Considering the following pricing concepts; Markup Methods (markup on Total Cost, Variable Cost, and Product Cost) and Target Costing, explain when it is appropriate (and why) to use each of the methods. (Hint: use multiple choice questions 1 and 2 to start you in the right direction.
To determine the appropriate pricing method, we can consider the nature of the business, the market conditions, and the strategic goals of the company. Let's analyze each pricing method in relation to these factors:
1. Markup on Total Cost:
This method involves adding a fixed percentage to the total cost of the product to determine the selling price. It is appropriate when:
a) The business wants to cover all costs and generate a consistent profit margin on each sale.
b) The business operates in an unpredictable and volatile market where cost fluctuations are common.
2. Markup on Variable Cost:
This method involves adding a fixed percentage to the variable cost of the product to determine the selling price. It is appropriate when:
a) The business wants to cover the variable costs and generate a higher profit margin on each sale.
b) The business operates in a market with intense competition, where pricing needs to be more responsive to cost changes.
3. Markup on Product Cost:
This method involves adding a fixed percentage to the product's direct cost (including material, labor, and overhead) to determine the selling price. The appropriate usage of this method depends on the specific context and strategic goals of the business.
4. Target Costing:
This method involves setting the selling price based on the target profit margin and working backward to calculate the maximum allowable cost. It is appropriate when:
a) The business operates in a highly competitive market where customers have price sensitivity.
b) The strategic goal is to offer products at a competitive price while maintaining a desired profit margin.
It's important to note that these methods are not mutually exclusive and can be combined or modified based on specific business requirements. Consider the cost structure, market dynamics, competition, and strategic objectives to determine the most suitable pricing method for your business.