Question

Valmont Company has developed a new industrial piece of equipment called the XP-200. The company is considering two methods of establishing a selling price for the XP-200—absorption cost-plus pricing and value-based pricing.

Valmont’s cost accounting system reports an absorption unit product cost for XP-200 of $9,200. Its markup percentage on absorption cost is 85%. The company’s marketing managers have expressed concerns about the use of absorption cost-plus pricing because it seems to overlook the fact that the XP-200 offers superior performance relative to the comparable piece of equipment sold by Valmont’s primary competitor. More specifically, the XP-200 can be used for 17,000 hours before replacement. It only requires $1,800 of preventive maintenance during its useful life and it consumes $160 of electricity per 850 hours used.

These figures compare favorably to the competing piece of equipment that sells for $17,000, needs to be replaced after 8,500 hours of use, requires $3,600 of preventive maintenance during its useful life, and consumes $188 of electricity per 850 hours used.

Required:

1. If Valmont uses absorption cost-plus pricing, what price will it establish for the XP-200?

2. What is XP-200’s economic value to the customer (EVC) over its 17,000-hour life?

3. If Valmont uses value-based pricing, what range of possible prices should it consider when setting a price for the XP-200?

Answer 1

Solution

Valmont Company

1. Determination of the price for XP-200 using absorption cost-plus pricing:

Unit product cost $9,200

Add: Markup 85% x 9,200 = 7,820

Selling price per unit = $17,020

2. Detrmination of XP-200 economic value to customer over its 17,000-hour life:

EVC = reference value + differentiation value

Reference value = $17,000

Differentiation value $22,960           (17,000 + 5,400 + 560)

EVC = $39,960

Differentiation value components –

1. First customer purchasing XP-200 instead of competing product would avoid the need for another piece of equipment for $17,000 to reach 17,000 hours of usage.
2. Second customer purchasing XP-200 instead of competing product would average preventive maintenance saving of $5,400 as computed below:

	Competing Equipment	XP-200
Preventive maintenance cost for 17,000 hours:
$3,600 x (17,000/8,500)	$7,200
$1,800 x (17,000/17,000)		$1,800
Differentiation value		$5,400

3. Third customer purchasing XP-200 instead of competing product would achieve $560 in electricity savings as shown below:

	Competing Equipment	XP-200
savings in electricity cost:
$188 x (17,000/850)	$3,760
$160 x (17,000/850)		$3,200
Differentiation value		$560

Determination of the range of possible prices if the company uses value-based pricing when setting a price for XP-200:

The range of possible prices = reference value ≤ value based price ≤ EVC

= $17,000 ≤value based pricing ≤ $39,960