Week 2

Decision Facilitating
Activity – Based Decision Making
Decision Influencing
How to control & implement strategy?
Management Accounting II
How to reduce costs?
Value Engineering
Driver
Analysis
12
Activity
Analysis
12
Performance
Measure
12
How to improve decisions that add value?
Decision Making (DM)
Service
Department
Profitability
Responsibility
15
Balanced
Scorecard
13
Cost of
Quality
19
Delegation
&
Managemen
t Control
Systems
22
Performance
Measurement &
Compensation
23
Ethics (1)
89
Process Value
Analysis (PVA)
Pricing
14
Product-
Mix
14
Customer
Profitability
14
Supplier
Profitability
14
Product design
14
Activity-Based Management Value Engineering (PVA) Cost Plus PricingTarget CostingMarkets & Target Pricing

86
Week 2
Dell Factory Tour
http://www.youtube.com/watch?v=EEhNkz
dKyrw
Pricing Decisions and Cost Management

CHAPTER 13
Pricing Decisions
and
Cost Management
96

4
Learning Objective 1: Discuss the three major factors that affect pricing
decisions
Learning Objective 2 : Understand how companies make long-run pricing
decisions
Learning Objective 3: Price products using the target-costing approach
Learning Objective 4: Apply the concepts of cost incurrence when resources
are consumed. and locked-in costs
Learning Objective 5: Price products using the cost-plus approach
Learning Objective 6: Use life-cycle budgeting and costing when making
pricing decisions
Learning Objective 7: Describe two pricing practices in which noncost factors
are important
Learning Objective 8: Explain the effects of antitrust laws on pricing
Week 2: Learning objective summary
Cost Allocation Value Chain Analysis Sales Profitability Analysis

88
How to Fight
Low Cost
Rivals?

92
Exercise
● The following financial data apply to the videotape production plant of Dill
Company for October 2009:
Budgeted Manufacturing
Cost per Videotape
Directed material $1.60
Directed manufacturing labor 0.90
Variable manufacturing overhead 0.70
Fixed manufacturing overhead 1.00
Total manufacturing cost 4.20
● Variable manufacturing overhead varies with the number of units
produced.
● Fixed manufacturing overhead of $1 per tape is based on budgeted
fixed manufacturing overhead of $150,000 per month and budgeted
production of 150,000 tapes per month. The Dill Company sells each
tape for $5.

93
● Marketing costs have two components:
1. Variable marketing costs (sales commissions) of 5% of revenues
2. Fixed monthly costs of $65,000
● During Oct. 2009, Lyn Randell, a Dill Company salesperson, asked the
president for permission to sell 1,000 tapes at $4.00 per tape to a
customer not in Dill’s normal marketing channels. The president refused
this special order because the selling price was below the total budgeted
manufacturing cost.
● Required :
1. What would have been the effect on monthly operating income of
accepting the special order?
2. Comment on the president’s “below manufacturing costs” reasoning for
rejecting the special order.
3. What other factors should the president consider before accepting or
rejecting the special order?
Exercise

1. Relevant revenues, $4.00 × 1,000 $4,000
Relevant costs
Direct materials, $1.60 × 1,000 $1,600
Direct manufacturing labor, $0.90 × 1,000 900
Variable manufacturing overhead, $0.70 × 1,000 700
Variable selling costs, 0.05 × $4,000 200
Total relevant costs 3,400
Increase in operating income $ 600
This calculation assumes that:
a. The monthly fixed manufacturing overhead of $150,000 and $65,000 of monthly
fixed marketing costs will be unchanged by acceptance of the 1,000 unit order.
b. The price charged and the volumes sold to other customers are not affected by
the special order.
8
Solutions

2. The president’s reasoning is defective on at least two counts:
a. The inclusion of irrelevant costs––assuming the monthly fixed manufacturing
overhead of $150,000 will be unchanged; it is irrelevant to the decision.
b. The relevant costs––variable selling costs (5% of the selling price) are
excluded.
3. Key issues are:
a. Impact of Existing Customer base
Will the existing customer base demand price reductions? If this 1,000-tape order is not
independent of other sales, cutting the price from $5.00 to $4.00 can have a large
negative effect on total revenues.
b. Once off or new channel?
Is the 1,000-tape order a one-time-only order, or is there the possibility of sales in
subsequent months? The fact that the customer is not in Dill Company’s “normal
marketing channels” does not necessarily mean it is a one-time-only order.
If the sale could well open a new marketing channel, then Dill Company should be
reluctant to consider only short-run variable costs for pricing long-run business.
9
Solutions

