To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 13 Joint Management of Revenues and Costs LEARNING OBJECTIVES Chapter 13 addresses the following questions: Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 How is value chain analysis used to improve operations? What is target costing, and how is it performed? What is kaizen costing, and how does it compare to target costing? What is life cycle costing? How are cost-based prices established? How are market-based prices established? What are the uses and limitations of cost-based and market-based pricing? What additional factors affect prices? These learning questions (Q1 through Q8) are cross-referenced in the textbook to individual exercises and problems COMPLEXITY SYMBOLS The textbook uses a coding system to identify the complexity of individual requirements in the exercises and problems Questions Having a Single Correct Answer: No Symbol This question requires students to recall or apply knowledge as shown in the textbook This question requires students to extend knowledge beyond the applications e shown in the textbook Open-ended questions are coded according to the skills described in Steps for Better Thinking (Exhibit 1.10):  Step skills (Identifying)  Step skills (Exploring)  Step skills (Prioritizing)  Step skills (Envisioning) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-2 Cost Management QUESTIONS 13.1 Just-In-Time (JIT) is an inventory management and manufacturing system where products are manufactured as demanded and raw materials are delivered just when they are needed in the manufacturing cycle Very little inventory is kept on hand; suppliers deliver small amounts on a regular basis Organizations adopt Just-In-Time systems to keep inventory costs down and also to better manage quality because defects are often monitored more closely with JIT systems Systems such as JIT are known as demandpull systems, because demand pulls inventory through the system to the point of sales 13.2 Similarities between target and Kaizen costing: Rely on goal setting to achieve cost reduction Focus on product design and the manufacturing process to find ways to reduce cost Encourage organizations to work with suppliers to reduce costs Use functional teams to determine where costs can be cut Encourage employees to take an active part in the cost cutting decision making process Take advantage of the trade-offs among price, functionality, and quality Focus on continuous improvements in products and processes Differences between target and Kaizen costing: Target costing occurs in the design and decision-making phase of product development Kaizen costing occurs after the product has been manufactured for the first time, and continues throughout the life of the product Similarities and Difference among life cycle, target, and Kaizen costing Life cycle costing (LCC) is similar to Kaizen costing in that cost reductions over time are expected LCC is different because there is no goal setting for specific targeted costs and the product is unprofitable in the beginning of the life cycle In target costing, an unprofitable product is never manufactured, but under life cycle costing the product is expected to make a profit at some time, although not at the beginning of its life cycle 13.3 Target and Kaizen costing are most appropriate in the following situations: Product development and design phases are long and complex The production process is complex The market is willing to pay for differences in quality or function The manufacturer can push some cost reductions onto suppliers and subcontractors The manufacturer can influence the design of subparts Students should draw from these characteristics in identifying products for which target and kaizen costing would and would not be appropriate For example, these methods would be appropriate for automobile design and production, heavy equipment manufacture, camera manufacture, computers, and electronics Some service industries To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 13: Joint Management of Revenues and Costs 13-3 use various forms of target costing practices For example, hospitals are reimbursed by Medicare with a flat-fee per patient by the diagnosis the patient is given Doctors agree on clinical pathways, that is, the steps taken to treat the average patient with that diagnosis The clinical pathway is designed to cost less than the reimbursement amount Similarly, a CPA firm may use these methods to evaluate whether services can be provided to achieve desired profits or whether the firm should continue offering services to a client Target and kaizen costing are not generally useful for simple product manufacturing such as small toys or for food and beverages such as colas, cereals, or pasta products 13.4 The value chain cycle follows these processes in an organization, in a continuous manner: research and development, product or service design, manufacturing process or service delivery design, manufacture or service delivery, marketing, distribution, customer service Following are some of the benefits from value chain analysis: enhanced efficiency, cost reduction, improvements in supplier and customer relationships, the ability to identify and eliminate non-value-added activities, reductions in rework, scrap, and waste, production cycle time reductions, and an increased ability to negotiate lower prices with suppliers 13.5 First determine the product’s target price, quality, and functionality Then determine the target cost Design the product and manufacturing or delivery process to achieve the target cost A pilot project is set up to evaluate the feasibility of the product and process design and operation If the product meets the target criteria, it goes into full production At each stage decisions are made about whether the product will be able to meet the price, quality, and functionality requirements If these are not met, the product will not be produced or the requirements will change in response to customer input 13.6 Cost-based pricing is performed by adding a mark-up to some measure of product cost, such as variable costs or a partially or fully allocated cost For example, if a computer’s variables costs were $300 and the required mark-up 100%, the price would be $600 ($300 + 100%*$300) 13.7 Market based prices are determined using some measure of customer demand Managers identify the amount that customers are willing to pay for a good or service and set the price at that amount With historical information about prices and quantities sold, the price elasticity of demand formula can be used to determine a profit-maximizing price Market research could be conducted and competitors’ prices could be analyzed The Internet is also a source for pricing information 13.8 Supply chain analysis explores the flow of resources from the initial suppliers (inside or outside the organization) to the delivery of products or services to customers or clients Often, prices of inputs are reduced through negotiations with suppliers and may entail long-term contracts To further reduce costs, the purchasing organization may provide engineering or other kinds of assistance to the supplier To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-4 Cost Management 13.9 