Transcript Chapter 7 - Cost Information for Pricing and Product Planning

Management Accounting
Chapter 7 - Cost Information for Pricing and Product Planning
Chapter 7
Cost Information
for Pricing
and Products Planning
Department of Accounting
Management Accounting
Chapter 7 - Cost Information for Pricing and Product Planning
Chapter Objectives:
To be able to:
1.
2.
3.
4.
Show how a firm chooses its roduct mix in the short term
Explain how a firm adjusts its prices in the short term depending on whether capacity
is limited
Discuss how a firm determines a long-term benchmark price to guide its pricing
strategy
Evaluate the long-term profitability of products and market segments
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Management Accounting
Chapter 7 - Cost Information for Pricing and Product Planning
Short-term versus Long-term Pricing
considerations
• Capacity
 Available not available.
 Price and timeframe to establish further capacity. Overtime,
outsourcing, investments.
 Length of commitment of order.
 Profitability.
• Pricing
 Can prices be influenced - or are prices set?
 When producing a commodity prices are normally set by aggregate
market forces of supply and demand. As such a single company can
typically not influcence the prices. Similarly if the industri is dominated by a major player, then the smaller company has to adjust
prices to the market leader.
 Contrary in a business area with relatively little competition or where
the company is a major player, prices can be influenced.
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Management Accounting
Chapter 7 - Cost Information for Pricing and Product Planning
Classification of Pricing and Product Mix
Decisions
Short-term decisions:
Price-taker firm
Price-setter firm
Long-term decisions:
Price-taker firm
Price-setter firm
Definitions:
Price-taker
A firm that accepts the prices set in the marketplace for its
products.
Price-setter
A firm that can determine the prices its customers will pay
for its products.
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Management Accounting
Chapter 7 - Cost Information for Pricing and Product Planning
Short-term Product Mix Decisions - Price Takers
Who:
• Companies acting within a commodity based market area
prices are
determined by the aggregate production decisions of all companies within
such a an industry.
• A small firm, or a firm with a negligible market share in this industry, behaves
as a price-taker.
What:
• Relevant costs (short-run variable cost plus any opportunity cost)
• Production capacity
Exhibit 7-2, 7-3, 7-4, 7-5, 7-6 and 7-7:
• Maximization of profits
• Opportunity costs
Department of Accounting
Management Accounting
Chapter 7 - Cost Information for Pricing and Product Planning
Short-term Product Mix Decisions - Price Takers
Definitions:
• Incremental costs per unit
The amount by which the total costs of
production and sales increase when one
additional unit of that product is produced
and sold.
• Contribution per unit
The price per unit lesss variable costs per
unit.
• Contribution margin per
machine hour
•Constrained resource
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A factor obtained by dividing the contribution per unit by the number of machine
hours per unit.
A ”bottleneck” that limits sales or production
in the short-term.
Management Accounting
Chapter 7 - Cost Information for Pricing and Product Planning
Short-term Product Mix Decisions - Price Setters
Who:
• Market leader/major player selling specialized products
What:
• Relevant costs
• Production capacity
Exhibit 7-8:
• Scenario: Available capacity
• Identify relevant cost
• Calculate breakeven
• Scenario: No available capacity
• Identify options of establishing short-term capacity
• Identify relevant cost of additional capacity
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Management Accounting
Chapter 7 - Cost Information for Pricing and Product Planning
Long-term Product Mix Decisions - Price Setters
Who:
• Market leader/major player selling specialized products
Full costs instead of incremental costs, when:
1)
2)
3)
Many contracts for the development and production of customized products and man contracts
with governmental agencies specify that prices should wqual full costs plus a markup. Prices set
in regulated industries also are based on full costs.
When a firm enters into a long-term contractual relationship with a customer to supply a
product, it has great flexibility in adjusting the level of commitment for all resources. Therefore,
most activity costs will depend on the production decisions under the long-term contract, and full
costs are relevant for the long-term pricing decision.
Most firms make short-term adjustments in prices, often by offering discounts from list prices
instead of rigidly employing a fixed price based on full costs. When demand for their products is
low, the firms recognize the greater likelihood of surplus capacity in the sort term. Accordingly,
they adjust the prices of their products downward to acquire aditional business based on the
lower incremental costs they incur when suprlus capacity is available. Converseley, when
demand for their products is high, they recognize the greater likelihood that the existing capacity
of activity resources is inadequate to satisfy all of the demand. Thus, they adjust the prices
upward based on the higher incremental costs they incur when capacity is fully utilized. The
higher prices serve to ration the available capacity to the highest profit opportunity.
Exhibit 7-9 Short-term prices relative to long-term benchmark price.
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Management Accounting
Chapter 7 - Cost Information for Pricing and Product Planning
Long-term Product Mix Decisions - Price Setters
Markups:
• Price elasticity
When demand is relatively inelastic, profits will usually
increase when prices increase. When demand is elastic,
the quantities sold will decrease sharply when prices
increase and profits decrease.
• Strength of demand
Demand curve deviates from equilibrium
• Intensity of competition
Supply curve deviates from equilibrium
• Strategy
Penetration pricing strategy versus skimming price
strategy
Penetration pricing strategy
The act of choosing a low markup for a new product to penetrate the
market and win over market share from an established product of a
competing firm.
Skimming price strategy
An act of initially charging customers a higher price, who are willing to
pay more for the privilege of possessing a product.
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Management Accounting
Chapter 7 - Cost Information for Pricing and Product Planning
Long-term Product Mix Decisions - Price Takers
•
Decisions to add products to or to drop products from the product portfolio, influencing the whole
cost structure of the company. Impacts both variable costs, batch-related costs, productsustaining costs and maybe even general overhead.
•
Full product line necessary? One-stop shopping?
•
Customer incentives/customer behavior.
•
If dropping products, profitability only improves if activity resources no longer required to
support the discontinued product is eliminated and/or redeploy the resources from the eliminated
products to produce more of the profitable products that is still offered.
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