Transcript ba-can_ev13_v01 2.5 MB

Deakin University CRICOS Provider Code: 00113B
Cost versus Price
Event 13
Costs, Prices and Profits
13.1 Defining Cost and Price
•
Cost is what business must pay to produce a
service or item of equipment
•
Price is what a business charges the buyer for
that service or item of equipment
• What are the components that business adds to
project cost to create a price?
– ‘Profit margin’
o
Corporate overhead recovery
o
Provision for risk
o
Return on investment
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13.1.1 Analysing Margins/Mark-up
Gross profit = Sales price – Cost of sales
Gross margin = Gross profit/Sales price
Margin is based on a % of sales price
Mark-up is based on a % of cost of sales
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13.2 Cost Breakdown
What are the components of cost?
• Materials
• Labour
• Marketing
• Transportation
• Research and development
• Property/rental
• Administration
• Finance
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13.2.1 Types of cost: Fixed/Variable
• Fixed costs: costs that do not change with changes in the
level of business activity, volume or output (within the
relevant range)
– Fixed costs per unit will change depending on level of output
• Variable costs: costs that change in line with the level of
business activity, volume and output
– Easier to quote as cost per unit remains unchanged
• Example: Fixed costs = $1m Variable costs = $5,000 per unit
– 1,000 units: Fixed costs = $1,000 per unit
– 5,000 units: Fixed costs = $200 per unit
• Utilisation rates will affect pricing
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13.2.2 Types of cost: Direct/Indirect
• Direct costs: costs that can be easily and cost-effectively
traced to the cost object (e.g. product).
– Easier to identify, trace and recover
• Indirect costs: costs cannot be easily and cost-effectively
traced to the cost object.
– Harder to trace and allocate, involving estimates and
guesswork, based on cost driver (i.e. what causes the cost)
• Example: Labour
– Direct labour: salaries of production staff working directly on a
product’s manufacturing line (full cost allocated)
– Indirect labour: salary of factory supervisor who oversees
manufacture of multiple products (proportional cost allocated
based on)
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13.2.3 Types of cost:
Outlay/Opportunity
• Outlay costs: costs that are actually incurred or
expended in the running of the project or the
manufacture of the product.
– Easy to identify, usually with invoice and actual transaction
• Opportunity costs: cost of the next best alternative that is
being foregone.
– Harder to identify or prove existence, with no transaction records
• Example: Opportunity cost
– Standard price in current industry is $5,000; but
– Opportunity cost for same output in new industry is $8,000.
– Supplier charges $8,000 in attempt to not forego/miss
opportunity.
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13.2.4 Types of cost:
Life cycle/Marginal
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Life cycle costs: represents total cost of preproduction, production and post-production
activities for a product.
–
•
Marginal costs: cost required to produce one
additional unit.
–
•
Pre-production and post-production costs need to be
incorporated into pricing
Typically represents the production cost only=> fails to
consider all the R&D, marketing, training etc
Example: Pharmaceuticals
–
–
Marginal cost of producing a tablet is probably $0.01; but
R&D and distribution costs of $750m also have to be
recouped.
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13.2.5 Why the mark-up?
• Uncertainty about the long-term (i.e. continuity of
orders/work)
• Cross-subsidisation (i.e. increased profits in one area to
make up for lost profits in another)
• Input, processing and distribution costs can all fluctuate,
whereas the price is typically locked in (i.e. needs to
provide a buffer)
• Achieve an adequate return on investment (i.e. rates of
return must increase to compensate for higher risk)
– Example: Investments in Government bonds (6%), bank term
deposits (7%), industrial shares (12%), defence shares (?)
Are the mark-ups really always high or excessive?
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13.2.6 Cost Estimation of New
Products
Cost of known product versus custom designed
• Known product
• Custom designed
• Known cost structure
• Cost structure more
• Easily adjusted for
differences due to
volume produced,
projected increases in
the cost of labour and
materials, or the effect
of inflation
difficult to estimate
• Many more decision
processes and unknown
custom development
costs e.g. design, system
integration, software
development, R&D
• More difficult to adjust
projected costs
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13.2.7 Costing a Known Product
Steps in new product costing
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Identify the cost elements and how they may
be related to each other
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Map product development process and
determine costs incurred
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Develop estimate based on known costs
and processes
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Adjust for volume, labour and material cost
increases, inflation
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13.2.8 Custom Designed –
Approach 1
First order estimate - component approach
•
Start with cost structure based on similar
components
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Add cost estimates for process factors
e.g. the cost of:
– Discovery – new technology, skills, manufacturing
processes, systems integration
– Decision processes – turnaround times
– Unanticipated disasters – nature, politics,
theoretical application
– Changed requirements over time – new threats
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13.2.9 Custom Designed –
Approach 2
First order estimate - process approach
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Start with cost structure for similar new product
development project
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Add estimates for components needed:
– Materials
– Labour
– Plant and equipment
– Transport
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13.2.10 Custom Designed –
Approach 3
Detailed estimate – zero based costing
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Quantity surveyor approach
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Detailed costing model built from the ground up
based on expected:
– Component costs
– Production process
– Schedule
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13.3 Including Expenses in Base Cost
Summary: Why is costing difficult?
• Tracing direct costs accurately
• Allocation of indirect costs (overhead):
– Indirect manufacturing & administration costs
– Apportionment of product life cycle costs (for example R&D)
• Can expenses be excluded in the base cost estimates?
• Can the expense be allocated more equitably?
– Using a broader cost base (allocate overheads to more than
one project)
– Spreading the expense over time (depreciation/amortisation)
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13.4 Cost of Additional Patrol Boats
Discussion
•
You recently awarded a contract for the
procurement of five new, custom-designed
patrol boats. Your requirement has now
changed and you ask the prime contractor for
the cost of providing an additional two boats.
The unit price is higher than that for the initial
five boats.
• Are there reasons why this might be so?
Discuss as a group.
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13.5 Market Factors and Price
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Market factors that reduce price
– competition/rivalry in the market
– new technologies
– favourable currency exchange rates
– government assistance
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Market factors that increase price
– limited suppliers
– unfavourable exposure to financial risk
– external factors
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