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  • Can we think of some industries where each of these is high
  • Luxury car cannot be sold at a discount price at start

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  • 1. Pricing & Costing: including budgeting & life cycle costing Anjana Vivek [email_address] www.bizkul.com
  • 2. Costs: Some terms
    • Direct
    • Indirect
    • Committed
    • Flexible
    www.bizkul.com
  • 3. Costs
    • Fixed
    • Variable
    • Semi variable
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  • 4. Exercise
    • Revenue- Restaurant A – Rs. 10,00,000
    • Restaurant B – Rs. 4,00,000
    • Direct - Restaurant A – Rs. 6,00,000
    • Restaurant B – Rs. 2,20,000
    • Indirect - Restaurant A – Rs. 2,00,000
    • Restaurant B – Rs. 80,000
    • What is the profit margin ??
    www.bizkul.com
  • 5. Exercise
    • Revenue- Restaurant A – Rs. 10,00,000
    • Restaurant B – Rs. 4,00,000
    • Direct - Restaurant A – Rs. 6,00,000
    • Restaurant B – Rs. 2,20,000
    • Indirect - Restaurant A – Rs. 2,00,000
    • Restaurant B – Rs. 80,000
    • What are your thoughts on the profit so calculated?
    www.bizkul.com
  • 6. Exercise
    • Revenue- Restaurant A – Rs. 10,00,000
    • Restaurant B – Rs. 4,00,000
    • Direct - Restaurant A – Rs. 6,00,000
    • Restaurant B – Rs. 2,20,000
    • Indirect - Restaurant A – Rs. 2,00,000
    • Restaurant B – Rs. 80,000
    • Do you think this is the true profit?
    • How has indirect cost been calculated (allocated)?
    • What are your views on the costing?
    www.bizkul.com
  • 7. Exercise
    • Revenue- Restaurant A – Rs. 10,00,000
    • Restaurant B – Rs. 4,00,000
    • Direct - Restaurant A – Rs. 6,00,000
    • Restaurant B – Rs. 2,20,000
    • Indirect - Restaurant A – Rs. 2,00,000
    • Restaurant B – Rs. 80,000
    • How does change in basis of allocation impact profit ?
    www.bizkul.com
  • 8. Solution www.bizkul.com Case I Amt Rs. Restaurant A B Total Revenues 1,000,000 400,000 1,400,000 Direct 600,000 220,000 820,000 Indirect 200,000 100,000 300,000 Margin 200,000 80,000 280,000 % margin 20 20 20
  • 9. Alternate scenario www.bizkul.com Case II Amt Rs. Restaurant A B Total Revenues 1,000,000 400,000 1,400,000 Direct 600,000 220,000 820,000 Indirect 150,000 150,000 300,000 Margin 250,000 30,000 280,000 % margin 25 7.5 20
  • 10. Costs
    • Costs are incurred in a variety of functions in business
      • Establishing business
      • R&D
      • Production / Delivery of service
      • Sales and marketing
      • After sales service
      • Administration
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  • 11. Importance of costing
    • Planning
    • Controlling
    • Decision making
    • Implementing
    • Continuous improvement
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  • 12. Costs
    • Controllable
    • Joint
    • Discretionary
    • Relevant
    • Sunk
    • Opportunity
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  • 13. Costs: Analysis
    • Useful to decide what is controllable and what is not
    • Helps to understand what is relevant to decision making
    • Must be done with care to avoid incorrect decisions
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  • 14. Relevant costs
    • Expected future costs to help in making decisions
    • Differ with alternate courses of action
      • Managers make decisions based on costs allocated
      • Managers may make short run decisions that may affect long term business and sales
    • Relevant costs help choose between alternatives
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  • 15. Costs - relevant / not relevant
    • Equipment replacement
      • Book value of old equipment – not relevant
      • Current disposal price of old equipment – relevant
      • Cost of equipment - relevant
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  • 16. Costing: Some terms
    • Contribution margin
    • Break even point
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  • 17. Break even point
    • Ram Kumar wants to sell Computer tables and chairs at a conference stall
    • He estimates that he can sell each unit for Rs. 10,000 each
    • The cost per unit is Rs. 6,000
    • The stall rent is Rs. One lakh
    • How many units must Ram Kumar sell to break even?
    www.bizkul.com
  • 18. Break even point
    • In continuation of the previous example, assume that Rs.6000 is not cost, ie assume some raw material which is anyway spare – eg. wood, is used for this purpose. So this cost actually may not be relevant, thou labour cost may be relevant then what happens to your decision?
