CIMA P2 Syllabus B. Capital Investment Decision Making - Different Price Strategies - Notes 3 / 3
Cost-plus
Cost-plus pricing involves establishing the unit cost and adding a mark-up or margin.
Advantages of Full Cost-Plus Pricing
It is quick, simple and cheap - andh can be delegated to junior managers.
Fixed costs should be covered and a profit made
Disadvantages of Full Cost-Plus Pricing
It ignores potential profit maximising
It ignores market and demand conditions.
Budgeted volume needs to be established, to absorb the fixed overheads correctly
A suitable overhead absorption basis must be selected
Marginal Cost-Plus Pricing Pricing
Adding a profit margin to the marginal cost of production
Advantages of Marginal Cost-Plus Pricing
Simple and easy
It draws management attention to contribution
Used where there is a readily-identifiable basic variable cost.
Disadvantages of Marginal Pricing
Insufficient attention is paid to demand conditions, competitors' prices and profit maximisation.
Fixed costs may not be covered
Market Skimming
For high unit profits in the early stages of a product’s life cycle.
Charge a high price initially through advertising and promotion - so some customers are willing to pay these high prices for the status of getting the product early
eg Technology based gadgets
The most suitable conditions for this strategy are:
New (and different) Product
Short life cycle and high development costs that need to be recovered quickly
High initial cash inflows are expected
Barriers to entry in order to deter competitors (as they will like the high initial selling prices)
The price is then reduced as the product ages - due to competition eventually coming in
The approach ‘skims’ the profit in the early stages of the life cycle
Penetration Pricing
Opposite to Skimming - here the initial price is low
The idea is to build a larger market share - this will be more successful than skimming when demand is elastic.
High sales volumes will compensate for the lower prices being charged - plus it leads to economies of scale which lead to reduced costs
A penetration policy discourages new entrants to the market.
It will shorten the initial period of a product’s life cycle in order to enter the growth and maturity stages quickly.
Complementary Product Pricing Strategy
A complementary product is one that is used in conjunction with another product.
For example, tennis balls and tennis rackets, razors and blades, printers and printer cartridges.
A Complementary Product Pricing Strategy can take two forms:
The major product (e.g. a printer) is set at a low price.
This then forces the customer to buy the subsequent complementary products with higher prices (eg. Ink Cartridges)
The major product is set at a high price (eg Gyms)
The customer is locked in again but subsequent complementary purchases are often lower (eg Use of squash court)
Product-line Pricing
A range of products for different target audiences.
The products are related but may vary in style, colour and quality.
Typically price points are high, medium and low
Eg Different Phones made by the same company
Volume Discounting
The more you buy the cheaper the unit price
2 Types:
Quantity discounts – for customers that order large quantities.
Cumulative quantity discounts – the discount increases as the cumulative quantity ordered increases.
Volume discounting is applied to products with a limited shelf life, e.g. fashion items and also to clear unpopular items.
Price-Discrimination
Price-discrimination occurs where a company sells the same products at different prices in different markets.
This is possible if:
Customers can be segregated into different markets.
Customers cannot buy at the lower price in one market and then they sell at the higher price in the other market
Price elasticity must be different in each market
So prices can be increased in 1 market and lowered in others
Relevant Costing
Only try to cover at future, incremental, cashflow costs
(For short-term decisions many costs are likely to be fixed and irrelevant)