Mba 504 Ch8 Solutions

Chapter 8 Pricing Decisions, Analyzing Customer Profitability, and Activity-Based Pricing QUESTIONS 1.

The manager would estimate the quantity that could be sold at various prices. The quantities would then be multiplied by the contribution margin per unit and fixed costs would be subtracted from the total contribution margin, yielding an estimate of profit at each price. The price that yields the highest profit is the profit maximizing price.

2.

The cost-plus price is based on full cost per unit. However, to determine full cost per unit, one must first estimate the quantity that can be sold. But the quantity that can be sold depends on the price!

3.

The target cost depends on price, and marketing staff is needed to determine product features and price. Engineers are needed to determine efficient production methods given the product features. And cost accountants are needed to estimate costs given the production process. A cross functional team helps ensure good communication among these various parties, increasing the likelihood that a product will be put into production that can be produced for the target cost.

4.

In customer profitability analysis, indirect costs are grouped into cost pools (e.g., the cost pool related to processing fax orders, the cost pool related to processing Internet orders, the cost pool related to shipping, etc.). The costs are then allocated to customers using various cost drivers (allocation bases) to determine customer profitability.

5.

With activity-based pricing, customers are charged for various services. For example, there might be separate charges for delivery, for rush orders, and for returns. This way, customers that impose high costs on a supplier will pay for the services they demand.

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EXERCISES

E1. While the computers may be a commodity, the business processes used by Bell to produce and sell computers are a source of competitive advantage. Assuming Bell is better at these business processes than its competitors, it may make sense to lower prices and gain market share. While Bell may be able to generate significant profit even at lower prices, the lower prices may be ruinous for competitors. E2. The marketing vice-president may, in fact, be worried that some customers really will be dropped. This will reduce sales and may have a negative effect on his bonus (which is based on sales rather than profit). However, if no customers are going to be dropped and prices to less profitable customers are not going to be changed, then there is, indeed, no point in conducting the customer profitability study. E3. At the Web site “Destination CRM,” there was an article by Tom Richenbacher on “The Art of Customer Profitability Analysis.” http://www.destinationcrm.com/articles/default.asp?ArticleID=3038 According to this article, to perform customer profitability analysis, marketing, and service, costs must be traced to individual customers. Unless this is done, profitable customers may be lost through overpricing, unprofitable customers won by underpricing, and unprofitable customers subsidized by profitable ones. In activity-based costing, indirect costs are allocated to products. In customer profitability analysis, indirect costs are allocated to customers.

Chapter 8 Pricing Decisions, Analyzing Customer Profitability, and Activity-Based Pricing 8-3

E4. Price 6.95 5.95 4.95

Quantity 20,000 25,000 32,000

Variable Cost per Unit 1.50 1.50 1.50

Contribution Total Margin Contribution per Unit Margin 5.45 109,000 4.45 111,250 3.45 110,400

Fixed Costs 80,000 80,000 80,000

A price of $5.95 yields the largest monthly profit.

E5. Accepting the order will result in $110,000 of incremental profit. Incremental revenue $100 x 2,000 Incremental costs: Material $25 x 2,000 Labor $15 x 2,000 Variable overhead $5 x 2,000

$ 200,000

$

Incremental profit

50,000 30,000 10,000

90,000 $ 110,000

E6. a. Variable cost per unit Fixed costs per unit (100,000 ÷ 1,000) Markup of 20% Price

$

$

50 100 150 30 180

Profit 29,000 31,250 30,400

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Jiambalvo Managerial Accounting

b. Variable cost per unit Fixed costs per unit (100,000 ÷ 500)

$

Markup of 20% Price

$

50 200 250 50 300

c. The company will not be able to sell 500 units at a price of $300. After all, the company could only sell 500 units at a price of $180.

E7. a. The target cost per unit is $1,600 ($2,000 – .2 ($2,000)). b. If the product cannot be manufactured for $1,600, the company should consider increasing the price or modifying features so that the target cost can be achieved.

E8. Sales Less: Cost of good sold .9 x $53,800 Order processing 200 x $5.00 Rush handling .6 x 200 x $8.50 Customer service 140 x $10.00 Relationship management costs Profitability of Johnson Brands account

$

$

53,800

$

53,840 (40)

48,420 1,000 1,020 1,400 2,000

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E9.

a. Revenue Sales Order processing fee 200 x $6 Rush order fee .6 x 200 x $10 Customer service fee 140 x $15 Total revenue Less costs: Cost of good sold .9 x $53,800 Order processing 200 x $5.00 Rush handling .6 x 200 x $8.50 Customer service 140 x $10.00 Relationship management costs Profitability of Johnson Brands account

$

$

53,800 1,200 1,200 2,100

$

58,300

$

53,840 4,460

48,420 1,000 1,020 1,400 2,000

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PROBLEMS

P1. a.

