Download Costs - HEC Lausanne

Thème 6
Pricing Decisions
and
Cost Management
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Pricing and Business
 How companies price a product or
service ultimately depends on the
demand and supply for it,
 Three influences on demand and supply:
1. Customers,
2. Competitors,
3. Costs.
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Influences on Demand and Supply
1. Customers – influence price through their
effect on the demand for a product or service,
based on factors such as quality and product
features,
2. Competitors – influence price through their
pricing schemes, product features, and
production volume,
3. Costs – influence prices because they affect
supply (the lower the cost, the greater the
quantity a firm is willing to supply).
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Time Horizons and Pricing
 Short-run pricing decisions have a time horizon
of less than one year and include decisions such
as:
Pricing a one-time-only special order with no long-run
implications,
Adjusting product mix and output volume in a
competitive market.
 Long-run pricing decisions have a time horizon
of one year or longer and include decisions such
as:
Pricing a product in a major market where there is some
leeway in setting price.
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Differences Affecting Pricing:
Long Run vs. Short Run
1. Costs that are often irrelevant for short-run
policy decisions, such as fixed costs that
cannot be changed, are generally relevant in
the long run because costs can be altered in
the long run.
2. Profit margins in long-run pricing decisions
are often set to earn a reasonable return on
investment – prices are decreased when
demand is weak and increased when
demand is strong.
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Alternative Long-Run Pricing Approaches
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.
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Markets and Pricing
Competitive Markets – use the marketbased approach,
Less-Competitive Markets – can use either
the market-based or cost-based approach,
Noncompetitive Markets – use cost-based
approaches.
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Market-Based Approach
Starts with a target price,
Target Price – estimated price for a
product or service that potential customers
will pay,
Estimated on customers’ perceived value
for a product or service and how
competitors will price competing products
or services.
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The Target Costing Process
Driven by the
customer.
Focused
on design.
Target costing is aimed at the earliest stages
of new product and service development.
Focused
simultaneously
on profit and
cost planning.
Contrôle Interne Avancé-HEC Lausanne2007/2008
Consideration
given to the
entire
value chain. 9
Components of the
Target Costing Process
Attaining the
Target Cost
Establishing the
Target Price
Production
design and
value
engineering
Concept
development
Target
price
Profit
margin
Planning
and market
analysis
Target
cost
Production
and
continuous
improvement
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Components of the
Target Costing Process
Developing target prices and target
costs requires four steps:
Develop products
that satisfy
customer needs.
 Target price
– Profit margin
= Target cost
Set target price using
Use value engineering
competitors’ prices and
to find least costly
customers’ perceived
combination of resources
value for product. Contrôle Interne Avancé-HEC Lausanneto meet customer needs.
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2007/2008
Characteristics of the
Target Costing Process
Involve entire value
An understanding of
chain in reducing
costs while satisfying
customer needs.
relationships between
process components
and costs is critical.
A product’s functional characteristics to the
customer are emphasized.
A primary
ABC is used to
objective is reducing
development time.
determine changes
that will reduce costs.
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Understanding the
Market Environment
 Understanding customers and
competitors is important because:
1. Competition from lower cost producers has
meant that prices cannot be increased,
2. Products are on the market for shorter periods
of time, leaving less time and opportunity to
recover from pricing mistakes,
3. Customers have become more knowledgeable
and demand quality products at reasonable
prices.
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Five Steps in Developing
Target Prices and Target Costs
1. Develop a product that satisfies the needs of
potential customers,
2. Choose a target price,
3. Derive a target cost per unit:
 Target Price per unit minus Target Operating Income
per unit.
4. Perform cost analysis,
5. Perform value engineering to achieve target
cost.
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Value Engineering
Value Engineering is a systematic
evaluation of all aspects of the value
chain, with the objective of reducing costs
while improving quality and satisfying
customer needs,
Managers must distinguish value-added
activities from non-value-added activities.
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Value Engineering Terminology
 Value-Added Activities – an activity that, if
eliminated, would reduce the actual or perceived
value or utility (usefulness) customers obtain
from using the product or service,
 Non-Value-Added Activities – an activity that, if
eliminated, would not reduce the actual or
perceived value or utility customers obtain from
using the product or service. It is an activity the
customer is unwilling to pay for.
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Value- and Non-value-Added
Activities
Activities
Analysis and
Classification
Non-valueAdded
Activities
ValueAdded
Activities
Reduce or
Eliminate
Continually Evaluate
and Improve 17
Contrôle Interne Avancé-HEC Lausanne2007/2008
Value-Added Activities
Value-added activities
enhance the value of products
and services in the eyes of
the customer while meeting
goals of the business.
I love them!
 Designing to customer
specification.