Activity-based management Implementation Model
97
ABM Model
Systems Planning
Identify, Define, and
Classify Activities
Reduce
Costs
Improve
Decisions
Increase Profitability
ABC
1. Continuous improvement (PVA)
2. Product design (eg complexity drivers)
3. Improved decision making
4. Accurate cost info (VCA)(ABC)
a. Products (MA1)
b. Customers (eg setup drivers)
c. Suppliers
PVA
Assess Value Content of
Activities
Define Root Causes of
Each Activity
Establish Activity
Performance Measures
Search for Improvement
Opportunities
Part 1 – Week 2 Part 2 – Week 3
Assign Resource Cost to
Activities
Identify Cost Objects and
Define Activity Drivers
Calculate Activity Rates
Assign Costs to Cost
objects
Product design
Value engineering
Design
analysis
Functional
analysis
Step 1 & 5 of
Target Costing

Pricing and Business
● How companies price a product or service ultimately depends on
the demand and supply for it
● Three influences on demand & supply:
1. Customers
2. Competitors
3. Costs
98
Learning Objective 1:
Discuss the three major
factors that affect pricing
decisions (P.539)
…customers, competitors,
and costs
1

Influences on Demand & 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)
101
Markets & Target PricingActivity-Based Management Value Engineering (PVA) Cost Plus PricingTarget Costing

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
102
Learning Objective 2 :
Understand how companies make long-
run pricing decisions…consider all
future variable and fixed cost and earn a
target return on investment (P540)
2

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
103

Example: Target Costing – Short run
104
● Astel Computers:
● Makes two brands of computers.
● Offer! – Datatech asked Astel to
bid on supplying 5000 provalue
computers over 3 months of 2008.
1981 19841983

Example: Target Costing – Short run
105
● Relevant costs:
● $460 (DM) + $64 (DL) + $50 (O/H) = $574
● $50 = Fixed costs of add capacity to make Provalue ($250,000 / 5000 = $50)
● Market intelligence:
● Astel believes that competing bids will be between $596 and $610 per computer,
Astel makes a bid of $595 per computer.
● If it wins this bid, operating income will increase by $105,000 (relevant revenues,
$595 x 5,000 = $2,975,000 minus relevant costs, $2,870,000).
● Decision point:
● Management’s strategy is to bid as high above $574 as possible while remaining
lower than competitors’ bids.

Example: ABC Manufacturing Cost
Exhibit 13-2 indicates – total cost of manufacturing Provalue = $102 million. To set long
run prices, Astel’s managers must calculate the full cost of producing and selling
Provalue
106

20
Exhibit 13-3 indicates – The Profitability of Provalue using Value Chain Activity Based Costing

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 cost to produce,
coupled with the ability to recoup the costs and still achieve a
required rate of return
107

Markets and Pricing
● Competitive Markets - use the market-based approach
● Less-Competitive Markets – can use either the market-based or
cost-based approach
● Non-Competitive Markets – use cost-based approaches
108

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
109
Price products using the target-
costing approach
…target costing identifies an estimated
price customers are willing to pay and then
computes a target cost to earn the desired
profit
(P.544)
3

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
110

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
111
Step 1 & 5 of
Target Costing

ABM Model
Systems Planning
Classify Activities
Reduce
Costs
Improve
Decisions
ABC
a. Products (MA1)
c. Suppliers
Process Value Analysis
Activities
Each Activity
Establish Activity
Opportunities
Activities
objects
Product design
Value engineering
Design
analysis
Functional
analysis
Markets & Target Pricing
Activity-Based Management Value Engineering (PVA) Cost Plus PricingTarget Costing
Step 1 & 5 of
Target Costing

27
Exhibit 13-3 indicates – The Profitability of Provalue using Value Chain Activity Based Costing
Lets return to the prior
example to see where you can
start on value engineering!

