Week 6 Everything Flashcards
How companies price a product or service ultimately depends
on the demand and supply for it
Three influences on demand and supply:
customers
competitors
costs
Market-based
Price charged is based on what customers want and how competitors react
Cost-based
Price charged is based on what it costs to produce, coupled with the ability to recoup the costs and still achieve a required rate of return
Market-based pricing starts with a target price:
Estimated price for a product or service that potential customers will pay. It is estimated on customers’ perceived value for a product or service and how competitors will price competing products or services.
Implementing target pricing and target costing:
Planning and concept design
Choose a planned sales volume and target price
Derive a target cost per unit
= planned selling price - required profit
Breakdown and analyse the costs
Apply value engineering to achieve target cost
A company requires a return of 12% in the coming year on its investment of $1,000,000 in product ‘Jocky’. The selling price of product ‘Jocky’ is set at $52.00 for each unit, and sales for the coming year are expected to reach 5,000 units. What is the target cost for each unit for the coming year?
Sales Revenue, 5000*52
=260000
Return on investment required
1000000*12%
=120000
Total cost allowed
=140000
Target cost per unit
140000/5000
=
$28
Planning and concept design:
Fix the product concept and the primary specifications for performance and design. The planned product must satisfy the needs of potential customers. E.g., A small, town car for two people with a large amount of luggage easily-accessible luggage space and low fuel consumption – aimed at those in their mid-twenties and so style is important.
Illustration of breakdown and analysis of target cost
10/4/19
Value analysis / Value engineering
“Value analysis / Value engineering is an activity which helps to design products which meet customer needs at a lower cost while assuming the required standard of quality and reliability” (CIMA).
Value engineering
Value engineering is “the redesign of an activity, product, or service so that value to the customer is enhanced while costs are reduced or at least increased by less than the resulting price increase. It involves a systematic evaluation of all aspects of the value-chain. Managers must distinguish value-added activities and costs from non-value-added activities and costs.
Value-added costs
A cost that, if eliminated, would reduce the actual or perceived value or utility (usefulness) customers obtain from using the product or service. Examples as applicable to Hellovalue: Adequate memory, Pre-loaded software, Easy-to-use keyboards, etc.
Non-value-added costs
A cost that, if eliminated, would not reduce the actual or perceived value or utility customers obtain from using the product or service. It is a cost the customer is unwilling to pay for. E.g., Cost of machine breakdowns, cost of rework or repair, etc.
Method of value analysis (1/2)
Determine the function of the product and each component that is used within the product
Determine the existing costs associated with individual components.
Develop alternative solutions to the needs met by the components. This may involve design changes, manufacturing methods, materials used, among others.
Ask questions:
Ask questions:
How does this component contribute to the value of the product?
How much does it cost?
Are all features and specifications absolutely necessary?
Is there another similar part that may be used?
Can an alternative part be used?
Will an alternative design perform the same function?
Method of value analysis (2/2)
Evaluate the alternatives and their anticipated effect/
Implement the recommendations.
Target costing and target pricing is widely used among different industries in different countries:
National Health Service (NHS) in United Kingdom.
Mercedes, Toyota, Nissan, and Daihatsu in the car industry.
Panasonic and Sharp in the electronics industry.
Apple, Compaq (Now part of HP) and Toshiba in the personal computer market.
Cost incurrence
Cost incurrence describes a resource consumed (or benefit foregone) to meet a specific objective.
locked-in costs
Locked-in costs (designed-in costs) are costs that have not yet been incurred but, based on decisions that have already been made, will be incurred in the future.
Cost incurrence and locked-in costs
To manage activities (costs) well, a company must identify how design choices lock in costs before the costs are incurred. For e.g., scrap and rework costs incurred during manufacturing are often locked in much earlier by faulty design.
Value chain analysis and cross-functional teams
There are five key aspects to the target pricing, target costing, and value-engineering process:
understanding customer requirements and competitor actions
selecting a target price and determining a target cost
anticipating how costs are locked in before they are incurred
improving product and process designs and efficiency to achieve target costs and better quality
using cross-functional teams to coordinate actions that need to be taken throughout the value chain.
To achieve target costing objectives, target-costing efforts should always:
Encourage employee participation and celebrate small improvements towards achieving the target
Focus on the customer
Pay attention to schedules,
Set cost-cutting targets for all value-chain functions to encourage a culture of teamwork and cooperation.
If it is not properly managed, value engineering and target costing can have undesirable effects:
Employees may feel frustrated if they fail to attain targets.
A cross-functional team may add too many features just to accommodate the wishes of team members.
A product may be in development for a long time as alternative designs are repeatedly evaluated.
Organisational conflicts may develop as the burden of cutting costs falls unequally on different business functions in the firm’s value chain.
The product life cycle
10/4/19
Life-cycle product budgeting and costing
Product life cycle spans the time from initial R&D on a product to when customer service and support are no long offered on that product. For car companies, the product life-cycle for different models may range from 12-15 years. For mobile phone manufacturers, the product life-cycle for different models may range from 3-5 years.
The sales part of the product life cycle has four stages:
When a product is introduced to the market
When sales grow
When sales stabilize as the product matures
When sales decline as the product loses acceptance in the market.
Life-cycle budgeting
Life-cycle budgeting involves estimating the revenues and business function costs of the value chain attributable to each product from its initial R&D to its final customer service and support.
Life-cycle costing
Life-cycle costing tracks and accumulates business function costs of the value chain attributable to each product from initial R&D to final customer service and support.
Budgeted life-cycle costs can provide useful information for pricing decisions.
For e.g., companies may realize that non-production costs (such as design and R&D) are large.
Life cycle costs (1/2)
Research & development costs
cost of purchasing any technical data
Training costs
Production costs
Research & development costs
Design costs
Cost of making a prototype
Testing costs
Production process and equipment: development and investment
cost of purchasing any technical data
The cost of purchasing any technical data required (for example purchasing the right from another organisation to use a patent)
Training costs
Training costs (including initial operator training and skills updating)
Production costs
Production costs, when the product is eventually launched in the market
Life cycle costs (2/2)
Distribution costs
Marketing and advertising costs
Inventory costs
Retirement and disposal costs.
Distribution costs
Transportation and handling costs
Marketing and advertising costs
– Customer service
– Field maintenance
– Brand promotion
Inventory costs
(holding spare parts, warehousing and so on)
Retirement and disposal costs.
Costs occurring at the end of a product’s life. These may include the costs of cleaning up a contaminated site
Customer life-cycle costing
Customer life-cycle costs focus on the total costs incurred by a customer to:
acquire a product or service
use a product or service
maintain a product or service,
dispose of a product or service.
For example: The customer life-cycle cost for a car include:
Cost of the car (+) Cost of operating and maintaining the car (–) Disposal value of the car
Traditional cost accumulation systems
Traditional cost accumulation systems are based on the financial accounting year and tend to dissect a product’s life cycle into a series of 12-month periods. This means that traditional management accounting systems do not accumulate costs over a product’s entire life cycle and do not therefore assess a product’s profitability over its entire life. Instead they do it on a periodic basis.
Life cycle costing
Life cycle costing, on the other hand, tracks and accumulates actual costs and revenues attributable to each product over the entire product life cycle. Hence the total profitability of any given product can be determined
How to maximise return over the product life cycle
- Design costs out of products
- Minimise the time to market
- Minimise breakeven time (BET)
- Maximise the length of the life span
