SMA Module 3 Pricing Controls

The Deep Dive podcast discusses the importance of pricing decisions in business and explores four key approaches to pricing. The first approach is full cost plus pricing, which involves adding a profit margin to all costs associated with bringing a product or service to market. While this approach ensures that costs are covered, it doesn't consider market demand or competitor pricing. The second approach is marginal cost plus pricing, which focuses on variable costs of production and allows for flexibility in adjusting prices based on market conditions. However, it may not account for fixed costs. The third approach is market-based pricing, which starts with customer willingness to pay and competitor pricing, then works backwards to determine costs. This approach is customer-centric and focuses on understanding the value delivered. The final approach is target costing, where the selling price is determined first, and then the target cost is calculated by subtracting the desired profit Welcome to the Deep Dive, where we unpack the knowledge you need fast. Fast, yes. That's right. Today, we're diving into something that really is the heart of any business, pricing decisions. You sent us some really interesting material, and I think what we want to try to do is figure out how to make this really work for you. Absolutely. So how do we actually decide what to charge for something? Yeah. That's the million-dollar question, isn't it, for every business owner? This session is brought to you by Ultimate Access Education, your learning partner. Our goal, really, is to give you a solid grasp on the core strategies of pricing. Exactly. Because it's not just about throwing a number out there and hoping it sticks. No. Right. It's really a strategic lever that impacts everything. Sales volume, profitability- Yeah. Brand perception. Oh, absolutely. Customer loyalty, all of it. So we're going to be dissecting four key approaches. Okay. All right. From the material you sent. Yeah. Looking at the logic behind each one, and when they might actually make sense for you out there listening. Right. Right. So let's dive in. Let's do it. Okay. The first set of strategies really has to do with your internal numbers. Okay. The cost of actually doing business. Makes sense. Right? Making your product, delivering your service. Right. We see a lot here about full cost plus pricing. Yes. What's the fundamental idea there? So full cost plus pricing is really about taking all of the costs associated with bringing a product or service to market and adding a predetermined profit margin on top. Okay. So that includes raw materials, labor manufacturing overhead, distribution costs. Got it. Everything. So you're really looking at the total outlay. Right. And then ensuring you make a certain percentage on top of that. Yeah. And I just want to point out that this can be really useful for people who are doing like custom work or contract-based projects where you need to give individual quotes. Right. But it also hints that there might be a little bit of a, you know ... A catch. A catch. Yeah. Yeah. What should our listener be mindful of with this approach? So while it is simple ... Yeah. And it seems to guarantee that you're going to cover your costs and make your desired profit. At a certain production level. At a given level of production, yes. Right. It doesn't consider what your competitors are doing or more importantly, what your customers are willing to pay. Oh. So you might calculate a price that's just too high for the market. Right. Or you could be leaving money on the table because you're not pricing it high enough. Right. Based on the value that your customers perceive. Yes. And also that overhead absorption piece, that can get a little bit complicated. Yeah. Explain that a little bit more. Overhead absorption, basically, it's the process of taking all of those indirect costs, those overhead costs ... Right. And spreading them out. Yeah. Over all the units of production. Okay. But it relies on an estimate of how much you're going to produce. Oh. So let's say you're ... Okay. You're renting a factory space. Right. And you plan on making 10,000 widgets. You would divide that rent ... Okay. By 10,000. Got it. And you figure out how much of that rent goes into each widget. Yeah. But what if you only make 5,000? Oh, right. Then you've underestimated your cost per unit. So just because it costs you, I don't know, $20 to make something ... Yeah. Doesn't mean that somebody's going to pay 25 for it. Exactly. Yeah. It's really about finding that sweet spot ... Right. Between what it costs you and what the market will bear. Okay. Now the material also discusses marginal cost plus pricing. Right. How does that differ from the full cost approach? So marginal cost plus ... Okay. Focuses on the variable costs of production. Okay. So those are the costs that change directly. With the number of units you produce. Got it. Things like raw materials. Got it. Direct labor. Yeah. Things like that. Got it. You determine the variable cost per unit. Uh-huh. And then you add a markup to that to determine your selling price. So you're really looking at the cost to produce one more unit. Exactly. That's the marginal cost. Okay. Got it. The cost of that next unit. Your sources suggest that this can be really relevant in retail. Yeah. Where a standard markup might be applied to the cost of goods. Yeah. Absolutely. Yeah. It's very common in retail. What are some advantages and maybe some potential pitfalls of this approach? So one of the big advantages is its simplicity. Okay. It's very easy to calculate that variable cost per unit. Right. And then add a markup. Yeah. It also allows for flexibility. So if market conditions change, you can adjust your markup. Got it. To stay competitive. So if the price of steel goes up, you can increase your markup to reflect that. Uh-huh. Got it. It also keeps management focused on the contribution margin. So that's the amount of money that each sale contributes towards covering fixed costs and generating profit. Got it. However, you need to be careful because this method doesn't explicitly account for fixed costs when you're setting the initial price. So if your sales volume is lower than anticipated, you might not be covering all of your fixed costs. Okay. So that's a really key consideration there. Yeah. So we've talked about cost as a starting point. But the sources also highlight this idea of market-based approaches to pricing. Right. This feels like kind of a different way of looking at