113
▪ 1. Functional analysis (short term)
▪ The performance and cost of each major
function or feature of the product is examined.
▪ Focus on key product functions
● Keep those that add more value than cost
● Find ways to reduce the cost of function
▪ 2. Design analysis - Better product design
● the design team prepares several possible designs of the
product, each having similar features with different levels of
performance and different costs.
● Reduce complexity
● Increase modularity – e.g. dashboards in cars
▪ 3. Process innovation - reverse engineering
▪ Radical dramatic improvement
▪ 4. Process improvement (PVA)
▪ Quality management
▪ Continuous incremental improvement
● Change physical location
● Change sequence
● Coordination technologies
Value Engineering: Four ways to reduce costs
Value
engineering
Focus on
product functions
and design to
achieve cost
reductions
Focus on process
improvement to
achieve cost
reductions
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

Which product function offering
can we best compete?
Price range (HK$)
15,000-55,000
5,000-10,000
2,000-4,000
2,000-4000
114
1. Functional analysis - Product segments and functions
Step 1 of
Target
Costing

Which product function
offering can we best
compete?
Price range
(HK$)
2. Design analysis
Can we change the components?
Can we reduce the number of
components?
15,000-55,000
5,000-10,000
2,000-4,000
2,000-4000
115
1. Functional analysis - Product segments and functions
Step 1 of
Target
Costing

Can we change the components?
Can we reduce the number of components?
116
2. Design analysis - Product segments and functions
Step 5 of
Target Costing

www.ChinaSupplier1000.com | 39
Step 5 of
Target Costing

33
Step 5 of
Target Costing

Chinese Fake iPhone Dissected
● Many of the no-name mobile phones sold in China are similar to Apple Inc's "iPhone."
We obtained one such handset, "ciphone," and torn it down (See related article).
● The product looks like a genuine "iPhone," but it is inferior in functionality and uses
many cheap parts. (This article was published on the December 1 issue of Nikkei
Electronics.)
● The ciphone uses MediaTek Corp's chipset that supports GSM.
● "Among the chipsets used in imitation products made in China, the grade of this
chipset is low," said one engineer from a parts manufacturer. "The price is probably
lower than US$6."
● Many of the parts, including the LCD panel and the Li-ion secondary battery, are
directly soldered on the main board, probably to reduce the cost, which the engineer
estimated at ¥3,000 (approx US$32) to 5,000 per unit.
Source: http://techon.nikkeibp.co.jp/english/NEWS_EN/20090106/163632/
34

35

ABM Model
Systems Planning
Classify Activities
Reduce
Costs
Improve
Decisions
ABC
a. Products (MA1)
c. Suppliers
Process Value Analysis
Activities
Each Activity
Establish Activity
Opportunities
Activities
objects
Product design
Value engineering
Design
analysis
Functional
analysis
Step 1 & 5 of
Target Costing

2. Driver analysis is the effort expended to identify the factors that are the root
causes of activity costs.
1. Activity analysis is the process of identifying, describing, and evaluating the
activities an organization performs.
4. Process value analysis
Process value analysis is fundamental to activity-based responsibility accounting, focuses on
accountability for activities rather than costs, and emphasizes the maximization of system-wide
performance instead of individual performance.
How can we (i) find out how we are doing?, and (ii) control human behavior?
3. Establish performance measures - the process of measuring the quality,
time and efficiency of activities.
1) Identify opportunities for improvement in the performance of activities (e.g. non-value
added costs) and people,
2) Assign responsibility (accountability) to people so that they will be motivated and
focused in their decision making.
Performance measurement should produce two outcomes:
121

1. Activity analysis is the process of identifying, describing, and evaluating the
activities an organization performs.
Activity analysis should produce four outcomes:
1) What activities are performed.
2) How many people perform the activities.
3) The time and resources are required to perform the
activities.
4) An assessment of the value of the activities to the
organization.
4. Process value analysis – identify activities
How can we better (i) preserve and (ii) allocate resources?
Activity analysis helps to
identify and eventually
eliminate all unnecessary
activities and increase the
efficiency of necessary
activities
122

4. Process value analysis – identify activities
Value added and Non-value-added costs
● 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
● 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.
For example – Employing inspectors to check on the quality of goods received or the quality of good produced
- Should we:
a) train inspectors?
b) ensure that suppliers deliver better quality?
c) improve the process that is producing the faulty goods?
123

124
4. Process Value Analysis
Elimination of Non-Value-Added Costs
Exercise – Fill in blanks
Activities
Reduce or
Eliminate
Continually Evaluate
and Improve
Value added activities
contribute to customer
value and/or help to meet
the organization’s needs

125
Elimination of non-value-added costs
Non-value-added
activities
NecessaryUnnecessary
Activities
Reduce or
Eliminate
Continually Evaluate
and Improve
Value-added
activities
Value added activities
contribute to customer
value and/or help to meet
the organization’s needs

126
What are we trying to do?
Achieving Cost Reduction
Activity Reduction Activity Selection
Activity Sharing Activity Elimination
Reduce Non-
value-added
Cost (PVA)

127
Which of the following is an example of a value-added
activity?
● a. supervision of production workers
● b. inspection of products
● c. scheduling of production
● d. all are value-added activities
Exercise: Process Value Analysis

128
Which of the following is an example of a non-value-added
manufacturing activity?
● a. assembly
● b. scheduling
● c. finishing
● d. All are value-added activities.

