Pricing And Costing

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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
  • Pricing And Costing

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

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