    • Try to develop a different perspective and way of thinking
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  • 19. Costing: Some terms
    • Contribution margin
    • = Sales – total variable cost
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  • 20. Costs: Analysis
    • Identify cost objects / cost centres
    • Accumulate costs
    • Assign / trace costs to cost objects
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  • 21. Assignment / Allocation
    • Selection of
    • Activity base – people; machine hours; material consumed
    • Activity level – normal/abnormal
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  • 22. Budgets
    • Plan performance in advance for a given time frame
    • Review performance with budget
    • Understand reasons for variation
    • Take remedial measures if required
    • Plan again based on actual performance and feedback
    www.bizkul.com
  • 23. Budgets
    • Keep company objectives in mind
    • Long term and short term
    • Rolling budgets
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  • 24. Budgets
    • Master budget, comprising of detailed budgets for eg. budgets for
      • Income
      • Production
      • Direct costs
      • R&D
      • Administration
    www.bizkul.com
  • 25. Product budget
    • Expected sale
    • Inventory on hand
    • Production schedule
    • Direct costs
    • Indirect costs
    • Company policies and strategy
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  • 26. Life cycle costing
    • Considers entire life cycle of product from start to finish
    • Provides important information for pricing decisions
    • For example, if a mobile phone is built, if the R&D costs are high for the company, the repairs and maintenance cost to the customer may be low; so the life cycle is across the life of the product and considers costs and impact on prices
    www.bizkul.com
  • 27. Life cycle costs
    • Upstream costs
      • R&D, design, prototyping, testing, quality development
    • Manufacturing/Operations costs
      • Purchasing, manufacture/service
    • Downstream costs
      • marketing, sales and distribution, customer service and warranty
    www.bizkul.com
  • 28. Life cycle costs
    • Product life cycle costs vary with industry and nature of industry
    • R&D is not only at start of product life, this may also occur at other stages, ie development of additional features in product
    • Life cycle may also depend on markets targeted, ie country, region, socio-economic background etc.
    www.bizkul.com
  • 29. Implementation of LCC
    • Identify stages in product life cycle
    • Identify target customer
    • Understand target customers perspective and estimate need
    • Analyse cost and pricing in detail
    • Educate employees about LCC
    www.bizkul.com
  • 30. Implementation of LCC
    • Develop product and pricing structure based on LCC
    • Create appropriate organisation structure for implementation
    • Educate customer on LCC, eg. mobile phone referred to in earlier slide
    • Focus on strategic marketing to address customer requirements and needs, stated and unstated
    • Continuous life cycle budgeting and monitoring and modify/change as required
    www.bizkul.com
  • 31. Life cycle costing benefits
    • Optimisation of profit over product life
    • Full set of costs associated with products are ascertained
      • Most accounting systems capture manufacturing costs
      • Other areas like R&D at start and customer service as close do not get much importance
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  • 32. Life cycle costing benefits
    • Differences in percentages in committed costs at initial stage of business is highlighted
      • The higher the initial costs, the more critical it is for management to develop better predictions about revenues
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  • 33. Life cycle costing benefits
    • Interrelationships across cost categories are highlighted
      • Many companies with high R&D & product refinement costs may experience less customer service costs and vice versa. Such costs are often hidden and affect quality of product
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  • 34. Pricing
    • Intuitive
    • Rule of thumb
    • Trial and error
    • Discount
    • Premium
    • Mark up
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  • 35. Pricing decisions
    • Influenced by
    • Costs
    • Competitors
    • Customers
    • Time horizon – short run or long run decisions
    • Strategic reasons
    www.bizkul.com
  • 36. Target Pricing
    • Develop product
    • Set target price
    • Try to achieve target cost
    • Target cost =
    • Competitive price – desired profit
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  • 37. Pricing for short run
    • Decide on relevant costs that should be used
    • Compute costs, direct, indirect and total
    • Compute any special costs that need to be incurred and savings that may be possible
    • Decide on pricing based on other factors such as long term impact, competition etc.
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  • 38. Pricing for long run
    • Important to consider long term pricing for long term sustainability and growth of business
    • Initial pricing and short term pricing should keep long term pricing in mind
    • Image and brand of business to be considered in pricing
    • Costs to be understood and allocated
    • Consistency in pricing in long term
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  • 39.
    • … ..to trigger thinking
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  • 40. A cup of coffee
    • A cup of coffee costs Rs. 10 to make
    • HOW will you plan to price this?
    • ……… .. continued ..
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  • 41. A cup of coffee
    • Will you charge based on the price of coffee in similar coffee shops and restaurants?
    • ……… .. continued ..
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  • 42. A cup of coffee
    • Will you charge cost plus a margin?
    • ……… .. continued ..
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  • 43. A cup of coffee
    • OR will you think differently?
    • ……… .. continued ..
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  • 44. A cup of coffee
    • For example …
    • You could charge differently during the rush hour
    • You could have special rates in non rush hours
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  • 45. Some thoughts…
    • You can … if you want
    • Think differently about your pricing
    • Think differently about your negotiations for pricing and selling
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