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EMBA 5412
Fall 2010
Hinterhuber,A, Towards value-based pricingAn integrative framework for decision making, Industrial
Marketing Management 33 (2004) 765 778
Hinterhuber,A, Towards value-based pricingAn integrative framework for decision making, Industrial
Marketing Management 33 (2004) 765 778
Hinterhuber,A, Towards value-based pricingAn integrative framework for decision making, Industrial
Marketing Management 33 (2004) 765 778
Pricing
External sales- outside
Target pricing-Competition-based pricing
Cost plus pricing
Variable cost pricing
Customer based pricing-value-based pricing
Time and material pricing
Internal-within the company among divisions
Negotiated transfer prices
Cost based transfer prices
Market based transfer prices
Effect of outsourcing on transfer prices
Transfers between divisions in different countries
8
Profit Maximization
Economic Theory
The quantity demanded is a function of
the price that is charged
Generally, the higher the price, the lower
the quantity demanded
Pricing
Management should set the price that
provides the greatest amount of profit
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Dollars
per unit
p*
Demand
Marginal
cost
Marginal
revenue
q*
Quantity made
and sold
per month
10
Example 1
The editor of EMBA Magazine is considering three
alternative prices for her new monthly periodical. Her
estimate of price and quantity demanded are:
Price
TL 6
TL 5
TL 4
Quantity
22,000
28,000
32,000
Solution Example 1
12
Dollars
p*
13
and sold
per month
Price Elasticity
The impact of
price changes on
sales volume
Demand is elastic if
a price increase has a
large negative impact
on sales volume.
Demand is inelastic if
a price increase has
little or no impact
on sales volume.
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Influences on Price
Customer demand
Competitors behavior/prices/actions
Costs
Regulatory environment legal,
political and image related
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Costs that are often irrelevant for shortrun policy decisions, such as fixed costs
that cannot be changed, are generally
relevant in the long run because costs can
be altered in the long run
Profit margins in long-run pricing decisions
are often set to earn a reasonable return
on investment prices are decreased
when demand is weak and increased when
demand is strong
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Market-Based Approach
Starts with a target price
Target Price estimated price for a
product or service that potential
customers will pay
Estimated on customers perceived
value for a product or service and
how competitors will price competing
products or services
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Understanding the
Market Environment
Understanding customers and competitors
is important because:
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Pricing approaches
Cost plus mark-up
Cost-Plus Pricing
Company estimates cost of production
Benefits
Simple approach
Limitations
What % markup to use?
Inherently circular for manufacturing firms
Requires considerable judgment and
experimentation
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http://www.hss.caltech.edu/~mcafee/Classes/BEM106/PDF/ProductLifeCycle.pdf
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26
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Life-Cycle Product
Budgeting and Costing
Life-Cycle Budgeting involves estimating
the revenues and individual value-chain
costs attributable to each product from its
initial R&D to its final customer service and
support
Life-Cycle Costing tracks and accumulates
individual value-chain costs attributable to
each product from its initial R&D to its final
customer service and support
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Example
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Example
110.000 U
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33
34
Cost-plus Pricing
Selling Price=
Cost + mark-up% x Cost
Mark-up % =
Desired profit per unit Unit cost
Desired profit =
Desired ROI x Investment
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Which cost?
Variable manufacturing cost
Price= variable manufacturing costs +
markup% * variable manufacturing cost
Mark-up should cover the remaining costs and provide for the
desired profit, i.e. variable selling and all fixed costs
Which costs?
Total variable costs
Variable manufacturing and selling costs
Price= variable costs + markup %* variable costs
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Which costs?
Absorption manufacturing costs
Unit manufacturing costs both
variable and fixed
Price= unit manuf. cost + markup %* unit manufacturing cost
Which costs?
Absorption total costs
Total costs manufacturing and selling
and administrative fixed (direct or
allocated, variable costs)
Price= unit cost + markup %* unit cost
desiredpro fit
markup %
Totalunit cos t * n
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Example - Pricing
Annual sales 480 units
Unit costs:
Variable manufacturing cost
Applied fixed manufacturing cost
Absorption manufacturing cost
Variable selling costs
Allocated and direct fixed selling and administrative costs
Total cost (Manufacturing and S&ADM)
Investment
Desired profit 10% of investment
Annual Fixed Manufacturing Costs
Annual Fixed (allocated and direct) Selling and
$ 400
$ 250
$ 650
$ 50
$ 100
$ 800
$ 600,000
$ 60,000
$ 120,000
Administrative Costs
$ 48,000
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42
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Mark
up %
Price
Variable
manufac
turing
cost
plus
mark up
131.25
Variable
cost
plus
mark up
105.56
42.31
15.63
925
925
925
925
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Retail Example
Yesim Textiles income statement for 2007 is as follows:
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Project Example
EMBA Consultancy Co needs to bid for a project.
