Legal and Social Forces

CHAPTER 5

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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