Johnson 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 a standard model, with any upgrades added by the buyer after the sale. Johnson Builders’s costs per developed sublot are as follows:
Variable selling costs 8,000
Johnson Builders would like to earn a profit of 14% of the variable cost of each home sold. Similar homes offered by competing builders sell for $207,000 each. Assume the company has no fixed costs.
1. Which approach to pricing should Johnson Builders emphasize? Why?
2. Will Johnson Builders be able to achieve its target profit levels?
3. Bathrooms and kitchens are typically the most important selling features of a home. Johnson Builders could differentiate the homes by upgrading the bathrooms and kitchens. The upgrades would cost $16,000 per home but would enable Johnson Builders to increase the sales prices by $28,000 per home.
(Kitchen and bathroom upgrades typically add about 175% of their cost to the value of any home.) If Johnson Builders makes the upgrades, what will the new cost-plus price per home be? Should the company differentiate its product in this manner?
The target full product cost of the company is $180,400.
The term “price taker” is used for the company that has control over the prices of its products and services because the product of the company is unique. The price-taker companies use the target pricing approach to fix the prices.
According to the given scenario, the company should use the target pricing approach because the company is a price-taker in this case. Under this approach, a company estimates the competitive price in the market and considers the standard profit margin.
Revenue per home
Less: Desired profit (14%*190000)
Target full product cost
Computation of total variable cost:
Variable selling costs
Total relevant variable costs
Upgraded variable cost per home (190000+16000)
Add: Fixed cost
Full product cost
Add: Desired profit (14%*206,000)
Upgraded selling price of home:
McCollum Company manufactures two products. Both products have the same sales price, and the volume of sales is equivalent. However, due to the difference in production processes, Product A has higher variable costs and Product B has higher fixed costs. Management is considering dropping Product B because that product line has an operating loss.
Month Ended June 30, 2018
Total Product A Product B
Net Sales Revenue $150,000 $75,000 $75,000
Variable Costs 90,000 55,000 35,000
Contribution Margin 60,000 20,000 40,000
Fixed Costs 50,000 5,000 45,000
Operating Income/(Loss) $10,000 $15,000 $(5,000)
Dan Jacobs, production manager for GreenLife, invested in computer-controlled production machinery last year. He purchased the machinery from Superior Design at a cost of $3,000,000. A representative from Superior Design has recently contacted Dan because the company has designed an even more efficient piece of machinery. The new design would double the production output of the year-old machinery but would cost GreenLife another $4,500,000. Jacobs is afraid to bring this new equipment to the company president’s attention because he convinced the president to invest $3,000,000 in the machinery last year.
Explain what is relevant and irrelevant to Jacobs’s dilemma. What should he do?
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