EMBAs recent income statement appears below:
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Project Example
EMBA Consultancy needs to bid for a new project.
Material costs will be TL 5.000; 150 man hours will
be used. What would be a guiding bidding price?
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51
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53
Target Costing
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Value Engineering
Value Engineering is a systematic
evaluation of all aspects of the value
chain, with the objective of reducing
costs while improving quality and
satisfying customer needs
Managers must distinguish valueadded activities and costs from nonvalue-added activities and costs
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Customer-based pricing
Value based pricing-the price is based on the
customer demand or need for the product
Unique product value based pricing might be
helpful to create demand
Two interpretations:
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Hinterhuber,A, Towards value-based pricingAn integrative framework for decision making, Industrial
Marketing Management 33 (2004) 765 778
64
Hinterhuber,A, Towards value-based pricingAn integrative framework for decision making, Industrial
Marketing Management 33 (2004) 765 778
65
Hinterhuber,A, Towards value-based pricingAn integrative framework for decision making, Industrial
Marketing Management 33 (2004) 765 778
66
67
WHY?
For each industry segment,the Japanese
company had developed detailed
financial models of different cost and
benefit components of its own
equipment versus its main competitor
For a customer in the printing ink
industry, the positive and negative
differentiation value was quantified in
the following way:
Hinterhuber,A, Towards value-based pricingAn integrative framework for decision making, Industrial
Marketing Management 33 (2004) 765 778
68
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Analysis
Under this angle, the price premium of
the Japanese company is modest. If an
interest rate of 8% is applied to the net
benefits gained over the average life
cycle of this equipment of 4 years, the
positive differentiation value amounts to
well over US$300,000. Customers are
expected to pay only a small fraction
less than 10% and US $30,000of the
products economic value.
Hinterhuber,A, Towards value-based pricingAn integrative framework for decision making, Industrial
Marketing Management 33 (2004) 765 778
70
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$5.00
$8.50
$10.00
$2,000.00
$53,800
200
60
140
Example Solution
Profitability of Johnson Brand account
Sales
Less:
Cost of good sold (.9 $53,800)
Order processing (200 $5.00)
Rush handling (.6 200 $8.50)
Customer service (140 $10.00)
Relationship management costs
Profitability of Johnson Brands account
$53,800
$48,420
$1,000
$1,020
$1,400
$2,000 $53,840
$(40)
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Example
4% x
1.000.000
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Example cont
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Activity-Based Pricing
Customers are presented with separate
prices for services they request in addition
to the cost of goods purchased
Example
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Transfer pricing
Transfer Price is:
the internal price charged by one segment of a
firm for a product or service supplied to
another segment of the same firm
Such as:
Transfer Pricing
The transfer price creates revenues
for the selling subunit and purchase
costs for the buying subunit, affecting
each subunits operating income
Intermediate Product the product or
service transferred between subunits
of an organization
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Comparison of
Transfer-Pricing Methods
Criteria
MarketBased
CostBased
Negotiated
Achieves Goal
Congruence
Yes, when
markets are
competitive
Yes
Useful for
Evaluating Subunit
Performance
Yes, when
markets are
competitive
Difficult unless
transfer price
exceeds full cost
and even then is
somewhat
arbitrary
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Comparison of
Transfer-Pricing Methods
Criteria
MarketBased
CostBased
Negotiated
Motivates
Management
Effort
Yes
Yes
Preserves Subunit
Autonomy
Yes, when
markets are
competitive
No, because it is
rule-based
Yes, because it is
based on
negotiations
between subunits
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Comparison of
Transfer-Pricing Methods
Criteria
Other Factors
MarketBased
CostBased
Negotiated
No market may
Useful for
Bargaining and
exist or
determining
negotiations
markets may
full cost of
take time and
be imperfect or products; easy may need to be
in distress
to implement
reviewed
repeatedly as
conditions
change
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Full-cost of production
Negotiated prices
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Transfer Pricing
Implementation
Internal accounting data are often used to set transfer prices, even
when external market prices are available
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