Common Advantages: Use of goal setting encourages better performance Team approach motivates employee cooperation Allows a competitive price advantage for a short period of time Common Disadvantages: Stress of cost reduction environment can impair employee wellbeing Encourages organizations to forego some products having long term profit potential that are not profitable in the beginning 13.10 This problem is called the death spiral because as demand falls, average costs increase because fewer units are produced This means that price will increase because it is based on average cost When price increases, demand usually falls, so production will also fall, and average cost will increase, causing prices to increase, causing demand to fall, and finally the company goes out of business 13.11 Not-for-profit organizations often receive donations and grants to help off-set operating costs Therefore they not have to set prices so that their operating costs are recovered They have other organizational objectives, such as providing services to low-income people Hence they may set prices using a sliding scale according to ability to pay They may not charge for some products or services To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 13: Joint Management of Revenues and Costs 13-5 EXERCISES 13.12 Value-Added and Non-Value-Added Activities A Inspection activities are non-value-added Some organizations have very low defect rates, making it unnecessary to inspect; that is, the product design and manufacturing process insures high quality production The concept of high quality is to ―do it right the first time.‖ Some firms may inspect incoming materials to guarantee high quality during their manufacturing processes, but these costs could be eliminated through contractual arrangements with suppliers that include high penalties for low quality material deliveries B Moving materials to work stations could also be either value-added or non-value-added, depending on the circumstance In organizations that use JIT systems, the amount of materials handling is reduced to the minimum level necessary, which reduces costs C Manufacturing extra inventory to keep employees busy is non-value added if there are no sales for the inventory 13.13 Lickety Split Percent change in price = ($1.93 - $1.75)/$1.75 = +10% Percent change in demand = (1,000 – 850)/1,000 = –15% The elasticity is ln (1 + percent change in quantity sold)/ln(1+percent change in price) = ln(1–0.15)/ln(1+0.1) = –0.16252/0.09531 = –1.705 Variable cost = $640/1,000 Profit-maximizing price = [–1.705/(–1.705+1)]*$0.64 = $1.55 To maximize profits, the manager needs to lower the price rather than increase it 13.14 Harold’s Flowers A The elasticity is ln(1+0.35)/ln(1–0.20) = 0.30010/–0.22314 = –1.345 Mark-up = [–1.345/(–1.345+1)] – = 2.899, or 2.9 Variable cost = $0.40 Price = (2.9 x $0.40) + 0.40 = $1.56 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-6 Cost Management B The elasticity is ln(1–0.12)/ln(1+0.10 = –0.12783/0.09531 = –1.341 Mark-up = [–1.341/(–1.341+1)] – = 2.93 The formulas indicate that he should increase his current markup, to nearly 300% However, these formulas are very sensitive to errors in the estimates of price and quantity changes, so they should be used only as guidelines He can slowly begin increasing the mark-up until he reaches the point where contribution margin times quantity sold maximizes his profits 13.15 Big Bertram A It is a cellular or kanban system An employee work team manufactures each item in a small workstation using Just-In-Time inventory control methods B Each employee inspects his own work, and so defects are caught very quickly Inventory is delivered to each cell just as it is needed and products are made only when they are ordered so inventory costs are minimized Usually there are space savings C A cellular system succeeds when manufacturing is continuous and the defect rates are low If the supplier has any problems with the software and deliveries are slow, the line cannot manufacture anything If there are any problems with quality, it may take longer to get these adjusted because the software has already been released materials for delivery In addition, Big Bertram would want to emphasize the security aspects of the supplier’s access to its inventory levels Firewalls and strong security code systems would be needed to protect the integrity of Bertram’s database and specialized software programs Organizations in competitive industries guard their production information to protect their private information regarding areas of their competitive strengths 13.16 Chrysler A If Chrysler had used target costing for the P.T Cruiser, the first step would have been to determine a market price for the new model Focus groups and customer surveys would have been conducted Once the market price had been established, the required profit margin would be subtracted, leaving the target cost At this point a team would be assembled of engineers, accountants, and marketing people to design the product and the manufacturing process If the team is able to this at the target cost, a pilot production line is implemented If costs come in at the target cost, the P.T Cruiser would go into full production If the target cost cannot be met, at either the design or pilot stage, the whole process is reiterated several times If the Cruiser never came in at the target cost, the marketing department could more research to see if customers would respond to an increased price or decreased quality or function If the target cost is never met, the product is dropped To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 13: Joint Management of Revenues and Costs 13-7 B New products such as the P.T Cruiser may be well received, or they may not be Consumers’ preferences vary across age groups, across geographical locations, across income brackets, across gender lines, and many other characteristics Because of this, the survey and focus group information may not represent the population of consumers needed In addition, economic factors affect the success of a new product None of these can be known for certain ahead of time 13.17 Sea Breeze Taffy A Elasticity = ln(1+0.20)/ln(1-0.10) = 0.18232/–0.10536 = –1.730 B Variable cost = $2,400/1,500 = $1.60 Profit maximizing price = [–1.730/(–1.730+1)] x $1.60 = $3.79 C She should drop the price, but in slow increments to determine the point at which the contribution margin times quantity sold maximizes profits D The following factors could affect her price decision: Any constraints in the resources and capacity she has available Competitor’s actions General economic factors, if the economy is down, she may need to lower her price Weather affects the number of customers and she may need to run sales during slow times to move inventory and ingredients that have a short shelf life 13.18 Oysters Away [Note: This problem requires knowledge of special order decisions (Chapter 4).] A Elasticity = ln(1–0.15)/ln(1+0.10) = –0.16252/0.09531 = –1.705 Variable cost (vc) = $120,000/2,000 = $60 Profit maximizing price = [–1.705/(–1.705+1)]*vc = 2.42 x $60 = $145 per case B The minimum price for a special order decision is variable cost, so it is $60 for Oysters Away C Linda must be sure that