This is part 3 in our short-term business decisions series and here we're
going to be discussing the setting of prices. When we set prices we have to
understand what our target profit is that's number one. Also you have to
realize or understand what exactly customers will pay for your product so
you'll have to do some research to find that out. Then you have to determine
are you a price-taker or are you a price- setter for this particular product? So
let's go into that a little bit deeper- price-taker and price-setter. If you're a
price-taker, then your product is not going to be unique, there will be intense
competition for your product, and we're going to have to emphasize what's called
target pricing and we'll look at that in just a second.
If you're a price-setter your product is going to be unique, there'll be less
competition because you do have a unique product, and you will have to emphasize
what's called cost-plus pricing. So let's start with the price-setter and what's
called cost-plus pricing. The formula to calculate cost-plus pricing we will
start with what's called our full cost so the cost of our product. To the cost
of our product we're going to add our desired profit. So full cost plus your
desired profit is going to give you what's called our cost-plus price.
If you are a price-taker you're going to use what's called target pricing. Now
this is where the terminology comes in handy for you. If you're a price-taker
you are now going to take the cost-plus price from the price-setter which is
also called the market price. From that you're going to subtract your
desired profit to give you what's called your target full cost. So the cost plus
price for the price-setter, the higher the better. The target full cost for the
price-taker, the lower the better. So let's look at an example of a price-
taker and a price-setter. Bennett Builders builds 1,500 square foot starter tract
homes in the fast-growing suburbs of Atlanta. Land and labor are cheap and
competition among developers is fierce. The homes are "cookie-cutter" with any
upgrades added by the buyer after the sale. Bennett's cost per developed sub
lot are as follows: so we have land of $54,000, construction of $122,000,
landscaping of $5,000, and variable marketing costs of $3,000. Bennett Builders
would like to earn a profit of 15% of the variable cost of each home sale.
Similar homes offered by competing builders sell for $200,000 each. So if we
added up our our cost here per developed sub-lot the land, construction,
landscaping, and variable marketing costs, that would give us
$184,000. That's what those add up to. So keep these numbers in mind.
What approach to pricing should Bennett Builder emphasize? Well they tell us in
the problem that it's cookie cutter houses so that would tell us that it's
not a unique product and we probably have severe competition.
So we would be a price-taker, and we would have to emphasize target pricing.
Will Bennett Builders be able to achieve their target profit levels? Well to do
this we're going to take the market price of similar homes which they tell
us is $200,000 because we're a price-taker so we have to take the
price the market price from the price- setters which is $200,000
and we're going to subtract our target profit and they tell us that our target
profit is 15% of our cost. Remember our cost was $184,000
$184,000. So 15% of $184,000 is
$27,600 giving us a target
cost of $172,400. But we
know our actual cost is $184,000 so we will not be
able to achieve that 15% profit.
you