Chapter 12 Pricing Discrimination

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Chapter 12 Pricing Discrimination Powered By Docstoc
					LO 1 Use differential analysis to analyze decisions

            Used in comparison of alternative selection
            short run versus long run (see LO2 and LO3)
                  some cost cannot be changed in short run, while all costs can be changed in long run
            Essential idea is to compare things that differ between the alternatives
                  differential costs
                  sunk costs
            differential cost versus total cost (can use both)

LO2 Understand how to apply differential analysis to pricing decisions

            short run decisions
                  one-time special order (see example in textbook)
                  decision is based upon $, any other items to consider?
            long run decisions
                  adjusting product mix or volume in competitive market

LO3 Understand several approaches for establishing prices based on cost for long-run pricing decisions
         Full cost to determine price
         Differential cost differs between short run and long run time horizon
         Methods to establishing prices
                Life-Cycle product costing and pricing
                Target costing
                Target pricing
         Issues related to pricing
                predatory pricing
                dumping
                price discrimination
                peak-load pricing
                price fixing

LO4 Understand how to apply differential analysis to production decisions

            make or buy decisions
            add/drop product line
            close a business unit
            product choice (mix) decisions

LO5 Understand the theory of constraints

            Assume organizations have limits on what they can accomplish
            Based upon these limits, organizations can maximize profit by
            determining a product mix that maximizes contribution margin per unit of
            constraining resource.
Difference between a sunk and differential cost

A sunk cost has taken place in the past and cannot be changed. A differential cost is one that will change with
erential cost is one that will change with a given decision.
SPECIAL ORDER
   current pro forma

Sales Revenues                                  18,000 $6 per unit               3000
costs of meals produced                         13,500
GP                                               4,500
administrative cost                              2,100
operating profit                                 2,400

   Special olympics is willing to purchase 300 meals for $3.50

   SHOULD SPECIAL ORDER BE ACCEPTED?

First separate into variable and fixed costs
    $4,500 meal production
    $600 for admin




                                        Status Quo        Special Order   Difference
    quantity                                      3,000           3,300
Sales Revenues                                   18,000          19,050         1,050
Variable Cost
    meal costs                                   9,000            9,900           900
    admin                                        1,500            1,500           -
                                                                                  -
                                                                                  -
Total Variable Costs                            10,500           11,400           900
CM                                               7,500            7,650           150
Fixed Costs
    meal costs                                   4,500            4,500           -
    admin                                          600              600           -
Total Fixed Costs                                5,100            5,100           -
Operating Profit                                 2,400            2,550           150

   Intangibles
   Qualitative
Price = $21

operating profit = 20% of costs

WHAT IS HIGHEST ACCEPTABLE COSTS?


price - costs = profit

price - costs = (.2 X costs)

price = (.2 X costs) + costs

price = 1.2 costs

costs = price / 1.2

costs = 21/ 1.2

costs = 17.5


COMPARE OPERATING PROFIT = 20%

price - costs = profit

how to make %

(price - costs)/ price = profit / price

price / price - costs / price = profit / price

cost / price = 1 - profit / price

cost = price * (1 - profit / price)

cost = 21 * (1 - .2)

cost = 21 * .8

cost = 16.80
MAKE OR BUY
                      BUY              MAKE      DIFFERENTIAL
costs to buy                0.60                         0.60
costs to make
materials                                 0.20          (0.20)
labor                                     0.15          (0.15)
variable o/h                              0.15          (0.15)
                            0.60          0.50           0.10




WHAT ABOUT FIXED O/H?

Is there any ethical considerations?
                         machine 2     machine 1
                         cartridge       holder
monthly capacity           800,000      1,000,000
monthly production         800,000        800,000
price                            10
variable cost                      4

fixed costs               4,000,000

Company could sell 1,000,000 pens per month




a) bottleneck?          machine 2


b) produce on the weekend?

additional info
produce 200,000 more
+$1 variable costs
+$800,000 fixed costs

                                       Status Quo   weekend       Difference
                                          800,000    1,000,000
Sales Revenues                          8,000,000   10,000,000     2,000,000
Variable Cost
 cartridge                              3,200,000     4,200,000    1,000,000
                                                                         -
                                                                         -
                                                                         -
Total Variable Costs                    3,200,000     4,200,000    1,000,000
CM                                      4,800,000     5,800,000    1,000,000
Fixed Costs
                                        4,000,000     4,800,000      800,000
                                                                         -
Total Fixed Costs                       4,000,000     4,800,000      800,000
Operating Profit                          800,000     1,000,000      200,000

c) add more workers?
produce 100,000 more
+$4.50 variable costs
+$0 fixed costs

                                       Status Quo   + weekday     Difference
                                          800,000       900,000
Sales Revenues         8,000,000   9,000,000   1,000,000
Variable Cost
                       3,200,000   4,050,000    850,000
                                                    -
                                                    -
                                                    -
Total Variable Costs   3,200,000   4,050,000    850,000
CM                     4,800,000   4,950,000    150,000
Fixed Costs
                       4,000,000   4,000,000        -
                                                    -
Total Fixed Costs      4,000,000   4,000,000        -
Operating Profit         800,000     950,000    150,000

				
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