The following question-and-answer format summarizes the chapter’s learning objectives. Each decision presents a key question related to a learning objective. The guidelines are the answers to that question.
| Decision | Guidelines |
| 1. What are the three major factors affecting pricing decisions? | Customers, competitors, and costs influence prices through their effects on demand and supply; customers and competitors affect demand; and costs affect supply. |
| 2. How do companies make long-run pricing decisions? | Companies consider all future costs (whether variable or fixed in the short run) and use a market-based or a cost-based pricing approach to earn a target return on investment. |
| 3. How do companies determine target costs? | One approach to long-run pricing is to determine a target price. A target price is the estimated price that potential customers are willing to pay for a product or service. The target cost per unit equals the target price minus the target operating income per unit. The target cost per unit is the estimated long-run cost of a product or service that, when sold, enables the company to achieve the target operating income per unit. Value-engineering methods help a company make the cost improvements necessary to achieve a target cost. |
| 4. Why is it important for managers to distinguish cost incurrence from locked-in costs? | Cost incurrence describes when a resource is sacrificed. Locked-in costs are costs that have not yet been incurred but, based on decisions that have already been made, will be incurred in the future. Value engineering techniques are most effective for reducing costs before costs are locked in. |
| 5. How do companies price products using the cost-plus approach? | The cost-plus approach to pricing adds a markup component to a cost base as the starting point for pricing decisions. Many different costs, such as full cost of the product or manufacturing cost, can serve as the cost base for applying the cost-plus formula. Prices are then modified on the basis of customers’ reactions and competitors’ responses, that is, the size of the “plus” is determined by the marketplace. |
| 6. Describe life-cycle budgeting and life-cycle costing. When should companies use these techniques? | Life-cycle budgeting estimates and life-cycle costing tracks and accumulates the costs (and revenues) attributable to a product from its initial R&D to its final customer service and support. These life-cycle techniques are particularly important when (a) a high percentage of total life-cycle costs are incurred before production begins while revenues are earned over several years or (b) a high fraction of life-cycle costs are locked in at the R&D and design stages. |
| 7. What non-cost considerations influence firms’ ability to set prices in relation to their cost of producing and delivering products and services? | Pricing below costs in an effort to drive competitors out of the market (predatory pricing) is illegal, as is colluding with other companies in the same industry to charge excessively high prices. Price discrimination refers to charging differential prices to customers for the same product or service. This may result from charging higher prices when demand approaches physical-capacity limits (peak-load pricing), or to reflect cross-country differences in regulations or the purchasing power of consumers. |