there are no constraints on the amount of oysters available at this time She also needs to know whether there would be any increase in wages or fixed costs if she adds more capacity She needs to know whether other customers might find To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-8 Cost Management out about this price and demand lower prices Students may think of other relevant factors 13.19 Blade Runner A Current price is equal to the cost plus 10% of the cost = 110% x $150 = $165 B New price = $165 – (10% x $165) = $148.50 Because the company wants to achieve a 10% return on sales, the new contribution margin = $14.85 ($148.50 x 10%) The contribution margin takes into account both fixed and variable product costs, because none of the costs will be incurred unless the motor scooter is produced Therefore the new target cost is cost = $148.50 – $14.85 = $133.65 C Need to reduce each cost by ($150 – $133.65)/$150 = 10.9%: Original Amount $ 45 15 10 10 20 25 25 $150 Target Cost $ 40.095 13.365 8.91 8.91 17.82 22.275 22.275 $133.650 13.20 Blade Runner (continued) A Following are the new costs: Direct materials $ 40.50 Direct labor 13.50 Machining 9.20 Inspection 10.00 Engineering 16.00 Marketing 22.50 Administration 25.00 $136.70 Costs need to be reduced further by $136.70 - $133.65 = $3.05 B The next step will be to look for more cost savings so that the target cost can be met No savings were mentioned for inspection, so that is one area that could be explored Other departments may have to cut back further to meet the target cost of $133.65 After the To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 13: Joint Management of Revenues and Costs 13-9 target cost has been met, a pilot project would be set up If the scooter can be produced for $133.65 in the pilot project, the product would be manufactured If costs still were too high, the target costing process would be reiterated C Any changes in suppliers would need to be carefully considered The reliability of the supplier, the timeliness of delivery and quality of products supplied, all need to be explored If suppliers not meet required standards, new vendors must be found, and/or the target cost may not be met Productivity gains by labor could reduce quality Any trade-offs in quality or functionality to meet the target cost need to be explored and discouraged The new target cost assumes no reductions in quality or functionality For each category: is the cost reduction actually attainable without affecting quality or functionality? For marketing, will the cost reduction affect sales volumes? Will cutting inspection costs mean that more defective units are sold? Will direct labor workers feel too much pressure to continually reduce costs and turnover increase? Will the machining department continue to be precise in their work while cutting costs? D Questions (i.e., uncertainties) about whether the company will be able to achieve its planned cost reductions are listed below Students may think of others Direct materials – How certain can managers be that the price set by vendors now will continue over the next accounting period? How certain can they be that no changes in the price of raw materials will occur? Direct labor – How certain can managers be that labor productivity will continue to improve? Could labor demand a pay rate increase in the next year? Machining – How certain can managers be that no new technology will be developed, making their current machines obsolete? Inspection – How certain can managers be that inspectors will not demand an increase in salaries, or that they will continue to provide high quality inspections? Engineering – How certain can engineers be that any changes will either improve quality or reduce costs as they anticipate? Marketing – How certain can managers be that the popular media will not increase prices for advertising? How certain can they be that appropriate customers are targeted in the advertising campaigns? Administration – How certain can managers be that administrative costs not increase, especially costs for computerized systems and software? To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-10 Cost Management PROBLEMS 13.21 Budget Cupboards [Note: An example is provided in the textbook for students to follow in answering Part A.] A Here are possible answers to this question; students may think of others Potential Area for Cost Reduction Manufacturing process Potential Cost Reduction (1) Reduce inventory by using a JIT system Administration Outsource functions such as payroll if it is cheaper to so Changes in quality or functionality Identify specialty functions with low volume sales and consider discontinuing them (2) Reduce inspection by using cellular manufacturing (also increases flexibility so that specialty items can be manufactured to order more easily) Explore software that would increase efficiency and reduce number of employees needed Identify lower cost materials that would not reduce current quality B To price more competitively, overall costs need to be reduced without affecting product quality or functionality Value chain analysis and JIT are methods that are used to reduce costs JIT manufacturing reduces inventory storage and insurance costs, and frees up extra space in the manufacturing plant If there are alternative uses for the space, the overall contribution margin should increase Value chain analysis enables managers to categorize activities into value-added and non-value added Then the non-value added activities are eliminated or minimized to save costs The supply chain can be analyzed to determine whether vendors can reduce their costs or provide higher quality goods and services at the same price 13.22 Sandy A Target and kaizen costing are both market-based pricing techniques Once the market price is established, both methods set cost goals for production However, target costing occurs at the decision-making phase of product development and kaizen costing occurs once the product has be manufactured and price reductions are anticipated Target costing specifies a particular cost for the product and the product will not be manufactured unless the target cost is met In contrast, kaizen specifies specific cost reduction goals for the product across its life cycle To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 13: Joint Management of Revenues and Costs 13-11 B Target Costing Information Needed Estimated selling price for a given design and functionality Estimates for sales volume Estimated product costs: Direct materials Direct labor Overhead costs Uncertainties How certain can managers be that customers will be willing to pay the estimated price? Will competition drive the price down? Will competitors’ advertising campaigns affect demand? How certain are managers that demand will not change if economic conditions change? How certain are managers that prices and quality will hold over time? How certain are they that labor productivity will meet their estimates? Will employees demand higher pay rates? Will electricity rates or taxes or insurance rates change? Will salaries for supervisory employees increase? Will other overhead costs increase or decrease? If the design phase takes very long, how certain can managers be that