and consumer cost and profitability. As such, Activity-based costing has predominantly been utilized to support strategic decisions such as pricing, outsourcing and recognition and measurement of procedure enhancement initiatives.
Activity based costing is basically a change in accent. People perform activities and activities use resources. Thus, by controlling activities the manager is making sure that costs are controlled at their source. A wise manager will not focus on how to estimate product costs, but will focus more on why the costs were there in the first place. When intending an activity based costing system this should be utilized as a departure point.
Advantages of an Activity Based Costing System
- The first and most significant benefit is the accuracy in the procedure of costing with regards to the product line, the consumers of the product, the stock-keeping units employed by the administration and the channel and group which streamline the flow of the product from the maker to the consumer.
- This system better helps in the procedure of understanding the concept of overhead costs i.e. the distribution of common business resources as they are utilized by particular product lines and their association to particular cost driver.
- The system is simple to interpret and understand is it is available, useable and specifically implement capable across all norms of business set-ups.
- This procedure consumes unitary cost, or marginal cost as the calculation base in comparison to the conventional cost accounting techniques which employ total cost.
- The system works extremely well will quality enhancement and up gradation programs e.g. Six Sigma.
- This system is specifically useful in recognizing and ear-marking some of the matters business activities which are a stress or burden on the business i.e. wasteful or non value adding services.
- The system also serves exceptionally with performance administration systems which are used by most human resource departments in modern businesses.
- This procedure permits firms to implement costing policies across another diagonal of the company as business procedures, supply chains and value addition channels are capably and optimally analyzed in this procedure.
- This system mimics the actual business procedure as the appropriation of common pool resources takes place in the same way as common resources are utilized in the business.
- This system aids in the procedure of benchmarking which is a vital part of he quality control procedure.
Disadvantages of an Activity Based Costing System
- Data collection procedure for this system is very time consuming.
- The capital expense on the activity based system and its subsequent running costs can be a road block for companies.
- The system is very apparent which some managers would not authorize of as they would like to keep some things out of the view of the owners of the firm.
Limitations of Applying Activity Based Costing
Even in ABC, some overhead costs are complex to assign to products and consumers, such as the chief executive's pay. These expenses are termed 'business sustaining' and are not assigned to products and consumers because there is no meaningful way. This lump of unallocated overhead costs must nonetheless be met by participations from each of the products, but it is not as large as the overhead costs before Activity-based costing is used. Although some may argue that costs undetectable to activities should be "randomly allocated" to products, it is significant to understand that the only purpose of Activity-based costing is to provide information to administration. Thus, there is no reason to assign any cost in a random manner.
Activity-based costing is considered a comparatively expensive accounting method, and whether its good value is questioned. Activity-based costing has been established to be a very high-cost accounting technology. Installing an Activity-based costing system is technically difficult, requiring talented workers and a substantial amount of time and money. Lean accounting methods have been developed in recent years to provide relevant and thorough accounting, control, and dimension systems without the difficult and highly wasteful techniques of Activity-based costing. Lean Accounting takes an opposite direction from Activity-based costing by working to reduce cost allocations rather than find difficult ways of distribution. While lean accounting is mostly utilized within lean manufacturing, the approach has proven helpful in several other areas containing healthcare, construction, financial services, regime, and other businesses.
In conclusion, it is significant to keep in mind that the goals should be met at the minimum cost and difficulty in order to intend an activity based costing system. To be successful, the last activity based costing system should give the right type of information at the right level of detail. In addition to this the design of the system should be as simple as feasible without being too easy since it may report inaccurate costs if it is too easy. The answer is to strike a balance between simplicity and difficulty. In addition to this, performance calculates should be recognized at procedure level and for key activities. They should be utilized to monitor and assess activities or procedures and must be utilized to promote consistent enhancement. This should be done without unnecessarily complicating the design of the system.
- Garrison, Ray. (2009). Managerial Accounting, 13th Edition. New York: McGraw-Hill/Irwin.
- Weygandt, Jerry J. (2008). Managerial Accounting: Tools for Business Decision Making, 4th Edition. New York: Wiley.