it. Absolutely. It's a completely different perspective. Instead of starting with your costs, you start with the market. Okay. What are your customers willing to pay? Mm-hmm. What are your competitors charging? Right. And then you work backwards. Oh, wow. To figure out your costs. That's fascinating. It's a very customer-centric approach. So it's about really understanding the value that you're delivering and what the market is willing to bear for that. Exactly. Okay. The material also mentions the product lifecycle and how that impacts your pricing power. Right. So, you know, we all know those stages, introduction, growth maturity, saturation, and decline. How should your pricing strategy change as your product moves through those stages? That's a great question. Yeah. So in the introductory phase, when your product is brand new, you often see two different strategies. Okay. One is market penetration pricing, where you set a low price to try to gain market share quickly. Okay. The other is market skimming pricing, where you set a high price to appeal to those early adopters who are willing to pay a premium to be the first ones to have the product. Then, as your product moves into the growth phase, typically you'll see prices stabilize. Okay. Or maybe even start to decline a little bit. Right. If more competitors come in. Exactly. More competition enters the market. Yeah. And then in the maturity phase, the focus really shifts to maintaining market share. Right. So you might see competitive pricing, where you're trying to match or beat your competitors' prices. Mm-hmm. Or you might try to differentiate your product based on features or branding. Okay. Rather than just price alone. And then finally, when you get to that saturation and decline phase. Right. You might need to lower prices. Right. To stimulate demand. Yeah. Or to clear out inventory. Okay. Because the product is becoming less appealing to customers. So it's really not a static thing. No. Yeah. You constantly have to be re-evaluating where you are in the market. Right. Where your product is in its lifecycle. Absolutely. All right. And the material also mentions this idea of price leadership. Yeah. That sounds really interesting. It is. Tell me about that. So, in some industries, you have a few dominant players. Okay. What economists call an oligopoly. Mm-hmm. And in those situations, direct price competition can be really risky. Oh, yeah. It can lead to price wars. Right. Because everybody starts cutting prices and, ultimately, everybody loses. Right. So what often happens is that one of those big players becomes a price leader. Got it. They set the price. Yeah. And everybody else kind of follows along. So they're kind of the benchmark. Exactly. They set the standard. And that creates more stability in the market. Right. Because nobody wants to start a price war. Yeah. Unless they have a really good reason. Now, what happens if a competitor does cut prices? Well, you have a few options. Okay. You can maintain your prices. Mm-hmm. If you believe that your product offers superior value, you can initiate non-price competition. So things like increasing your advertising or improving your product. Got it. Or, as a last resort, you can match the price cut if you really need to protect your market share. So you really have to analyze what's going on in the market and decide what's the best course of action. Exactly. Okay. So we've talked about cost plus pricing. Mm-hmm. We've talked about market-based pricing. Yes. Now, the final approach that the sources discuss is target costing. Right. This sounds like a very proactive kind of a strategy. It is. Yeah. Very forward-thinking. Yeah. So with target costing, instead of starting with your cost and adding a markup, you start with the selling price. Oh. What are your customers willing to pay? Okay. You subtract your desired profit margin. Uh-huh. And that gives you your target cost. Okay. And you don't have to work backwards to design and produce a product that meets that cost. Uh-huh. So profitability is built in right from the beginning. Yeah. From the very beginning. And the sources mention that Japanese car manufacturers, like Toyota, have been really successful with this. They have. What's the key takeaway for you, our listener? I think the key takeaway is that target costing is all about being customer-centric and market-driven from the very start. Right. Okay. So you have the customer and the market in mind. Right. And you're constantly looking for ways to reduce costs without sacrificing quality. So it's a continuous improvement kind of a process. Absolutely. Okay. So we've looked at these four key approaches to pricing decisions. Mm-hmm. Full cost plus. Yep. Marginal cost plus. Uh-huh. Market-based strategies. Right. And this really proactive approach of target costing. Exactly. And each one has its own pros and cons. Yeah. And the best choice for you is really going to depend on the specifics of your business. Right. Your industry. Your goals. Yeah. What you're trying to achieve. Exactly. What I think is so interesting here is. Yeah. They all kind of reflect a different business philosophy. They do. Right. Yes. Are you focused on covering your cost and ensuring a margin? Uh-huh. Or are you more attuned to market dynamics and what your customers are willing to pay? Right. So you really need to think about what's important to you. Uh-huh. As a business. What are your priorities? Right. Yeah. We hope that this deep dive has given you a clearer understanding of pricing decisions. And some things to think about. Yeah. For your own business. Right. And, of course, this is just the beginning. Uh-huh. Right? This is just an introduction. Right. But I think it gives you a good foundation. Mm-hmm. To start thinking about how you want to approach pricing. Absolutely. What stands out to you as the most relevant or maybe compelling approach for you? That's a good question. Yeah. I think it really depends on your specific situation. Right. But I would encourage everyone to really think about what their customers value. Mm-hmm. And what their competitors are doing. Right. And then use that information. Yeah. To make informed pricing decisions. That's great advice. Thank you. This session was brought to you by Ultimate Access Education, your learning partner. Your learning partner. Join us next time for another Deep Dive. We'll see you then. See you later. Bye. This session was brought to you by Ultimate Access Education, your learning partner. Yeah. We'll catch you next time on the Deep Dive. See you then.