Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Department of Accounting Chapter 7 Cost Information for Pricing and Products Planning

Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Department of Accounting Chapter Objectives: To be able to: 1. Show how a firm chooses its roduct mix in the short term 2. Explain how a firm adjusts its prices in the short term depending on whether capacity is limited 3.Discuss how a firm determines a long-term benchmark price to guide its pricing strategy 4. Evaluate the long-term profitability of products and market segments

Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Department of Accounting 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 domi- nated 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.

Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Department of Accounting 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-takerA firm that accepts the prices set in the marketplace for its products. Price-setterA firm that can determine the prices its customers will pay for its products.

Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Department of Accounting 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

Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Department of Accounting Short-term Product Mix Decisions - Price Takers Definitions: Incremental costs per unitThe amount by which the total costs of production and sales increase when one additional unit of that product is produced and sold. Contribution per unitThe price per unit lesss variable costs per unit. Contribution margin per machine hourA factor obtained by dividing the contribu- tion per unit by the number of machine hours per unit. Constrained resourceA ”bottleneck” that limits sales or production in the short-term.

Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Department of Accounting 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

Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Department of Accounting Long-term Product Mix Decisions - Price Setters Who: Market leader/major player selling specialized products Full costs instead of incremental costs, when: 1)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. 2)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. 3)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.

Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Department of Accounting Long-term Product Mix Decisions - Price Setters Markups: Price elasticityWhen 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 demandDemand curve deviates from equilibrium Intensity of competitionSupply curve deviates from equilibrium StrategyPenetration pricing strategy versus skimming price strategy Penetration pricing strategyThe 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 strategyAn act of initially charging customers a higher price, who are willing to pay more for the privilege of possessing a product.

Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Management Accounting Chapter 7 - Cost Information for Pricing and Product Planning Department of Accounting 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, product- sustaining 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.