CHAPTER 5

You Are Here
Chapter 5 builds on Chapters 1 - 4 as it explores three strategic decisions that impact the revenue, conversion, and expenditure processes. In Chapter 5 we study the process of determining the selling price and the process of determining the compensation package offered to employees. / Key Points
There are four primary influences on selling price.
  • Customers
  • Competitors
  • Legal and social forces
  • Cost
There are four primary economic environments that impact selling prices.
  • Pure competition
  • Monopolistic competition
  • Oligopoly
  • Monopoly
There are a variety of pricing strategies followed by companies.
  • Penetration pricing
  • Skimming pricing
  • Life-cycle pricing
  • Target pricing
Employees can be compensated in a variety of ways.
  • Piece-rate pay
  • Commissions
  • Hourly pay
  • Salary
  • Bonuses—contingent compensation
Involuntary withholdings include:
  • Federal income taxes
  • State and local income taxes
  • Social security taxes
Voluntary withholdings include:
  • Pension contributions
  • Charitable contributions
  • Health and life insurance contributions

CHAPTER 5 DISCUSSION OUTLINE

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)

• 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)

• 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

• 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

How does the External Market Influence Selling Prices?

• 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

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

  • Setting high price due to unusual increase in demand (gas prices on 9/11)
  • Illegal

What is the difference between life cycle pricing and target pricing?

  • Life cycle pricing—setting a selling price that can be maintained over the life cycle of the product by first determining cost, then adding a markup to determine selling price
  • Target pricing—setting a selling price that can be maintained over the life cycle of the product by first determining the selling price, then subtracting a required return to determine the target cost

What are the reasons commonly given for maintaining inventory?

  • To meet customer demand
  • To smooth production scheduling
  • To take advantage of quantity discounts
  • To hedge against anticipated price increases

What are the reasons commonly given for not maintaining inventory?

  • Significant costs are incurred to hold inventory
  • Having inventory allows a company to “hide” its internal process problems because on hand inventory can be used to cover up for defects

What are the differences among piece-rate, commission, hourly, salary, and bonus compensation?

  • Piece-rate—pay based on the number of items completed
  • Commission—pay based on the number of items sold
  • Hourly—pay based on the number of hours worked
  • Salary—pay based on a period of time
  • Bonus—pay based on some future event

What is the difference between gross pay and net pay?

  • Gross pay—total amount earned
  • Net pay—total amount received—gross pay less voluntary and involuntary withholdings

What other fringe benefits do companies provide and why do they provide them?

  • Health and life insurance—to protect employees
  • Paid leave—to provide employees with time off
  • Why? Because it is cheaper to provide the benefits than to pay the employees to provide these opportunities for themselves; internal control

Chapter 5 Notes f091