In the bakery business, Kim makes various types of bread and other products like cakes and pies. With the production of different products with different requisite of raw materials, Kim faced problem in setting the prices of products. As per the given situation, the bakery business has been “struggling” with operating loss or small profit margin at the end of the monthly production. The main problem is identified as the product pricing approaches which had not followed any systematic approach while setting the prices of product. In this assignment, the entire business situation has been analyzed on the perspective of the business adviser.
To reduce the loss or increase the profit margin, Kim makes strategy to work out the full cost particularly of making each product. However, this approach may create many confusions or difficulties in setting the prices. By making full costs on each unit of product, the company will face difficulties in indentifying the nature of the costs associated in their manufacturing process. Under this approach, the company will consider the element of costs such as material, labor and expenses. Generally each element of cost is subdivided into direct and indirect method (Karthikeyan et al., 2013). This indicates that the company will not be able to classify incurred costs of manufacturing according to behavior of expenses. According to the cost accounting concept, there are three types of costs are classified following the behavioral approach in the purpose of costs classification including variable costs, Semi-variable costs and Fixed costs. As per the provided information, Kim has incurred fixed and variable costs while manufacturing the different types of breads. For instance, the fixed rental cost has to bear by Kim on monthly basis. Apart from that Kim is responsible for electricity and heating expenses as well which are variable nature of costs as well. Here variable costs will be fluctuated with per unit production whereas the fixed costs only will effect on marginal cost generation. Thus, costs allocation or treatment of manufacturing costs will be varied with monthly production of each product. In short, an effective costs allocation should not be considered under the comprehensive cost ascertainment approach.
Secondly, full costs approach does not give an idea about which product is the most profitable compare to others (Ghofrani?Jahromi et al., 2013). Though the company has manufactured different products under their manufacturing process, the full cost ascertainment approach will calculate comprehensive per unit selling costs without segregating that into each categories of items. Here the manufacturing overhead costs will not be allocated to individual product units (Lin & Chen, 2016). Thus the company may face problem in decision making.
Thirdly, the company may figure out the profit margin for certain period of time. However, such profit margin needs to be revised on daily basis considering the sales volume. Here it would certainly be a difficult task for monitoring the sales unit on the basis of different products. Thus, this approach should not consider a universal method for setting up the price of product on monthly basis.
Kim is looking for covering fully costs with ensuring a profit margin. To consider this situation, Kim should consider Cost-plus pricing method. This is a straightforward and simple pricing approach where Kim can recover full cost with maintaining a substantial profit margin. Under this approach, the company will primarily determine its break-even price for each bakery products of the company. For this, Kim needs to consider all the costs involved in the expenses like suppliers, production, promotion and distribution of the product costs and many others. By the use of Cost-plus pricing method, thus, the company will consider all types of costs such as variable costs like heating and electricity; fixed costs like fixed rental of the premises, insurance; fixed and variable salaries of employees, advertisement costs and many others. Pulling all the expenses together, Kim will determine the cost of each product. Now a mark-up price needs to be set for each unit. As per the management consent, profit will be added up which the company needs to make after selling. Here the company will consider the sales objectives and believing the price the customers is ready to pay.
Under this value based pricing strategy, Kim, thus will clearly maintain the cost breakdowns. In this way, the company will ensure their sufficient profit margin by generating accurate costs estimation under following method:
(Costs of total production + Selling and administration costs + Markup value) / Number of unit expected to sell
However, there are several difficulties may be faced by Kim while implementing this pricing strategy into the business:
Generally, this pricing strategy does not consider the competition. The company may set a product price considering cost plus pricing formula. However, the company may get surprise response if other competitors of the market charges considerably different prices.
While implementing this method, the bakery business may be pricing too high or substantially tool low in comparison of what buyers are willing to pay against that product of the company. Therefore, the effect of price elasticity may impacts on profitability and thus, the company may achieve minor revenues.
The entire proposed pricing strategy is completely depends on an accurate budget estimation. Here the formula of pricing is based on correct estimation of sales volume and costs which are associated with the bakery business. In the circumstances, the decision making may be differ if it founds that the estimation of budget is not appropriate.
Guajardo & R?nnqvist (2016) stated that this pricing formula can be suitably implemented by calculating price only for the single product. Without following a proper cost allocation methodology, this method might be inactive in case of the production of multiple products.
To make adequate profit at end of the monthly sales, Kim needs to follow certain recommended steps in the near future:
- Measure right costs for the right product is an indeed a challenging decision making for Kim. Thus distorted information about costs should not be practiced by the management of the bakery business of Kim. Thus the details of costs related to individual products must be disclosed properly before setting pricing decision.
- The purchasing power of the customer is definitely an important factor consideration for making decision about pricing. This is also good for analyzing the customer product preferences in the advance period of time as well. Thus, Kim needs to investigate the customer buying opportunities and payment abilities as well.
- The business should maintain a certain volume of production where the company does not make any loss. In other words, Kim should calculate Break even sales (volume) to reduce the loss opportunities during their manufacturing process.
- A proper allocation of large bucket of costs such as sales, advertising, and customer service needs to be accurate. For this, the company should follow the direct method of cost allocation. Here all the overhead costs shall b absorbed by the corresponding service departments of the company. A proper cost allocation helps to monitor each product’s costs and control mechanism as well.
- A provisional amount must be charged up at the time of monitoring costs for repair and maintenance of bakery equipments. This contingency plan would be beneficial in the competitive business environment.
- The company should clear their dues of their ranges of local suppliers on time.
- Lastly, the variable costs like product promotional costs must be minimized to reduce per unit cost of manufacturing.
References and Bibliography:
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Drury, C. M. (2013). Management and cost accounting. Springer.
Garcia, C. (2015). Individual and Dynamic Capital in Cost Accounting.
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Guajardo, M., & R?nnqvist, M. (2016). A review on cost allocation methods in collaborative transportation. International Transactions in Operational Research, 23(3), 371-392.
Karthikeyan, S. P., Saravanan, B., Jain, A., Ranu, I., Raglend, I. J., & Kothari, D. P. (2013, February). A comparative study on transmission network cost allocation methodologies. In Power, Energy and Control (ICPEC), 2013 International Conference on (pp. 145-152). IEEE.
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