129
A company keeps 20 days of materials inventory on hand to avoid
shutdowns due to materials shortages. Carrying costs average $4,000
per day. A competitor keeps 10 days of inventory on hand, and the
competitor's carrying costs average $2,000 per day.
The value-added costs are
● a.$80,000.
● b.$40,000.
● c.$20,000.
● d.$-0-.

130
A company keeps 20 days of materials inventory on hand to avoid
shutdowns due to materials shortages. Carrying costs average $4,000
per day. A competitor keeps 10 days of inventory on hand, and the
competitor's carrying costs average $2,000 per day.
The value-added costs are
● a.$80,000.
● b.$40,000.
● c.$20,000.
● d.$-0-.
Inventory carrying costs are non-value-added costs.

131
A time-and-motion study revealed that it should take 2 hours to
produce a product that currently takes 6 hours to produce. Labor is
$8 per hour. The value-added costs are
● a.$16.
● b.$32.
● c.$48.
● d.$-0-.

132
A time-and-motion study revealed that it should take 2 hours to
produce a product that currently takes 6 hours to produce. Labor is
$8 per hour. The value-added costs are
● a.$16.
● b.$32.
● c.$48.
● d.$-0-.
SUPPORTING CALCULATIONS:
$8 x 2 hours = $16

2. Driver analysis is the effort expended to identify the factors that
are the root causes of activity costs.
4. Process value analysis – Driver analysis
LOW
CUSTOMER
SATISFACTION
What is causing what?
Think of a time when you made a large purchase of a product or
service? And you were unsatisfied?
133

POOR SUPPORT
LOW QUALITY PRODUCT HIGH PRICING
Example - Causes of low customer satisfaction
Cost of
Materials
Ineffective
Marketing
Incompetent
Employees
Bad Design
Poor
Materials
Wrong Answers
Long Hold Times
Fee Structure
LOW
CUSTOMER
SATISFACTION
134
4. Process value analysis – Driver analysis

Incorrect Delivered Location
(YTD : 1.5 % vs. mthly gross sale)
Procedure
communication Skill
Transportation
135
Exercise- Incorrect delivered location

3. Chaotic
delivery
schedule
6. Missing
delivery date
& schedule
5. Wrong
invoicing
data
1. System Bug
& instability
4. Manual
pick involve
unreliable &
accuracy
8. Inadequate
procedure &
training
11. Illiterate in
English invoice
10.
Illiterate in
English &
product
knowledge
2.
Outdated
doc.
9. Lack of
communication
with sales
7. Ambiguous
order
54

Incorrect Delivered Location
(YTD : 1.5 % vs. mthly gross
sale)
Chaotic delivery
schedule
Missing delivery
date & schedule
Wrong invoicing
data
Procedure
System Bug & instability
Manual pick involve unreliable &
accuracy
Communication Skill
Inadequate procedure &
training
Illiterate in English
invoice
Illiterate in English & product
knowledge
Outdated
doc.
Lack of
communication
with sales
Ambiguous
order
Transportation
137

4. Process Value Analysis – Performance Measure
How can we…..
(i) find out how we are doing (________________)?
(ii) control human behavior (________________)?
3. Establish performance measures - the process of measuring the quality,
time and efficiency of activities.
1) Identify opportunities for improvement in the performance of activities (e.g.
non-value added costs) and people,
2) Assign responsibility (accountability) to people so that they will be motivated
and focused in their decision making.
Performance measurement should produce two outcomes:
138

139
Financial measures of activity efficiency include:
▪ Value- and non-value-added activity costs
▪ Trends in activity costs
▪ Kaizen standard setting
▪ Benchmarking
▪ Activity flexible budgeting
▪ Activity capacity management
4. Process Value Analysis – Performance Measure
Financial Measures of Activity Efficiency