estimated costs will hold until production begins? Kaizen Costing Information Needed Same information as above Estimates for cost reductions over time: Direct materials Direct labor Overhead costs Uncertainties Same uncertainties as above How certain are managers that vendors will reduce prices and maintain quality over time? How certain are they that labor productivity will increase over the product’s life cycle so that estimated cost reduction goals can be met? Will employees be willing to continually strive for productivity gains without reducing quality or functionality? Some costs will likely increase over time, such as property taxes and utilities How certain are managers that other costs can be cut to override any cost increases and reduce costs further? Can they find activities to eliminate to reduce overhead costs, such as number of set-ups? C Managers are able to create biased estimates under any system, by underestimating or overestimating costs and revenues If managers are biased toward producing particular goods or services, they may unintentionally be very optimistic in their estimates of prices and volumes, and overestimate them They may also underestimate costs, not checking with vendors to be certain that quality remains high when direct material costs are To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-12 Cost Management reduced In addition, they may ask direct labor employees to estimate time under the best circumstances, not average circumstances Because these analyses rely on the target costing team’s estimates, any bias in the estimates affects the decision, and potentially the success of the product Similarly if managers are biased against products or services, they will underestimate volumes and prices, and overestimate costs In this case, a decision could be made to forego an otherwise profitable product or service D Kevin needs to understand that biased estimates affect all types of analyses An advantage of target costing is that a pilot project is implemented before full production begins At this stage any optimistic biases in estimates are highly likely to be revealed While this method uncovers positive biases, negative biases may not be as easily discovered However, because target and kaizen costing use teams, individual biases are likely to be minimized with input from a number of different people Both target and kaizen costing focus on market prices, and this information is relatively easy to obtain in many industries, so team members can monitor their own biases with concrete information from the market place or from customer surveys All methods of decisionmaking are subject to bias, so managers must continually monitor their own and colleagues’ tendencies toward bias as plans are developed and decisions made 13.23 Heritage Jewelry Store A John is probably influenced by traditional pricing methods in this industry The mark-ups may be published in industry trade journals and John knows that his competitors are using similar methods and so feels comfortable using this method B Elasticity is the sensitivity of demand to changes in price The demand for some products is greatly affected by any change in price For example, commodities prices are published daily Demand for these products is considered very elastic (very responsive to price changes) For other products, changes in price lead to little change in demand For example, demand for expensive cars such as a Rolls Royce or Lotus is inelastic; it is not very responsive to small changes in price C When prices increase, consumers will not buy products for which demand is very elastic For example, if frost has damaged this year’s asparagus crop and the price increases, consumers will substitute other vegetables for asparagus and demand will decrease However, if the weather is perfect for asparagus and the crop is large, prices decrease and demand increases because consumers buy asparagus instead of other vegetables that are similarly priced D If John has not tracked sales and prices over the years, he does not have accurate data with which to use in the elasticity formulas Therefore he cannot be certain about the accuracy of his estimates These formulas are very sensitive to error, and if they are based on inaccurate estimates, he may set a price that is profit-minimizing instead of maximizing In addition, response to changes in his prices may depend on whether his competitors match his new prices, and John cannot know for certain whether their prices will change To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 13: Joint Management of Revenues and Costs 13-13 E Elasticity of demand depends on the availability of substitutes As more substitutes are developed, demand becomes more elastic In addition, as competitors enter a market, prices may drop to levels at which demand is satisfied, and small decreases in prices will not affect demand As new markets open through globalization, prices may increase because demand is greater than supply for a period of time Students may think of other possibilities F Changes in the economy cause a shift in the demand function If economic times are good, people may be more willing to buy higher priced goods and services Alternatively if there is a downturn, people may forego some types of purchases For example, during a recent recession (2001 to 2003) people continued to indulge in low-priced luxury products such as specialty coffee drinks, but cut back on large expenditures such as luxury cars or boats These changes in consumer preferences affect the elasticity of demand for these products 13.24 Haywood Ceramics A Under cost-based pricing, decreases in volumes result in increases in prices Because demand is sensitive to price, as prices increase, volumes are likely to decrease Over time the product is discontinued because sales not cover costs This is called the death spiral B There are a number of different reasons that customers would continue to shop at Haywood or choose to shop elsewhere If there are other ceramics studios nearby, pricesensitive customers will find another studio with better prices Some customers may decide to change hobbies if they believe the price increases are unwarranted Some customers may value their relationship with the studio and not be willing to change, even if prices increase C Pros: Customers may enjoy their relationship with the owner and be willing to accept price increases to continue the relationship because they understand the reason for the price increase Cons: Customers may not care about why prices increase, but be more concerned about their ability to pay higher prices These customers could be annoyed by letters explaining the price increase and feel resentful that they cannot afford to buy at Haywood, or cannot participate in their hobby as often D Following is the recommendation of Roberta Maynard in ―Taking the Guesswork Out of Pricing‖ (Nation’s Business, December, 1997) She recommends that small businesses fail to consider the many interrelated factors that should affect pricing decisions She suggests that pricing decisions should consider the company’s costs, the expected costs of product updates and new equipment, objectives for each product, and competitors’ products She quotes a business