Management Accounting for Decision Making Flashcards
PRODUCT LIFE CYCLE
May refer to the phases of a product’s life.
What are the four costing methods?
- Life-cycle costing
- Target costing
- Theory constraint
- Strategic pricing
Upstream and downstream costs.
Upstream costs - before manufacturing
Downstream costs - after manufacturing
What is the cost life cycle?
Upstream activities: R&D Design Manufacturing Downstream activities: Marketing and Distribution Customer Service
THE SALES LIFE CYCLE
The sequence of phases in the product’s or service’s life:
Introduction of the product to the market
Growth in sales
Maturity
Decline
Withdrawal from market
TARGET PRICE
The estimated price for a product (or service) that potential customers will be willing to pay.
The target price, calculated using customer or competitors’ inputs, forms the basis for calculating target costs.
TARGET COST
Target sales price per unit or competitive price - Target operating profit per unit or desired profit = Target cost per unit
What are the steps in developing target prices and target costs?
- Develop a product that satisfies the needs of potential customers.
- Choose a target price.
- Derive a target cost per unit.
- Perform value engineering to achieve target costs.
- Use kaizen costing and operational control to further reduce costs.
VALUE ENGINEERING
Analyse trade-offs between product functionality (features) and total product cost.
Perform a consumer analysis during the design stage of the new or revised product to identify critical consumer preferences.
Benchmarking
Design analysis
Other cost reduction methods:
-Cost table (manufacture parts of different size from the same design)
-Group technology (identifying similarities in the parts of products)
KAIZEN
Using continuous improvement & operational control to reduce costs in the manufacturing stage of the product life-cycle.
Achieved through: Streamlining the supply chain. Lean manufacturing. Improving manufacturing methods and productivity programs. Employing new management techniques
What are the benefits of target costing?
- Increases customer satisfaction (design is focused on customer value).
- Reduces costs (more effective and efficient design)
- Helps the firm achieve desired profitability on new and redesigned products.
- Reduces “surprises” - more costly than expected.
- Can improve overall product quality.
- Facilitate coordination of design, manufacturing, marketing, and cost managers throughout the product cost and sales life-cycle.
MANUFACTURING CYCLE TIME (lead or throughput time)
The amount of time between the receipt of a customer order and the shipment of that order.
Lead time has the same definition as that of supply chain management, but includes the time required to ship the parts from the supplier.
Made up of:
- Preprocessing Lead Time (planning/paperwork)
- Processing Lead Time
- Postprocessing Lead Time
MANUFACTURING CYCLE EFFICIENCY
Processing time divided by total cycle time.
Separates total cycle time into:
- Processing time
- Inspection time
- Materials handling time
- Waiting time, etc
Most firms would like to see a MCE close to one -> reflects less time wasted on moving, waiting, inspecting, and other non-value- adding activities.
CONSTRAINTS
Activities that slow a product’s total cycle time.
THE THEORY OF CONSTRAINTS
Focuses on improving speed at the constraints, to decrease overall cycle time.
Five Steps:
- Identify the constraint.
- Determine the most profitable product mix given the constraint.
- Maximise the flow through the constraint.
- Add capacity to the constraint.
- Redesign the manufacturing process for flexibility and fast cycle time.
Main objectives of TOC and ABC
TOC:
Short term focus: through put margin analysis based on materials and materials-related costs.
ABC:
Long term focus: analysis of all product costs.
Resource constraints in TOC and ABC
TOC:
Included explicitly, a principal focus of TOC
ABC: Not included explicitly.
Cost drivers in TOC and ABC
TOC:
No direct utilisation of cost drivers.
ABC:
Develop an understanding of cost drivers at all levels.
Major use of TOC and ABC
TOC:
Optimisation of production flow and short-term product mix.
ABC:
Strategic pricing and profit planning.
What does strategic pricing decisions require information from?
The cost life-cycle
The sales life-cycle
What is the cost information for pricing commonly based on?
One of four methods:
- Full manufacturing cost plus markup
- Life-cycle cost plus markup
- Full cost and desired gross margin percent
- Full cost plus desired return on assets.
Strategic pricing depends on the position of the product or service in the sales life cycle. What are the prices at each stage?
Phase 1 INTRO: Pricing is set relatively high to recover development costs and take advantage of new-product demand.
Phase 2 GROWTH: Pricing is likely to stay relatively high as the firm attempts to build profitability.
Phase 3 MATURITY:
The firm becomes more of a price taker than a price setter and attempts to reduce upstream and downstream costs.
Phase 4 DECLINE:
The firm becomes more of a price taker than a price setter and attempts to reduce upstream and downstream costs.
ROLE OF COST INFORMATION IN PRICING DECISIONS: A price setting firm facing short-run pricing decisions.
- Applies where companies are faced with the opportunity of bidding for one time special orders in competition and other suppliers.
- In this situation only the incremental cost of undertaking the order should be taken into account.
- Given the short term one off nature of the opportunity many costs will be non-incremental.
- Bids should be made at prices that exceed the incremental cost & must meet the following conditions:
1. Sufficient capacity must be available to meet the order.
2. The bid price should not effect future selling prices & the customer should not expect repeat business at short-term incremental cost.
3. The order will utilise unused capacity for only a short period & capacity will be released for use on more profitable opportunities.
ROLE OF COST INFORMATION IN PRICING DECISIONS: A price setting firm facing long-run pricing decisions.
Three scenarios considered:
- Pricing customised products using cost-plus pricing.