Value Engineering Terminology
● Cost Incurrence – describes when a resource is consumed (or
benefit foregone) to meet a specific objective
● 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
● Are a key to managing costs well
140
Apply the concepts of cost incurrence
…when resources are consumed
And locked-in costs
…when resources are committed to be
incurred in the future
(P.547)
4
Target CostingActivity-Based Management Value Engineering (PVA) Cost Plus PricingMarkets & Target Pricing

Cost Incurrence and Locked-In Costs Graph
141

Problems with Value Engineering
and Target Costing
1. Employees may feel frustrated if they fail to attain targets
2. A cross-functional team may add too many feature just to
accommodate the wishes of team members
3. A product may be in development for a long time as alternative
designs are repeatedly evaluated
4. Organizational conflicts may develop as the burden of cutting
costs falls unequally on different business functions in the firm’s
value chain
142

88
How to Fight
Low Cost
Rivals?

How to Fight
Low Cost
Rivals?Seatingdensity
AircraftUtilization
Lowercrewcosts
Cheaperairports/landing
fees
Singleaircrafttype
Minimalstationcosts
Noin-flightcatering
Noagentscommission
Reducedsales/reservation
costs
Smalleradministration
Product Function
Product Design
Manufacturing /
Service Process

143
ABM Model
Systems Planning
Classify Activities
Reduce
Costs
Improve
Decisions
ABC
a. Products (MA1)
c. Suppliers
PVA
Activities
Each Activity
Establish Activity
Opportunities
Activities
objects
Product design
Value engineering
Design
analysis
Functional
analysis
63
Example: ABC
Manufacturing Cost
Step 1 & 5 of
Target Costing

Exhibit 13-2 indicates – total cost of manufacturing Provalue = $102 million. To set long
run prices, Astel’s managers must calculate the full cost of producing and selling
Provalue
144

Example: Product Profitability Using ABC Costing
Exhibit 13-3 shows operating income for Provalue – 2013 based on activity-based
analysis of costs in all business functions.
145

Example: Target Costing (p.549)
146
● Exhibit 13-5 uses an activity-based approach to compare cost driver
quantities and rates for the 150,000 units in 2013 and 200,000
budgeted for 2014.
● How can Provalue reduce its costs to a target cost of $720?
● Reduce costs through better design
● Less costly materials – DM -> $460 to $385 per unit
● Fewer components – Ordering and Rec costs → $12 to $8.50 per unit
● Reduce costs through better process
● Fewer machine hours per unit – 2 hours to 1.5 hours (total 300,000 stays the same) $76
to $57 per unit
● Fewer direct labor hours per unit – 3.2 hours to 2.65 hours -> $64 to $53 per unit
● Fewer testing hours per unit – 30 hours to 15 hours → $60 to $30 per unit
● Lower defect rate – 8% to 6.5% - → $8 to $6.50 per unit

Example: Target Costing
147
2013 2014

Example: Target Costing
148

ABM Model
Systems Planning
Classify Activities
Reduce
Costs
Improve
Decisions
ABC
a. Products (MA1)
c. Suppliers
PVA
Activities
Each Activity
Establish Activity
Opportunities
Activities
objects
Product design
Value engineering
Design
analysis
Functional
analysis
69
Step 1 & 5 of
Target Costing

150
● Starcom communications Technologies, Inc., has introduced a
new phone so small that it can be carried in a wallet. Starcom
invested $400,000 in research and development for the
technology and another $800,000 to design and test the
prototypes. It predicts a four-year life cycle for this phone and
has gather this cost data for it:
Exercise – Functional Analysis
Monthly fixed costs Variable costs
Manufacturing costs $25,000 $20
Marketing costs 20,000 5
Customer service costs 3,000 8
Distribution costs 5,000 15
Sales predictions:
For price of $150 – average annual sales of 20,000 units

151
● If the price of a wallet phone is $225, Starcom must increase its
research and development costs by$100,000 and the
prototyping costs by $400,000 to improve the model for the
higher price. Fixed customer service costs would also increase
by $500 per month and variable distribution costs would
increase by $5 per units to improve the customer service and
distribution at the $225 level. At the lowest price level of $150,
fixed marketing costs would be reduced by $5,000 per month
because the low price would be the principal selling feature.
● Requires:
1. Determine the life-cycle costs for each pricing decision
2. What price for the wallet phone’s life cycle will produce
the most profit for Starcom?
Exercise – Functional Analysis