consultant from Arthur Andersen who says that business owners typically price products arbitrarily, or they base prices only on cost or on competitors’ prices In addition, customer perceptions, involvement of distributors and suppliers, government regulations, ethical considerations, and economic conditions play To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-14 Cost Management roles Maynard gives a coffee wholesales example of the role of communicating with customers When the cost of green coffee rose dramatically, the small business owner sent a six-page letter to customers explaining how coffee prices were changing, what his firm was doing to control costs, suggested things customers could to reduce their costs, and informed them of the new price and when the change would be made He allowed customers to place orders at current prices He believed that his approach gave him credibility He didn’t lose a single customer Students may have made a similar recommendation 13.25 Java Alive [Note about problem complexity: Item A is not coded as Step 2-3 because the solution is explicitly described in the textbook.] A Java Alive can develop information about prices and demand and use the profitmaximizing formula to guide their pricing decisions B Other information needed includes the size of the local coffee shop market, Java Alive’s market share, competitors’ drinks and prices, economic predictions for the local and regional area, any seasonal variation in sales and differences in elasticity due to seasonal variation 13.26 Transrapid A Here are examples of information that could be gathered before recommending a pricing policy; students may think of others Information about prices, number of train departures, and volumes from train systems in other similar sized cities because this would give me an indication about price and volume relationships Information about competing transportation systems, for example information about prices, frequency, and volume of riders for busses in the area, or in similar locations Information on expected economic conditions, particular gas and parking prices because automobiles would be a competing form of transportation so as costs to drive a car increase, ridership on trains may increase B Before making a recommendation to Transrapid, it would be wise to conduct market research Transrapid did this before building the system As reported by the consultants who worked with Transrapid: ―The engineers were thinking of a system to accommodate trains departing every 10 minutes Research indicated, however, that the value-to-customer increased significantly when planned departure frequency went from every hour to every To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 13: Joint Management of Revenues and Costs 13-15 half-hour to every 20 minutes The value was only slightly increased if the departure interval was further decreased to the planned 10 minutes At the same time, costs increased dramatically due to more complex electronics in the track, more train units, more personnel, and so forth The result: Transrapid has now been re-engineered for scheduled departures every 20 minutes The resulting design simplifications and scheduling of fewer trains per hour result in savings of hundreds of millions of dollars.‖1 Considering its pricing policies, Transrapid could set the initial price to be competitive with other land-based transportation, such as busses and other trains As information is logged into its information system, a price based on product elasticity could be developed C Customer preferences may be different for this type of product than others because the product potentially reduces the amount of time that customers travel It is difficult to know the value that people set on extra time In addition, it is difficult to know whether increasing the scheduled departure times would affect the price people are willing to pay Because these factors are uncertain, gathering information about their preferences could be an important part of the pricing process If prices are set too high, people will not try the train service, even though they may benefit from having more time for other activities If prices are set too low, and need to be increased later, people may complain and look for other modes of transportation at that point 13.27 Hanson & Daughters A Elasticity = ln (1 + percent change in quantity sold)/ln(1+percent change in price) = ln(1 – 0.10)/ln(1 + 0.10) = –0.10536/0.09531 = –1.105 B Variable cost (VC) = $50,000/100,000 = $0.50 Profit maximizing price = [elasticity/(elasticity + 1)] x VC = (–1.105/(–1.105+1)] x $0.50 = 10.52 x $0.50 = $5.26 This solution assumes that Hanson has enough capacity to fill increasing volumes of demand The profit-maximizing price is that point where contribution margin is largest overall, so as contribution margin decreases, volume of sales has to increase to more than make up for the decrease in margin If an organization cannot increase volumes to this point, it may be better off with a higher contribution margin and sales within its relevant range of operations Hermann Simon and Ulf Munack, ―Setting the Right Price, at Internet Speed,‖ Brandweek, August 21, 2000, pages 22-27 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-16 Cost Management C Customers may find substitutes for the product such as a cheaper brand or another type of juice D Quality is good, the price was perceived as being reasonable, in light of quality, customer loyalty E The assumptions are that the variable cost remains constant, that elasticity is greater than and constant, and that changes in the price of juice not affect product costs or sales of other products In addition, the calculations are very sensitive to error, so any measurement error could affect the price These are strong assumptions If they are not met, the calculated price may not maximize profits F Here is a sample recommendation Student responses will vary, but should include the following points My best estimate is that a price of $5.26 will maximize your profits However, you should reduce your price slowly and monitor demand and profits Keep reducing the price slowly until profit plateaus, and then keep the price steady at that point You want to identify the point at which lower prices and higher volumes maximize profits 13.28 Bainbridge University A This problem is open ended because there are a variety of solutions to the university’s problem These solutions could involve not increasing tuition but cutting costs, increasing tuition and not cutting costs, or a combination of tuition increases and cost cutting In addition, the amount that tuition could be increased is an open-ended problem that does not have a single correct answer The same is true of potential cost cuts, and the combination of tuition increases and cost cuts There are likely a number of different optimal solutions to this problem B Some class members may want to analyze competitors’ programs and tuition and financial aid policies Some class members could gather information to determine the elasticity of demand for the MBA degree Some class members may gather information about costs, and may choose to use activity-based-costing and activity-based management or target and kaizen