Pricing in Tesco involves a delicate act of balancing. The higher the prices are the more revenue earned per unit sold. However, this will drive down the unit sales. One difficult problem here is the actual setting of prices in its exact amount in order to maximize profits. In general, however, the markup over cost for those products, whose customers are least sensitive to price, should be the highest (Shim 3). In particular, the demand for such products is termed as being price inelastic. Managers of Tesco often rely on cost-plus formulas in setting their target prices.
In the approach of absorption costing, the cost base is the absorption costing unit product cost, while the markup is computed to cover both non-manufacturing costs as well as to provide an adequate investment return. However, costs will not be covered here and there will be no adequate return on investment unless the unit sales forecast used in the cost-plus formula is accurate (Selto 3). If through the application of the cost-plus formula resulted in a price that is too high, the unit sales forecast will be unattainable.
Some supermarkets, however, make use of a different approach to pricing. Instead of starting with costs and determine the prices afterwards, they start first with the prices and then determine the allowable costs. Tesco meanwhile used the target costing approach used the new product’s anticipated features as well as the prices of the existing products in the market, as their basis for their estimate on the likeness of the new product’s market price (Young 10).
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In order to arrive at the product’s target cost, they subtract the desired profit from the estimated market price. Thus, the responsibility of ensuring that the actual cost of the new product should not exceed the target cost is given to the team of design and development.
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