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Cost Based Pricing - Welcome to Prospect Learning

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Cost Based Pricing - Welcome to Prospect Learning Powered By Docstoc
					Detailed lecture on
Cost-Based Pricing
     Ted Mitchell
     Three Approaches to
     Setting A Selling Pice

    CostBased Pricing
    Competitive Based Pricing
    Customer Based Pricing




2
               Goal
    Seta Selling Price that covers
    our Normal Costs and Profit
    assuming a normal business
    environment




3
      A Basic Perspective
    In Cost Based Pricing or
     Budget Setting
    You know Everything or
     Everything is forecasted




4
Cost Based Pricing Is Most Important
Why Cost Based Pricing?
     Four Reasons
1 Sounds Fair
2 Easy to Calculate
3 Industry Stability
4 “guarantee a profit”
    In Cost Based Pricing or Budget
      Setting You know Everything
    You   are solving for the needed Price,
     P
    You know the variable cost per unit, V
    You know the Total Promotion Cost, TP
    You know the other fixed costs, F
    You know the profit needed or
     expected, Z
    You know the sales quantity
     forecasted, Q
    Solve for Price, P
7
    What   Costs Should I include?




8
Some Costing Is Crude
Direct Materials plus
Direct Labor plus
300% of Direct Labor (to
 cover Fixed Costs) plus
A 50% Markup plus
Competitive adjustment plus
What the customer will bear
     Revenue, R = PQ                     PQ
     Cost of Goods Sold, COGS = VQ       VQ
     Gross profit, G = (P-V)Q            G
     Gross Return on Sales, GROS = G/R
     Markup Percentage, Mp = (P-V)/P
     Direct Total Marketing Effort, TP   TP
     Marketing Contribution, MC = G-TP   MC
     Marketing Return on Sales
     MROS = MC/R
     All other overheads, F              F
     Net Profit, Z = R – E - F           Z
     Net Return on Sales, ROS = Z/R




10
     To select the costs needed in
     the calculation you need to
     know the definition of the
     profit that is being targeted




11
           Remember the key is
     the definition of profit being used
     Is it the gross profit?
     Is it the marketing profit?
     Is it the net profit




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     Revenue, R = PQ                     PQ
     Cost of Goods Sold, COGS = VQ       VQ
     Gross profit, G = (P-V)Q            G
     Gross Return on Sales, GROS = G/R
     Markup Percentage, Mp = (P-V)/P
     Direct Total Marketing Effort, TP   TP
     Marketing Contribution to Profit,   MC
     MC = G-TP
     Marketing Return on Sales
     MROS = MC/R
     All other overheads, F              F
     Net Profit, Z = R – E - F           Z
     Net Return on Sales, ROS = Z/R



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     Revenue, R = PQ                     PQ
     Cost of Goods Sold, COGS = VQ       VQ
     Gross profit, G = (P-V)Q            G
     Gross Return on Sales, GROS = G/R
     Markup Percentage, Mp = (P-V)/P
     Direct Total Marketing Effort, TP   TP
     Marketing Contribution to Profit,   MC
     MC = G-TP
     Marketing Return on Sales
     MROS = MC/R
     All other overheads, F              F
     Net Profit, Z = R – E - F           Z
     Net Return on Sales, ROS = Z/R



14
      If you are given the dollar profit
      needed the calculation is trivial
 If   I tell you the dollars of gross profit normally
     needed, G
 PQ –  VQ = G
 You know the invoice cost or
  variable cost per unit, V and
  Forecasted Quantity Solve for P
 P = V + G/Q

15
     Revenue, R = PQ                     PQ
     Cost of Goods Sold, COGS = VQ       VQ
     Gross profit, G = (P-V)Q            G
     Gross Return on Sales, GROS = G/R
     Markup Percentage, Mp = (P-V)/P
     Direct Total Marketing Effort, TP   TP
     Marketing Contribution to Profit,   MC
     MC = G-TP
     Marketing Return on Sales
     MROS = MC/R
     All other overheads, F              F
     Net Profit, Z = R – E - F           Z
     Net Return on Sales, ROS = Z/R



16
      If you are given the dollar profit
      needed the calculation is trivial
 If   I tell you the dollars of marketing profit
     needed, MC
 PQ –  VQ – TP = MC
 You know normal V, Q, and the
  total marketing expense, TP
 Solve for the Price P
 P = V + TP/Q + MC/Q
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     Revenue, R = PQ                     PQ
     Cost of Goods Sold, COGS = VQ       VQ
     Gross profit, G = (P-V)Q            G
     Gross Return on Sales, GROS = G/R
     Markup Percentage, Mp = (P-V)/P
     Direct Total Marketing Effort, TP   TP
     Marketing Contribution to Profit,   MC
     MC = G-TP
     Marketing Return on Sales
     MROS = MC/R
     All other overheads, F              F
     Net Profit, Z = R – E - F           Z
     Net Return on Sales, ROS = Z/R



18
      If you are given the dollar profit
      needed the calculation is trivial
 If   I tell you the dollars of net profit normally
     needed, Z
 PQ – VQ – TP – F = Z
 You know the normal V, Q, TP,
  and other fixed costs, Solve for P
 P = V + TP/Q + F/Q + Z/Q


19
Target Returns (Profits)
Where Do They Come
        From?
     Sources of Targets
1 Deciding What Seems Fair
2 Wanting A Better Return
 Than Last Year
3 Establishing What They
 Believe They Can Get
4 Estimated Cost Of Capital
5 Wanting To Stabilize Prices
Price Formula Come From
The Basic Profit Formula
   Z = (P - V)Q - F
The Basic Cost Based
  Pricing Formula is
             F Z
        P=V + +
             Q Q
   Basic Cost Based
   Pricing Formula is
               F Z
          P=V + +
               Q Q
Plug in the values for V, F, Q,
and Z and solve for the Price
     When    You are given the
      dollar amounts of the profit
      that you are to earn the
      calculation is trivial
     HOWEVER IT NEVER HAPPENS!




