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Chapter 5
Strategic Planning
Regarding
Operating
Processes
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
What are the Primary Influences on
Selling Price?
• Customers—
 customers want high quality and service at a
reasonable price
 Must understand customers and respond to
their needs
 Price increase, demand decreases
 Price decrease, demand increases
• These trends can be affected by
 loyalty and unwillingness to substitute (ex: coffee)
 staple vs. luxury item (hamburger vs steak)
 Perceived high quality and service (Toyota vs Ford)
5-2
What are the Primary Influences on
Selling Price?
• Competitor—
 Depending on the competitiveness of the
market, competitors may influence the selling
price
 Must monitor and learn from them
• Pure competition
 Market determines selling price
 Individual company is price taker (ex: agriculture
industry)
• Monopolistic competition
 Market influences selling price
 Individual companies influence selling price through
advertising (ex: airlines, computers, athletic wear)
5-3
What are the Primary Influences on
Selling Price?
• Legal and social forces—
 there are legal restrictions and social influences on
selling price
 Must monitor changes and learn from them
 Monopoly (ex: utility companies)
• One company controls market and selling price
• Government approves price changes
 Oligopoly (ex: oil companies)
• Very few companies control selling price
• Government monitors selling prices
 Price fixing
 Price gouging
5-4
What are the Primary Influences on
Selling Price?
• Cost—
 In the long run, the selling price set by a company
must cover all its costs and provide a sufficient return
to the owners
 Must control costs and eliminate non-value added
activities
• Markup - what is added to cost of product to ensure profit
• Selling margin = selling price - cost
• Selling margin % = selling margin/selling price
5-5
How does the External Market
Influence Selling Prices?
•
•
•
•
5-6
Pure competition
Monopolistic competition
Oligopoly
Monopoly
What is the Difference between Penetration
Pricing and Predatory Pricing?
• Penetration pricing
 Setting a lower initial selling price to entice
customers to try the product/service
 Legal
• Predatory pricing
 Setting a low initial selling price (usually below
cost) to drive out the competition
 Then raise prices once they control the
market
 Illegal
5-7
What is the Difference between
Skimming Pricing and Price Gouging?
• Skimming pricing
 Setting higher initial selling prices due to
uniqueness of product
 Appeals to customers who want to be the first
to own the product and are willing to pay more
 Later when novelty wears off, lowers the price
 Legal
• Gouging
5-8
 Setting high price due to unusual increase in
demand (gas prices on 9/11)
 Illegal
What is the Difference between Lifecycle and Target Pricing?
• Life-cycle pricing
 Setting a selling price for the life of the
product/service based on cost
 Determine cost, determine required markup,
set selling price
• Target pricing
 Setting a selling price for the life of the
product/service based on the market
 Determine selling price, determine required
return, set target cost
5-9
What are the Common Reasons for
Holding Inventory?
•
•
•
•
5-10
Meet customer demand
Smooth production scheduling
Take advantage of quantity discounts
Hedge against anticipated cost increases
What are the Common Reasons for
Not Holding Inventory?
• Significant costs are incurred
• Holding inventory allows the company the
“hide” its internal process problems because
demand can be met from inventory
5-11
What are the Common
Compensation Plans?
• Piece rate
 Pay based on units completed
• Commission
 Pay based on sales
• Hourly
 Pay based on hours worked
• Salary
 Pay based on period of time
5-12
Other Compensation Issues…
• Gross pay versus net pay
 Gross = amount earned
 Net = amount received
5-13
Fringe Benefits Companies Provide
and Why…
• Insurance
 Protection for employees
• Paid leave
 Protection for the company
• Bonuses
 Additional pay based on some future event
5-14
How are Bonuses Calculated?
• Bonus amount
 Net income before bonus (and taxes)
 Net income after bonus (before taxes)
 Net income (after bonus and taxes)
• Bonus rate
 Percentage of bonus amount
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Example
A company anticipates an income before
bonus or taxes of $400,000. It has set its
bonus rate at 12% and it expects a tax rate of
20%. Determine the amount of the bonus if:
1.
Bonus is based on income before taxes
or bonus
2.
Bonus is based on income before taxes
(after bonus)
3.
Bonus is based on net income (after
taxes and after bonus)
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Answers; B = Bonus
1. B = 0.12 * $400,000
B = $48,000
2. B = 0.12 * ($400,000 – B)
B = $48,000 – 0.12B
1.12B = $48,000
B = $42,857.14
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Answers continued; T = Tax
3. B = 0.12 * ($400,000 – B – T)
B = $48,000 – 0.12B – 0.12T
T = 0.20 * ($400,000 – B)
T = $80,000 – 0.20B
B = $48,000 – 0.12B – 0.12 * ($80,000 – 0.2B)
B = $48,000 - 0.12B - $9,600 + 0.096B
B = $38,400 – 0.096B
1.096B = $38,400
B = $35,036.50
5-18
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