Pricing and Revenue Management
What the exam tests
Pricing questions test how costs, customers, competitors and capacity set price, and how revenue management changes yield. Expect cost-plus, target costing, value-based pricing, elasticity, price discrimination, bundling, skimming and penetration.
Core rules and concepts
- Cost-plus pricing starts from cost and adds a markup; it is simple but inward-looking. Use full cost for long-run price floors only if all costs must be recovered; use variable cost for short-run special orders with spare capacity, plus opportunity cost.
- Target costing works backward: target price from market research or competition, less required margin = allowable cost. Manage design and supply chain to close the gap.
- Value-based pricing sets price from customer-perceived value and willingness to pay. Price elasticity = percentage change in quantity / percentage change in price; demand is elastic if the absolute value exceeds 1.
- Revenue management uses capacity, timing and segment restrictions. Yield = revenue / available capacity. Price discrimination charges different segments different prices; it requires separation and limited arbitrage.
- Skimming sets a high launch price; penetration sets a low price to build share. Bundling and versioning capture heterogeneous willingness to pay.
Worked example
A competitor's comparable product sells for $120. The company requires a 25% margin on selling price, so allowable cost = $120 x (1 - 0.25) = $90. Current designed cost is $98, leaving an $8 gap. The team can redesign a component ($3), renegotiate a supplier ($2), and cut expedited freight ($1), closing $6; the remaining $2 needs a specification change or a lower margin. If the company instead adds 25% to its $98 cost, it would price at $122.50 and exceed the market. The target-cost discipline exposes the gap before launch, while cost-plus hides it in a higher price.
Traps that cost marks
- Using full cost as the minimum price for a special order with idle capacity.
- Adding markup to cost when the market sets the price.
- Ignoring cannibalization and competitor reaction.
- Treating elastic demand as a reason to raise price.
- Confusing yield with volume; empty capacity has zero yield.