STRATEGIC MANAGEMENT ACCOUNTING

Strategic Management Accounting



Strategic Management Accounting

Pricing Decisions - Introduction

Companies price their products in many different ways. Pricing methods include contribution pricing, in which a variable pricing strategy is adopted, with different prices charged for the same product depending on the circumstances, and competitive pricing, which sets prices in relation to competitors' prices (Kieso, 2009).

Predatory pricing is a pricing policy designed to put competitors out of business. Large national companies can operate a differential pricing policy across the country, lowering prices below an economic level where there is intense local competition. The company then cross-subsidizes losses with profits from areas where there is little or no competition. Once local competition is eradicated, the company can raise prices again. Companies operating a predatory pricing policy may fall foul of restrictive trade practice legislation (Sharman, 2003).

By-product pricing is the pricing of products produced incidentally during a production process. Pricing by-products is difficult, as they are an unintended consequence of production and therefore do not have an obvious cost associated with their production. By-products are often priced as high as the market will bear in order to make the overall production process and therefore production of the principal good as competitive as possible.

Often there will be a single company, product or service that is a leader in its market. As the leader, it serves as the pricing benchmark for the rest of the market. This company is known as the price leader (Meyers, 2007). When the price leader sets the price for its product, all of the other products in the market price according to their position relative to the price leader. This pricing policy leads to a stable market and avoids over-competitive pricing, which critics might argue was not in the interests of the consumer. Although this pricing strategy is common, companies, especially in a mature market with a small number of large firms, must be careful not to cross the boundaries of accepted practice by forming a cartel and colluding over pricing.

Meyers (2007) provide a formal model of the determination of the relationship between price and costs under conditions of oligopoly. Their theoretical model indicates that the mark-up of price over (marginal) costs (and thereby the ratio of profits plus fixed costs to sales revenue) will depend upon the industry elasticity of demand, industrial concentration (as measured by the Herfindahl index), and the firms' expectations of the response of rivals to output changes. The model is estimated using data for the UK for 1958, 1963, and 1968, which produce evidence to support their model.

Duchac (2009) argues that the financing requirements for investment generate a need for internal finance that generates a mark-up of price over costs (profit margin) to give the required finance (where profits equal profit margin multiplied by volume of output). They assume that, over a range, prices and quantities of output are independent. They conclude that when the amount of extra capacity to be laid down, the choice of technique and the method and cost of finance are ...