24
     You    are told the the target
      profit in terms of
     1) normal markup, Mp
     2) normal gross return on
      sales, GROS
     3) normal marketing return
      on sales, MROS
     4) normal Net Return on
      Sales, ROS
25
     When given Profit as a
        Rate of Return
     Markup
      P = V/(1-Mp)
     Gross Return on Sales
      P = V/(1-GROS)
     Marketing Return on Sales
      P = (V + TP/Q)/(1-MROS)
     Return on Sales
      P = (V+ TP/Q + F/Q)/(1-ROS)
26
     Know these four approaches to
               price setting
     Markup
      P = V/(1-Mp)
     Gross Return on Sales
      P = V/(1-GROS)
     Marketing Return on Sales
      P = (V + TP/Q)/(1-MROS)
     Return on Sales
      P = (V+ TP/Q + F/Q)/(1-ROS)
27
     Where do they come from?
     How   do we get the classic
      return on sales method?

     Price   =
     (average    cost per unit)/(1-ROS)



28
     If you are told the target
      profit in terms of the normal
      return on sales then you are
      told To target a ROS of some
      % of Revenue
     Z = ROS x R
     Remember you know the
      forecasted revenue
     Substitute ROS(R) = Z


29
      How to get the ROS equation
     P = V + TP/Q + F/Q + Z/Q
     Substitute ROS(R) = Z
     P = V + TP/Q + F/Q + ROS(R)/Q
     Substitute P x Q = R
     P = V +TP/Q +F/Q +ROS(PQ)/Q
     Gather the P’s
     P – ROS(P) = V +TP/Q +F/Q
     P(1-ROS) = V +TP/Q +F/Q
     P = (V +TP/Q +F/Q)/(1-ROS)

       P = Average Cost per Unit /(1-ROS)
30
      Classic ROS Method
     Price,P, is set knowing the
      average cost per unit or the
      breakeven price, BEP, and the
      normal return on sales. ROS


     P   = BEP/(1-ROS)

31
     How to get the classic gross return
     on sales method for setting price?

     R – COGS = Gross Profit
     You are told you need a Gross
      Return on Sales of GROS equal to
      some % of sales
     You know that
     (GROS x Revenue) = Gross Profit
     Substitute
      R-COGS = GROS x Revenue
32
     R-COGS = GROS x Revenue
     Revenue  =R=PxQ
     Cost of Goods Sold = V x Q
     PQ – VQ = GROS x P x Q
     P-P(GROS) = V
     P(1-GROS) = V
     P = V/(1-GROS)

33
        The classic Gross
     Return on Sales Method
     Set  the price based on the
      invoice cost or the variable
      cost per unit, V, and the
      normal percent of gross profit
      returned on sales, GROS


     P     = V/(1-GROS)
34
     The classic retailer’s method
         of setting price is the
            markup method
     P   = V/(1-Mp)

     In  the game with a single
      product the gross return on
      sales percent is the same as
      the markup percent
35    P = V/(1-GROS)
     Retailer’s method of markup
     You   get the markup method
      simply by knowing the
      definition of markup on price
     (P-V)/P = Mp
     If you know the normal
      variable cost, V, and the
      normal profit margin or
      markup, Mp, needed to stay
36    in business then
     Retailer’s method of markup
     (P-V)/P = Mp
     P-V = Mp(P)
     P – Mp(P) = V
     P(1-Mp) = V
     P = V/(1-Mp)



37
     Four Cost Based Pricing
           Equations
     Retailer’s Markup
      P = V/(1-Mp)
     Gross Return on Sales
      P = V/(1-GROS)
     Marketing Return on Sales
      P = (V + TP/Q)/(1-MROS)
     Classic Return on Sales
     P = (V+ TP/Q + F/Q)/(1-ROS)
38    P = BEP/(1-ROS)
           Remember the key to
     cost-based pricing is the definition
          of the profit being used
     1) Is it the gross profit or profit after COGS?
       The gross profit returned on sales, GROS
      or the markup (the unit profit on price), Mp
     2) Is it the marketing profit or profit after total
      promotion?
      The marketing profit returned on sales, MROS
     3) Is it the net profit or profit after all
      expenses?
      the net profit returned on sales, ROS




39
        Weakness of Cost
         Based Pricing
     1) it assumes that the
      demand or the quantity sold
      can be forecasted before you
      know the price you are
      charging
     2) it assumes that the costs
      are going to be the same as
      they normally are
40
      Cost Based Pricing Does

     NOT  Guarantee Fairness
     Not Guarantee Demand
     Not Guarantee A Net Profit
     Not Simplify if Managers
      Confused About Costs
      Unitcost versus variable cost
      Sunk costs vs fixed cost
      Discretionary, inescapable
41
     Any  Questions on Cost Based
     Pricing?




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posted:5/22/2013
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