- Pricing non-customised products using cost-plus pricing or demand estimates.
- Pricing non-customised products using target costing.
- In the long term a firm can adjust the supply of resources that are committed to it - therefore a product or service should be priced to cover all of the resources that are committed to it.
- Price setters have stronger grounds for adopting ABC.
PRICING CUSTOMISED PRODUCTS WITH COST PLUS PRICING
- An accurate costing system is required since undercosting will result in acceptance of unprofitable business and overcosting in loss of profitable business.
- To determine the selling price a full cost/long-run cost should be calculated and a mark-up added.
- Cost assignments for pricing should be based on direct cost tracing or cause-and-effect assignments - Arbitrary allocations should be allocated using behavioural drivers or covered within the markup.
- ABC provides a better understanding of cost behaviour for negotiating with customers the price and size of the orders.
Pricing non-customised products (cost-plus pricing)
- Pricing decision involves large volumes to many customers of a single product/service.
- Cost-plus pricing requires an estimate of sales volume to determine unit cost in order to derive the cost-plus price.
- Recommended that cost-plus prices are estimated for a range of potential sales volume.
PRICING NON-CUSTOMISED PRODUCTS (using demand estimates)
If approximations of demand can be derived they may be preferable to using the cost-plus pricing approach
Pricing non-customised products (target costing)
- Target costing is the reverse of cost-plus pricing - the target selling price is the starting point.
- Four stages involved:
Stage 1: Determine the target price which customers will be prepared to pay for the product.
Stage 2: Deduct a target profit margin from the target price to determine the target cost.
Stage 3: Estimate the actual cost of the product.
Stage 4: If estimated actual cost exceeds the target cost investigate ways of driving down the actual cost to the target cost. - Marketing factors and customer research provide the basis for determining selling price (not cost).
- Emphasises a team approach to achieving the target cost.
- Most suited to high sales volume products.
A price taker firm facing short-run product-mix decisions
- Applies where opportunities exist for taking on short-term business at a market determined selling price.
- Cost information required and the same conditions apply as those specified for price setter facing short-term pricing decisions.
- If short-term capacity constraints apply the product mix should be based on maximising contribution per limiting factor.
A price taking firm facing long-run product-mix decisions
- In the long-term a firm can adjust the supply of resources that are committed to it- therefore the sales revenue from a product or service should be sufficient to cover all of the resources that are committed to it.
- Periodic profitability analysis is required to ensure that only profitable products/services are marketed.
- Profitability analysis should be used as an attention-directing mechanism.
- Ideally ABC hierarchical profitability analysis should be used.
COST PLUS PRICING
- Target mark-ups seek to provide a contribution to non-assigned costs and profit.
- Target mark-ups are also adjusted to reflect demand, types of products, industry norms, competitive position, etc.
CRITICISMS OF COST-PLUS PRICING
- Ignores demand
- Does not necessarily ensure that total sales revenue will exceed total cost.
- Can lead to wrong decisions if budgeted activity is used to unitise costs.
- Circular reasoning - volume estimates are required to estimate unit fixed costs and ultimately price.
REASONS FOR USING COST-PLUS PRICING
- May encourage price stability.
- Demand can be taken into account by adjusting the target mark-ups.
- Simplicity
- Difficulty in applying sophisticated procedures where a firms markets hundreds of products/services.
- Used as a guidance to setting the price but other factors are also taken into account.
- Applied to only the relatively minor revenue items.
DIFFERENT TYPES OF PRICING POLICIES
- Differential pricing
- Peak load pricing
- Price-skimming
- Penetration pricing
- Complementary pricing
- Product bundling
Pricing policies may vary depending on the different stages of a product’s life cycle.
DIFFERENTIAL PRICING
Occurs where:
Two or more people pay entirely different prices for the same service.
Circumstances include late booking prices for holidays - holiday companies might have spare capacity and want to fill it as they will be getting some return anyway.
Another example is where demand patterns fluctuate by season, week, time of day, etc.
PEAK LOAD PRICING
Closely connected with differential pricing.
It’s really the opposite idea - the principle that when demand is high, prices should be similarly high.
Businesses with high, committed, fixed costs will exploit peak demand, not only to make money but also to encourage customers to use cheaper, off-peak services.
PENETRATION PRICING
Generally but not exclusively applies to fast moving consumer goods.
E.g. pet food and confectionery.
Manufacturer introduces new product.
Product is marketed at a low price.
Becomes an established feature of the weekly shop.
At some point, the price increase, quite surreptitiously and gradually.
It can be v. difficult to sway certain consumer groups once brand loyalty has been established.
PRICE SKIMMING
An approach to pricing which is seen in certain markets.
The price bears no relation whatsoever to the cost of the goods or services being provided.
e.g. luxury goods or tickets for sporting events and music.
Sometimes, consumers can be fooled into thinking that just because something is more expensive, it is going to be better.
Where this misapprehension arises, the supplier ought to take advantage of higher returns until tastes/fashions change or economic conditions alter.
COMPLEMENTARY PRICING
Think of items which you can’t use without buying something else, especially where the “something else” is consumed frequently.
e.g. razors, printer ink, apps, downloaded music.
PRODUCT BUNDLING
Similarities to complementary pricing.
A set of products is sold together, but there is no frequent replacement product or “add on” item. Aim is to increase sales volume.
Customer pays a lower price to buy the “bundle” than if items bought separately.
CUSTOMER PROFITABILITY
Essentially, we compare:
operating profit contribution
with
the known costs of servicing individual customers.
