management Back Forwards
Accounting: Operational Decision-Making (Short-Term)
 

Selling Price Decisions

Establishing appropriate selling prices for new products requires very careful judgement of market conditions, competitors' responses, customer preferences, and long-term product strategy. However, we are concerned here with the much simpler situation in which short-term selling price decisions must be made for existing products.

Consider a situation in which an order for 200 units of Product C falls through unexpectedly at the last minute. The company is faced with a situation in which it has production capacity for 1,000 units of C but now has only 800 units ordered. To salvage the situation the sales team is set to work to find more customers for Product C.

  

In haggling with potential new customers, what is the absolute minimum price the sales representatives can drop to, while still allowing the additional sales to increase the companies overall profit?

In order to increase profit by producing more units of C, each additional unit of C produced must earn contribution towards fixed overhead costs (which cannot be avoided in the short term). Hence Sales - Variable costs for C must be positive. Consequently, any selling price that exceeds the variable production costs will provide some contribution. The minimum selling price must therefore exceed the variable costs of £1.70 - The sales representatives have a good deal of leeway for bargaining based on the normal, long-run selling price of £8.00 per unit!