costing to reduced costs Alternatively, value-chain analysis could be performed to provide information about costs and value-added and nonvalue added activities C For this problem, an assumption is made that students will perform target costing They may have made a different assumption, so the steps they list will be different from these For target costing, the students would need to follow the target costing cycle presented in exhibit 13.4 They would need to gather information about past volumes and tuition levels, and current information using surveys of current and prospective students’ price preferences In addition, they would need information about the direct costs of the program, number of courses offered, and number of students enrolled in different courses Further, information about revenues from all possible sources would need to be To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 13: Joint Management of Revenues and Costs 13-17 gathered, including all educational offerings such as executive education, CPE courses, donations, grants, and government support D Student responses will vary At a minimum, students should consider multiple sources of information, and they should describe some trade-offs in making the decision Here is a sample response When deciding upon an appropriate level of tuition, I would evaluate the results of marketing research, the ability of students or other providers to pay tuition, alternative sources of funds, and the ability of the university to reduce costs For example, if market research suggests that students are price sensitive, then the rate of tuition charged by competitor universities and the extent of available financial support from employers or governmental agencies might weigh heavily in the decision I would also consider the university’s values and priorities For example, some universities establish a relatively high tuition rate, but then give scholarships to students meeting certain criteria, such as low income, race, gender, scholastic aptitude, and so on 13.29 Fancy Fleece A Because this product involved large costs for research and development before the product could be manufactured, life cycle costing would be the best analysis method B Market-based costing is the only real alternative for pricing If cost-based pricing is used, the price is likely to be so high that demand would be very small C This is a new product with a new manufacturing process, creating many uncertainties For example, accountants cannot be certain that estimated costs for direct materials will hold Changes in prices and quantities required could affect these costs Similarly, they cannot be certain that direct labor will meet the productivity estimates The direct labor rate could also increase Accountants cannot be certain that fixed and variable overhead costs will remain constant Price changes or productivity changes could affect these estimates They cannot know whether new technology will reduce the cost of production D Because this is a new product, variable costs cannot be estimated easily If variable costs increase or are underestimated initially, the price based on these estimates will not cover variable costs 13.30 State of Arizona A Not-for-profit organizations usually have other sources of funds than revenues from their products and services This allows them to set prices based on different objectives than just contribution margin Some not-for-profits charge based on customer ability to pay, and they may provide services for free to low-income customers For-profit organizations usually set one price for all customers, and the price includes a profit margin To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-18 Cost Management B Fees for caves in national parks, such as Oregon Caves National Monument, are $7.50 for adults and $5.00 for children Kentucky Caverns are priced at $10.95 for adults and $6.95 for children Carlsbad Caverns in New Mexico charges $6.00 for adults and $3.00 for children to enter the park, and an additional $8.00 for adults and $5.00 for children to take a guided tour C Information about other attractions in the local area could be gathered, for example prices for mine tours, entrance fees for any other types of similar tourist activities that could substitute for the cave tours Surveys of tourists at nearby natural attractions, such as the Grand Canyon would provide information about pricing Focus groups could be held with local residents touring the facility and then providing information about acceptable prices D Because tourists can substitute among activities, the price for tours is likely to affect volume Because national park entrance fees are $5 to $6, prices set similarly would probably attract the highest volume of tourists, but this may not be the profit-maximizing price It is possible that prices up to $10 to $15 would result in lower volumes, but a larger contribution If capacity limits are a problem, prices could be increased during times when demand exceeds capacity and lowered when demand is low E There is no one answer to this part Sample solutions and a discussion of typical student responses will be included in assessment guidance on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg 13.31 Burton Turner and Short Whittum A The following pricing policies are available: cost-based pricing and market-based pricing B This is an open-ended problem and has no single, ―correct‖ solution There are many different cost-based prices that could be developed, depending on the cost definition used Because the cost of wholesale gasoline varies widely, retail prices also vary widely Information for setting market-based pricing could be competitors’ prices, or could be developed from the relationship between price and demand C Turner and Whittum may see nothing wrong with their desire to collude in setting prices They may feel that they each have loyal customers who will continue to use their services even if small price differences arise Regular customers may not care whether the prices are collusively set because they value their relationships with the owner more than responding to changes in prices However, over time prices could become higher than in nearby communities and local and out of town customers might feel resentful at having to pay more in this town To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 13: Joint Management of Revenues and Costs 13-19 Government officials would see Turner and Whittum’s behavior as collusion in setting prices Even if gas and service prices are similar to prices in nearby small towns, government officials believe that prices should be set independently by competitors to guarantee free market economies D Legally, Turner and Whittum are prohibited from colluding on prices From an ethical point of view, price collusion is detrimental to the local business environment and should not occur Therefore, both viewpoints would condemn collusion because it restricts free trade Legal consequences are more stringent than ethical consequences E Because the town is so small, local residents cannot know whether both owners are monitoring each other’s prices and pricing competitively or colluding on prices However, if prices are set competitively, they would