Accounting Business Reporting for Decision Making

484 Accounting: Business Reporting for Decision Making

a competitor or decide not to purchase at all. There are two common methods of pricing — cost-based

and market-based.

Cost-based pricing applies a mark-up to some calculations of the product or service cost. The

cost base can be calculated in several ways. For example, some entities may use a variable cost

base, or an average cost that includes both fixed and variable costs. Mark-ups can originate from

general industry practice, be based on previous entity practices, or be chosen so that the entity can

earn a target rate of return on investment. Therefore, cost-based pricing will vary significantly across

entities.

Market-based pricing is based on some measure of customer demand. The market price is influenced

by the degree of product differentiation and competition in the market. Managers would attempt to

identify what price customers are willing to pay for a product or service. An entity with many competi-

tors will set the price at what customers would pay to any entity offering such a product or service. With

less competition, where the entity is selling a more unique good or service, the entity will set the price

at the maximum the market will bear.

Which pricing method is more suitable? Cost-based pricing ignores customer demand and therefore

prices could be either higher or lower than what customers are willing to pay. However, one of its major

benefits, at least initially, is its simplicity, as prices can be calculated from readily available data. In con-

trast, market-based pricing allows managers to make better decisions about sales volumes and whether

to sell products or services, leading to more success in entity strategies. A disadvantage is that estimating

market demand and prices is often difficult; however, this is being addressed with the use of more

sophisticated information systems.

To illustrate the different pricing methods, let’s return to Coconut Plantations Pty Ltd. From our

costing exercise we were able to calculate the unit cost of the soap in 2017 to be $23.00 and the candle

product to be $16.125. We could apply a cost-based pricing policy whereby we add 50 per cent mark-up

to cost. However, given the differences in the two products, is a 50 per cent mark-up across both products

appropriate? It could be that soap is a product available from competitors and, as such, the price should

be in line with competitors’ pricing. However, if candles were not available from competitors, Jo Geter,

the manager of Coconut Plantations Pty Ltd, would want to maximise the price to be charged for this

product.

Regardless of the method chosen, there are other factors that can influence the setting of product

prices of individual entities or in specific circumstances.

• Peak load pricing — different prices are charged at different times to reduce capacity restraints. For

example, cinemas charge less for movies shown early in the day or on quieter days.

• Price skimming — a higher price is charged for a product or service when it is first introduced. For

example, when DVD players were first introduced into the market they were around $1000, whereas

today we can purchase a unit for as little as $20.

• Penetration pricing — prices are set low when new products are introduced to increase market share.

For example, Microsoft reduced the price of their Xbox to match its competition.

It should be noted that an entity is not free to establish any price they wish; some pricing practices

are illegal. In Australia, illegal practices include price discrimination, predatory pricing, collusive pricing

and dumping. A brief discussion of these follows.

• Price discrimination — the practice of setting different prices for different customers.


• Predatory pricing — the deliberate act of setting prices low to drive competitors out of the market

and then raising prices once competition is removed.

• Collusive pricing — two or more organisations conspire to set prices above a competitive price.


• Dumping — a foreign-based entity sells products in Australia at prices below the market value in the

country where the product is produced, and the price could harm an Australian industry.

The reality check ‘Taxi fees set to fall after ACCC action against Cabcharge’ highlights the predatory

pricing practice within the taxi industry in relation to the use of Cabcharge. To improve competition, the

taxi industry will now allow other in-taxi payment options.