Price 69.99 59.99 49.99 39.99 29.99

Quantity 10,000 15,000 25,000 40,000 60,000

Variable Cost* CM/Unit Total CM 36.50 33.49 334,900 35.00 24.99 374,850 33.50 16.49 412,250 32.00 7.99 319,600 30.50 -0.51 (30,600)

Fixed Costs 120,000 120,000 120,000 120,000 120,000

Profit 214,900 254,850 292,250 199,600 (150,600)

* Equals 15% of price + $20 + $6

b. The profit maximizing price is $49.99, which yields a profit of $292,250.

P2. This approach does not seem unethical. Consumers in certain zip codes are apparently willing to pay higher prices and the company is simply identifying them. Consumers who are in the same zip code but unwilling to pay the 3% higher prices are not forced to make purchases.

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P3. a. Price of Quantity Price of Quantity Total Rover of Rover Royal of Royal Revenue1 8.99 35,000 16.99 11,000 501,540 9.99 34,500 16.99 11,300 536,642 10.99 34,000 16.99 11,500 569,045 11.99 33,000 16.99 12,000 599,550 12.99 30,000 16.99 13,000 610,570 13.99 25,000 16.99 14,000 587,610 14.99 15,000 16.99 15,000 479,700 15.99 10,000 16.99 19,000 482,710 16.99 5,000 16.99 21,000 441,740 N/A – 16.99 25,000 424,750

Cost of Rover2 210,000 207,000 204,000 198,000 180,000 150,000 90,000 60,000 30,000 –

Cost of Royal3 99,000 101,700 103,500 108,000 117,000 126,000 135,000 171,000 189,000 225,000

Profit4 192,540 227,942 261,545 293,550 313,570 311,610 254,700 251,710 222,740 199,750

1. Revenue equals price of Rover times quantity of Rover plus price of Royal times quantity of Royal. 2. Cost of Rover equals $6 times quantity of Rover. 3. Cost of Royal equals $9 times quantity of Royal. 4. Profit equals total revenue minus cost of Rover minus cost of Royal. The profit maximizing price of RoverPlus is $12.99. b. At the profit maximizing price, profit is $313,570. Without the RoverPlus brand, profit was $199,750. Thus, profit is $113,820 higher with RoverPlus.

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P4. a. Variable cost per unit Fixed cost per unit ($10,000,000 ÷ 5,000) Total Markup of 30% Price

$

2,000

$

2,000 4,000 1,200 5,200

b. Price influences the quantity demanded, but the estimated quantity demanded is being used to determine the price! c. Variable cost per unit Fixed cost per unit ($10,000,000 ÷ 4,000) Total Markup of 30% Price

$

2,000

$

2,500 4,500 1,350 5,850

d. The number of units sold will not equal 4,000 at a price of $5,850 since only 4,000 units were sold at a lower price of $5,200.

e. To mark-up full cost, a manufacturing firm must first estimate the quantity that will be sold so that it can determine the fixed manufacturing cost per unit. But price influences the quantity that can be sold, so the process is inherently circular.

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P5. a. Price Desired profit of 25% Target cost

$ $

3,500 875 2,625

b. $2,000 + ($1,500,000 ÷ x) = $2,625 x = 2,400 c. Price Desired profit of 25% Target cost

$ $

3,000 750 2,250

Variable cost per unit Fixed cost per unit ($1,500,000 ÷ 2,500) Total

$

1,400 600 2,000

The revised target cost will be $2,250 and, after dropping the steam feature, the cost per unit will only be $2,000 (with sales of 2,500 units). Therefore, the company will be able to produce the item at less than the new target cost.

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P6. a. Cost per change order ($175,000 ÷ 700) Cost per return ($63,750 ÷ 850) Cost per design meeting hour ($60,000 ÷ 1,200) Indirect cost related to Orvieto job Change orders 20 x $250 Returns 25 x $75 Design hours 30 x $50 Total

$

250

$

75

$

50

$

5,000 1,875 1,500

$

8,375

b. Lauden should consider adopting activity-based pricing and charging companies like Orvieto for the indirect costs it imposes.

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P7. a. Mark-up of product cost and installer salary Charges for indirect services Change orders 20 x $300 Charge for returns 25 x $100 Charge for design time 30 x $75 Total revenue and charges Less costs Product costs Installer salaries Change orders 20 x $250 Returns 25 x $75 Design time 30 x $50 Total costs

$ 208,000

Profit

$ 50,375

6,000 2,500 2,250 218,750 140,000 20,000 5,000 1,875 1,500 168,375

b. Use of activity-based pricing will discourage customers from imposing indirect costs on the company. On the other hand, some customers may find the “pay for service” plan to be offensive (aren’t we paying for service in the bid price?) and take their business elsewhere.