increase relatively slowly, and are likely to be affected only by increases in underlying costs The Wall Street Journal occasionally carries reports of large companies in the fast food or airlines industries that raise prices expecting others to follow suite, and finally reduce their prices because no one else increased prices If prices are set collusively, they would increase because both parties agree to the increase, so it is likely that they would be higher under collusion than under competition If prices are higher for services in this small town, local residents are paying more than they should This could mean unnecessary hardship for some people on limited incomes Because of these possibilities, price collusion is unethical F Price changes can be monitored but it would be very difficult to determine that collusion was taking place without actually recording a conversation in which prices were set collusively, or the practice of collusive pricing was mentioned 13.32 Mountain County Legal Services A Avoidable costs would be any variable costs Supplies appear to be the only variable costs, so the average cost of supplies of $1.20 ($6,000/5,000) would be the minimum fee B Avoidable costs for the whole department would be the cost of lawyers, secretary, supplies, and paralegal and the avoidable administrative cost, plus the $8,000 savings in rent, or $38.00 [($178,000 + $4,000+$8,000)/5,000] These costs would be dropped if the program were dropped C The minimum fee for all avoidable and allocated costs is $44.40 ($222,000/5,000) D This fee may be higher than many of the clients can afford and so volumes would drop Then the fee would have to be increased, and volumes would likely drop again E This price would be considered arbitrary because the cost allocations are considered arbitrary The current allocation bases are salary for administrative costs and space occupied for rent The use of other allocation bases would result in different amounts of allocations, and a different pricing structure To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-20 Cost Management F The county executive may rely on those closer to the clients to determine how to best carry out instructions Alternatively, the executive may not have analyzed the information and realize that there are a number of different ways to interpret the edict 13.33 French Perfumery A Breezy Sales volume Price Revenue Variable costs Contribution margin Original Data New Price and Demand 200,000 160,000 $6.00 $6.60 $1,200,000 800,000 $ 400,000 $1,056,000 640,000 $ 416,000 B The uncertainty depends on several factors The problem does not indicate how accountants estimated these amounts If optical character readers tracked changes in prices and volumes, the estimates might be relatively accurate However, the profitmaximizing formula is sensitive to small changes in estimates Measurement error could reduce the ability to anticipate how changes in price will affect demand Other factors that could affect demand are competitors’ prices, the availability of close substitutes, and economic downturns To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 13: Joint Management of Revenues and Costs 13-21 BUILD YOUR PROFESSIONAL COMPETENCIES 13.34 Focus on Professional Competency: International/Global Perspective A Global competition results in increased pressure on prices at a given level of quality and functionality Compared to domestic competitors, global competitors may have lower prices from lower resource costs (such as labor), more efficient production facilities, or greater product innovation Thus, global competition places more pressure on companies to compete effectively and operate efficiently To maintain low prices but still pay attention to quality and functionality, costs must be managed The most competitive companies succeed in a global economy and, therefore, cost management is crucial As more firms enter markets, prices become more competitive As markets go global, many more firms enter these markets and, therefore, the degree of price competitiveness increases, placing downward pressure on prices B Any information gathered from public sources is not generally considered to be espionage Because products are readily available for sale, a competitor may purchase a competitor’s product, tear it apart, and rebuild it Many companies routinely reverse-engineer competitors’ products In addition, a quick search on the Internet will confirm that many engineering companies can be hired for reverseengineering projects Although reverse-engineering is common, legal issues sometimes arise For example, during the 1990s Intel and AMD battled each other in the courts over AMD’s reverseengineering of Intel’s computer chips The two companies ultimately reached an outof-court settlement, and during 2004 technology experts claimed that Intel has since reverse-engineered one of AMD’s computer chips.2 In the 2004 Intel case, it appears that the reverse-engineering involved Intel’s use of documentation made publicly available by AMD In the 2004 Intel case, one commentator argued that ―there’s a distinction between reverse engineering and using public documents to engineer a competitive product.‖3 This comment makes it clear that at least some people believe it is acceptable to use publicly available information but that it is unethical to take a competitor’s product apart to learn how it was made The ethical issues surrounding reverse-engineering are murky It is clear that conflicts of interest exist between companies, and these conflicts can lead to ethical as well as legal questions Social issues also exist, as discussed in Part B.2 See, for example, Tom Halfhill, ―Be Thankful for Reverse-Engineering,‖ Maximum PC, June 2004, available at www.maximumpc.com/reprints/reprint_2004-06-01b.html Mark Devlin, ―64-Bit Battle Rages: Who Will Win the Duel?‖ Desktop Engineering, June, 2004, available at www.deskeng.com/index.php?option=content&task=view&id=41&Itemid=54 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-22 Cost Management Reverse engineering has several social costs and benefits Consumers are likely to benefit, because reverse engineering often increases price competition and may also improve product features At the same time, the business environment often becomes more competitive and some competitors could exit the market, leaving only a few firms who might serve customers less well The effects of reverse-engineering on innovation are unclear Some people argue that product innovation is harmed from reverse engineering; they believe that companies are more likely to invest in innovation when they are protected from this type of competition through patent or copyright laws However, others argue that innovation increases when companies are threatened by reverse-engineering because companies are forced to innovate even more to stay ahead of their competitors.4 As manufacturing jobs are lost, they are generally not replaced by other high-paying jobs for people with relatively low levels of education Some new job creation that does not pay well occurs in service industries such as fast foods Some new job creation occurs in the technology sector, where people need higher levels of knowledge and education This creates a