 Processing for just-in-time
delivery to customers.
 Competent customer service.
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Non-value-Added Activities
Non-value-added activities
use resources without
providing value to customers.
 Material and other inventory
storage.
 Moving parts and materials in
the factory.
 Waiting for work.
 Inspection.
 Creating scrap and rework.
 Product design without
customer input.
Contrôle Interne Avancé-HEC Lausanne2007/2008
Get rid
of them!
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Example
 In a recent survey of the soap box market by Boards and More’s
Marketing and Planning Department, customers expressed
dissatisfaction with currently available packaging. Further analysis
revealed soap manufacturers believe the packaging is too heavy,
increasing their shipping costs. Soap consumers are also unhappy with
the ink used because, when the boxes get wet, the printing bleeds or
rubs off.
 A cross-functional, cross-organizational team is assembled to create a
product to satisfy customer needs. Notice that two sets of customers,
both in the value chain, are important: the soap manufacturer and the
soap consumer. The product creation team consists of marketing, design
engineering, accounting, and production engineering personnel from
Boards and More and similar personnel from the printing firm and the
soap company.
 The charge to the team is to create new paperboard for the cardboard
soap boxes that satisfies customers’ needs.
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Example
 All members of the value chain should participate in new
product creation: if the new cardboard created by Boards
and More is of a lighter weight but cannot properly
absorb ink, then the solution is not viable.
 Similarly, if the cardboard is lightweight but its strength
does not allow proper filling by the machinery at the soap
manufacturer, then the solution is not feasible.
 Finally, in addition to the design changes that Boards
and More considers undertaking, other team members
from the printing or soap companies may want to modify
or change their processes to satisfy the ultimate
customer, the soap consumer.
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Product function analysis
The requirements/functions table helps the design engineers
to focus on product functions that can best meet the needs
of the customers.
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Example
 The ability to bend and cut the cardboard is very
important for how easy the box is to pour, its weight, and
its strength.
 Unfortunately, the current technology in paperboard
implies that, although lightweight cardboard is easier to
bend and cut and is easier for the consumer to pour, it is
not strong enough to meet the soap manufacturer’s
requirements.
 If the box could be made stronger while simultaneously
maintaining light weight and high absorption, several
consumer requirements could be met. Of course, the
problem of the additional cost associated with the lighter
weight paperboard must be considered.
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Example
The marketing members of the team must
determine the target price consumers are
willing to pay to gain the desired
requirements. After market surveys, it
becomes clear that soap consumers are
unwilling to pay more than the current
price for the desired requirements. The
soap manufacturer is thus unwilling to
increase the amount it pays to Boards and
More for the printed soap boxes.
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Example
 Additional investigation reveals competitors are about to
release new packaging designed to solve some of these
problems—plastic bottles. The plastic bottles are
lightweight and strong and have labels that eliminate the
printing problems.
 Although this new packaging approach does not require
a price increase, the head marketing and engineering
managers at Boards and More are skeptical of its
acceptance by soap consumers because of pouring
problems. The narrow neck of the plastic jug causes the
powdered soap to clump together as it pours, creating
problems for the consumer. It is clear, however, that
competitors are working to solve these problems.
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Example
The design engineers, working with the accountants who have
gathered ABC information, have come up with a potential
solution to meet customer requirements
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Example
 The design engineers propose an initial target cost of
$1.77. Lowering the wood fiber content of the
paperboard and using microscopic plastic fibers that
reduce weight and increase strength generates this initial
target cost. The new mixture would require fewer pounds
of pressure when being rolled but would require longer
drying time and higher heat during drying. The
paperboard would then be ready for printing.
 However, the printing company determines the new
paperboard would require new printing technology
because of absorption problems created by the plastic
fibers. The new paperboard would increase printing
costs by $0.03 and the total cost by $0.05 per box ($1.72
to $1.77).
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Example
 Because the initial target cost of $1.77 is too high to maintain
previous margins, value engineering becomes critical. Cost must be
driven out of the value chain or the proposed solution will not be
acceptable. One piece of the value chain not yet considered is the
bending and cutting used to create the box.
 Boards and More approaches the supplier that bends and cuts the
boxes before they are shipped to the soap manufacturer. Boards
and More asks for a price cut of $0.03 from the current price
because the bending and cutting process should be easier and less
costly, and the supplier agrees.
 Then Boards and More suggests splitting the remaining $0.02 of the
total cost increase with the printer to achieve the target of $1.72, the
price the soap producer is willing to pay. The printer agrees to the
$0.01 reduction and Boards and More finds a way to cut $0.01 out of
its heating and drying costs. Through value engineering across the
value chain, suppliers and producers are able to arrive at the
desired target cost.
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