1. Price and Units for each sales prediction, 4 years
Price $150 $180 $225
Units 80,000 60,000 48,000 for 4 years
Operating Profit for each price (all figures in $000)
Revenue $12,000 $10,800 $10,800
Cost
R&D $400 $400 $500 more at the $225 price
Prototyping 800 800 1,200 more at the $225 price
Manufacturing
Fixed 1,200 1,200 1,200 $25,000 x 12 x 4
Variable 1,600 1,200 960 $20 per unit
Marketing
Fixed 720 960 960 less at the $150 price
Variable 400 300 240 $5 per unit
Customer Svc
Fixed 144 144 168 more at the $225 price
Variable 640 480 384 $8 per unit
Distribution
Fixed 240 240 240 $5,000 x 12 x 4
Variable 1,200 900 960 $15 per unit ($20 at the
$225 price)
Total Costs 7,344 6,624 6,812
Operating Profit $4,656 $4,176 $3,988
72
Solutions – Functional Analysis

$150 $180 $225
73
Solutions

Cost-Based (Cost-Plus) Pricing
● The general formula adds a markup component to the
cost base to determine a prospective selling price
● Usually only a starting point in the price-setting process
● Markup is somewhat flexible, based partially on
customers and competitors
Cost Plus Pricing
Activity-Based Management Value Engineering (PVA)Markets & Target Pricing Target Costing
154
Price products using the cost-plus
approach
…cost-plus pricing is based on some
measure of cost plus a markup
(P.551)5

Forms of Cost-Plus Pricing
● Setting a Target Rate of Return on Investment: the
Target Annual Operating Return that an organization
aims to achieve, divided by Invested Capital
● Selecting different cost bases for the “cost-plus”
calculation:
● Variable Manufacturing Cost
● Variable Cost
● Manufacturing Cost
● Full Cost
155
Cost Plus Pricing

Common Business Practice
● Most firms use full cost for their cost-based pricing
decisions, because:
● Allows for full recovery of all costs of the product
● Allows for price stability
● It is a simple approach
156
Cost Plus Pricing

How to Fight
Low-Cost
Rivals?
Seating
density
Aircraft
Utilization
Lower
crew
costs
Cheaper
airports /
landing
fees
Single
aircraft
type
Minimal
station
costs
No in-
flight
catering
No agents
commissi
on
Reduced
sales /
reservation
costs
Smaller
administra
tion
Product Function
Product Design
Manufacturing /
Service Process
158
Cost Plus Pricing

R+D
STRATEGIC PRICING STRATEGIC CONTROL
F
Q C
VALUE
ENGINEERING
KIAZEN
COSTING
Total
Quality
Management
MARKETING
DISTRIBUTION
CUSTOMER
SERVICE
(ST solution to managing through put)
Theory
Of
Constraints
Operational
Control
DESIGN MANUFA-
CTURING
ACTIVITY BASED COSTING
(LONG TERM SOLUTION TO EFFICIENCY IMPROVEMENT)
Cost Life Cycle (Bottom Up)
LONGTERMDECISONS
SHORTTERMDECISIONS
Sales Life Cycle (Top Down)
TARGET
COSTING
159
6
Use life-cycle
budgeting and costing
when making pricing
decisions…accumulate
all costs of a product
from initial R&D to final
customer service for
each year of the
product`s life. (P553)
Cost Plus Pricing

ABM Model
Systems Planning
Classify Activities
Reduce
Costs
Improve
Decisions
ABC
a. Products (MA1)
c. Suppliers
PVA
Activities
Each Activity
Establish Activity
Opportunities
Activities
objects
Product design
Value engineering
Design
analysis
Functional
analysis
79
Step 1 & 5 of
Target Costing
Cost Plus Pricing

160
Revision
● What is ABC?
● What is target costing?
● What is value engineering?
● What is process value analysis?
● What are three ways to reduce costs?
● Why do we attach costs to processes?
Cost Plus Pricing

81
Learning Objective 1: Discuss the three major factors that affect pricing
decisions
Learning Objective 2 : Understand how companies make long-run pricing
decisions
Learning Objective 3: Price products using the target-costing approach
Learning Objective 4: Apply the concepts of cost incurrence when resources
are consumed. and locked-in costs
Learning Objective 5: Price products using the cost-plus approach
Learning Objective 6: Use life-cycle budgeting and costing when making
pricing decisions
Learning Objective 7: Describe two pricing practices in which noncost factors
are important
Learning Objective 8: Explain the effects of antitrust laws on pricing
Week 2: Learning objective summary
Cost Plus Pricing

Week 2

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Week 2