MBA FPX 5010 Assessment 2 Product Pricing Recommendation

Product Pricing Recommendation

• Slide 01

Hi! My name is ______ and in this presentation, I’m going to give you some price recommendations for a particular product. Price is an important aspect since it directly affects the profitability, positioning on the market, and financial stability of companies. With today’s always-changing business landscape, companies should be very careful when choosing pricing before taking a look at their cost and financial information. I’ll look at the cost structure of the Acme Pickle Company and the pricing strategy the company has in place to see if it’s a smart investment to accept the discounted deal offered by “Super Deals. I am going to review the cost structure of Acme Pickle Company and the pricing strategy they use in order to see if it is a wise financial decision to accept the discounted offer from “Super Deals.

Company’s Overview

• Slide 02

Acme Pickle Company’s reputation has been established over the last eight years, and its employee-owned reputation-building initiatives are mainly responsible for the company’s strong market presence, owing to its reputable product line, Florida’s Best. The Jacksonville-based firm sells its pickles in the southeastern U.S. and enjoys a loyal customer base for its delicious flavor and quality. Acme’s monthly production capacity is typically between 8000 and 10,000 cases and can double when necessary, but without the need for an additional man or piece of equipment. The company’s production capacity and the premium quality of its products allow it to sell regular products at $20 per case.

Variable and Fixed Production Costs

• Slide 03

Mostly, production costs for Acme can be divided into two categories – Variable and fixed costs. Costs that fluctuate with the amount of a product that the company produces are called variable costs. For Acme, these include the price of raw ingredients (cucumber, vinegar, spices, bottles and lids) and the labour needed in each case. S. Capella University (n.d.) explains that fixed costs, however, remain constant, no matter how much is produced.

The costs of these include equipment depreciation, supervisors’ wages, insurance, and property taxes. These fixed costs will not vary as Acme increases or decreases its production in the short run; thus, they are not a critical element in determining special orders that do not need to increase or decrease the size of the plant.

Benefits of Recalculating the Cost of Pickle Production

• Slide 04

It’s important to realise that there are fixed costs and variable costs in determining the financial effect of the Super Deals offer. As in this example, Acme Pickle Company would be better off calculating the incremental costs that will be incurred in making 2,000 extra cases. The company does not have a shortage of production capacity; therefore, fixed costs are not relevant, as within this level of production, the level of the fixed costs doesn’t change. But it is all about the contribution margin, which is defined as: Contribution margin = Selling price – Variable cost (Capella University, n.d.).

• Slide 05

Evaluating production costs better could not only help Acme Pickle Company make better decisions over time, but also tell if the special order is profitable. It becomes clear how the costs will change at different levels of production to management and helps them determine the efficient production level without overusing their resources if they have multiple different cost types. It also simplifies identifying cost reduction and efficiency gains opportunities to reduce costs and improve efficiencies, making more accurate budgets and more reliable forecasts – and better overall strategic planning – possible. Applying contribution margin analysis in this – and in future pricing and operations decisions – can assist not only in the overall profitability of that situation, but also in the long-run growth of the business.

Financial Accounting vs. Managerial Accounting of Production Costs

• Slide 06

Financial accounting and managerial accounting treat the cost of production differently based on the two different uses and users of each of the two approaches. Financial accounting is prepared primarily for external parties like investors and the regulatory authorities, and managerial accounting is prepared for internal accounting and use for planning and decision-making within the organisation. Absorption costing would be the usual costing method used in financial accounting, where all manufacturing costs of a product are added to the cost of the product (Capella University, n.d.). The direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead make up the product costs. Another big difference lies with the accounting of costs on the income statement.

From a financial accounting point of view, all the costs of creating products are not shown as expenses, but rather as inventory until the products have been sold, when they are recorded as cost of goods sold. As a result of this technique, there could be some of the fixed manufacturing costs incurred on ending inventory that may not be sold during the same year. Consequently, net income may be higher at times when production is greater than sales because some fixed costs do not appear on the current income statement, but are deferred and thus do not appear on the next income statement.

• Slide 07

The main areas of managerial accounting where it is used in an organization are in decision making, budgeting, controlling, and planning. In managerial accounting, which is the practice of accounting, the variable costing method is sometimes used, in which costs are classified based on their cost behavior. Under variable costing, only variable costs are included in the cost of goods sold, with the fixed manufacturing overhead costs treated as a period cost and allocated in the period the cost is incurred. Further, the income statement prepared based on the variable costing method has a different format as compared to a traditional absorption costing income statement. The difference between the sales revenue and the contribution margin is the total variable cost; the difference between the contribution margin and the total fixed cost is the net income figure—the net income number is calculated in a variable costing income statement first.

It is apparent from comparing the two costing methods, absorption costing and variable costing, that there are wide differences in the way the costs are recorded, and in how the amount of the net income is calculated. With the absorption cost accounting system, profit or loss will depend on the volume of production, as a portion of the fixed overhead would be carried over in the inventory account. Variable costing, on the other hand, will only have a net impact based on sales—fixed costs will be recorded in the year that they are incurred. Therefore, variable costing will be more suitable for decision-making purposes, particularly in making decisions about special orders (like the Super Deals offer).

Recommended Plan of Action

• Slide 08

The modified cost structure of Acme Pickle Company and the cost per case (after modification) shows that the order from Super Deals is economical. From the analysis, it is evident that even if the firm sells the cases at a price of $9.50 per case, there will be a positive contribution margin. This is because Acme Pickle Company has the spare production capacity, so producing an additional 2000 cases won’t require any extra fixed costs or investments, but will help spread the production capacity effectively. The order not only helps the firm earn profits, but also increases its geographical coverage as well.

• Take the Super Deals order at $9.50 per order placed since it has a positive contribution margin.
• Understand that, on average, each unit costs approximately $7.33 to produce, and the estimated variable cost of $7.33 per case will be used to meet every case’s direct cost.
• Use existing production capacity to finish the order – avoid employing more staff and/or more equipment.
• Consider the Wisconsin order a strategic opportunity to expand into a new market and increase brand visibility.
• Use contribution margin analysis to continue to make decisions for future special orders to maximize profits and in a long-term manner.

Conclusion

• Slide 09

From the above analysis, it can be inferred that, from the viewpoint of contribution margin analysis with available production capacity, Acme Pickle Company can accept the special order given by Super Deals. Even more so, as the company would not have to cover any extra costs in the making of other products, the order is feasible if the selling price of the products is greater than the variable costs of the order made. In fact, the analysis carried out shows that it is profitable for the company, and this is why it should be accepted. It is at this stage that the importance of cost analysis needs to be reiterated, for this analysis not only explained an important practical question, but it was also helpful in highlighting the importance of correct cost analysis. In this case, since it was presumed that there were fixed and variable costs, it was possible to make an informed choice.