Pricing Decisions and Short-term Decisions
Domain focus
Pricing decisions connect cost, demand and competition. The exam tests cost-plus pricing, marginal-cost pricing, target costing, lifecycle pricing, skimming, penetration and tender pricing.
Core rules
- Cost-plus price = cost base + markup. Markup is on cost; margin is on selling price. Convert carefully.
- Marginal-cost pricing sets price above variable cost to contribute to fixed costs and profit; it is useful for short-term tactical decisions but risky as a long-term policy.
- Target cost = target selling price - desired profit. It is derived from the market price and required return, not from current cost.
- Skimming sets a high initial price for early adopters; penetration sets a low price to build share.
- Price elasticity affects revenue: elastic demand means a price rise reduces revenue.
Worked example
Expected market price is ₹500. The company requires 20% profit on selling price, so desired profit is ₹100 and target cost is ₹400. Current cost is ₹430. Target cost reduction = ₹30 per unit. If instead a 20% markup on cost were used, price would be ₹430 × 1.20 = ₹516, which exceeds the market price; the two percentages are not interchangeable.
Traps
Confusing markup and margin; adding fixed overhead to a short-term marginal decision without checking relevance; setting target cost by adding profit to current cost; ignoring competitor reaction and capacity; treating all costs as controllable in target costing.