social problem, especially when the education systems are not well-funded On the other hand, consumers generally benefit from lower prices as manufacturers reduce their costs Reduced prices allow consumers to purchase more goods and help keep inflation levels low C Global supplier demographics are the characteristics, such as the number, location, age, and size of companies that supply a product If there are a number of suppliers located nearby and these companies have been in business for a long time and are very reliable, resource costs tend to be lower than otherwise If there are few suppliers, their locations are distant, and there is little information about their reliability because they are relatively new to the business, costs could be higher Global customer demographics are the characteristics of customers—their locations, size, number, age, buying patterns, and so on If there are a large number of customers, prices can probably be set lower because large volumes of products are sold at competitive prices Alternatively, if there are few customers, sellers may need to concentrate on both price and quality, but prices will tend to be higher because fixed costs need to be covered by the contribution margins from these few customers On the other hand, changes in global customer demographics can lead to greater demand that increases selling prices, particularly if product supply does not keep pace with the increased demand See, for example, Mark A Haynes, ―Commentary: Black Holes of Innovation in the Software Arts,‖ available at www.law.berkeley.edu/journals/btlj/articles/vol14/Haynes/html/text.html To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 13: Joint Management of Revenues and Costs 13-23 D Many sources of information are available about how to communicate effectively in a given global setting Sources include books about languages and customs, articles, college courses, and seminars Communication involves all verbal and nonverbal interactions with others Differences in communication between domestic and foreign settings vary by setting Below are some of the common differences; students may think of others Business etiquette Expected gender roles Expression of or deferral to authority Negotiating tactics Gift-giving protocols Dress codes Meal and entertainment expectations Dietary choices 13.35 Integrating Across the Curriculum: Information Technology A No, the new system is not likely to completely eliminate out-of stock occurrences Although it will track inventory levels across the supply chain, out-of-stock occurrences could still occur when demand for a given part exceeds forecasts or when delays occur in manufacturing or delivery However, the company should experience fewer out-of-stock occurrences under the new system than under the old one because the new system tracks activity for all parts, not just the 100 highest-cost and best-selling ones B Students not know exactly how Mopar does business with its customers, so they need to speculate, which is a more difficult task Most likely, Mopar’s customers are parts distributors and, perhaps, individual auto repair shops Those companies’ customers are individual consumers who need a part to repair a vehicle When an average consumer brings a vehicle to a repair shop, they expect most parts to be available that same day This means that some company—the repair shop or a nearby distributor—must carry a large number of parts that can be delivered immediately Accordingly, Mopar’s ability to institute a JIT inventory management system could depend on whether its customers demand fast delivery If Mopar would lose significant amounts of sales if it is no longer to meet fluctuating demand for parts, then a JIT system might not be possible for its deliveries to customers However, Mopar could still institute a JIT system for delivery of raw materials to its production systems It could use forecasted deliveries to its customers, plus some amount of safety stock for its own warehouses, to plan its manufacturing operations C Data can be inaccurate because of errors, such as entry of incorrect part numbers, when inventory is transferred It can also be accurate because of errors in counting and compiling physical inventory counts Mopar’s new system relies on the accuracy of inventories at each of its own warehouses as well as the accuracy of suppliers’ and To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-24 Cost Management customers’ inventories Thus, errors in any of these systems will cause inaccuracies in the data used by Mopar to forecast production and shipment requirements D The use of electronic systems for recording inventory movement, such as bar codes or RFID tags, can reduce errors caused by human transaction entry Errors can also be reduced by frequently counting physical inventories and adjusting accounting records to the physical counts These controls also reduce database inaccuracies caused by inventory theft, by providing managers with more timely information about inventory shrinkage problems Additional controls to prevent inventory theft include security, such as warehouse access restrictions and computerized controls over the inventory database E The estimate of annual savings from reduced backorders and rush orders was probably based on probability distributions of these events under the new and old systems For example, think about a part that was not individually tracked under the old system Mopar had information about prior period inventory levels, but it did not have records about the quantity and timing of individual sales or of inventory levels at its suppliers or customers The new system allows the company to monitor these items Over time, this monitoring will allow Mopar to better forecast its inventory needs The estimated savings consist of two items: (1) a reduced probability of backorders for the part times an estimated cost of fulfilling a backorder, and (2) a reduced probability of rush orders for the part times an estimated cost of fulfilling a rush order The probabilities would most likely be developed from the system software itself; the company would establish an acceptable probability of these events, and the system would build these probabilities into the production and distribution forecasts The estimated costs of filling a backorder or a rush order could be based on an analysis of the incremental costs associated with these activities The annual savings estimates depend on assumptions about the new system’s ability to achieve given probabilities of backorder and rush order events, and it also assumes that the company can accurately estimate the costs of these events An assumption also exists that the new system does not alter manufacturing costs  ... elasticity of demand for the MBA degree Some class members may gather information about costs, and may choose to use activity-based-costing and activity-based management or target and kaizen costing to... administrative costs not increase, especially costs for computerized systems and software? To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-10 Cost Management. .. target cost of $133.65 After the To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 13: Joint Management of Revenues and Costs 13-9 target cost