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Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-1
10-3 The strategic pricing approach changes over the sales life cycle of the product.
In the first phase, pricing is set relatively high to recover development costs and
to take advantage of product differentiation and the new demand for the product.
In the second phase, pricing is likely to stay relatively high as the firm attempts
to build profitability in the growing market. Alternatively, to maintain or increase
market share at this time, relatively low prices (penetration pricing) might be
used. In the latter phases, pricing becomes more competitive, and target costing
and life-cycle costing methods are used, as the firm becomes more of a price
taker rather than a At least three factors that make sensitivity analysis prevalent
in decision making including the following price setter, and efforts are made to
reduce upstream (for product enhancements) and downstream costs.
10-4 At the introduction and into the growth phases, the primary need is for value
chain analysis, to guide the design of products in a cost-efficient manner. Master
budgets (Chapter 8) are also used in these early phases to manage cash flows;
there are large developmental costs at a time when sales revenues are still
relatively small. Then, as the strategy shifts to cost leadership in the latter
phases, the goal of the cost management system is to provide the detailed
budgets and activity-based costing tools for accurate cost information.
10-5 Target costing is a method by which the firm determines the desired cost for the
product, given a competitive market price, so that the firm can earn a desired
profit. It is used by several manufacturing firms, particularly in the automotive
and consumer products industries, such as Honda, Toyota, Ford, Volkswagen,
and Olympus camera.
10-6 Life-cycle costing considers the entire cost life cycle of the product, and thus
provides a more complete perspective of product costs and product profitability.
It is used to manage the total costs of the product across its entire life cycle. For
example, design and development costs may be increased in order to decrease
manufacturing costs and service costs later in the life cycle.
10-7 There are five steps in TOC analysis:
Step One: Identify the Constraint
Use a flow diagram. The constraint is a resource that limits production to less
than market demand.
Step Two: Determine the Most Efficient Utilization of Each Constraint
Product mix decision: based on capacity available at the constraint, find the most
profitable product mix.
Maximize flow through the constraint:
-reduce setups
-reduce lot sizes
-focus on throughput rather than efficiency
Step Three: Maximize the Flow Through the Constraint
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-2
10-3
Design analysis is a process where the design team prepares several possible
designs of the product, each having similar features but different levels of
performance on these features and different costs.
Functional analysis is a process where each major function or feature of the
product is examined in terms of its performance and cost.
10-12 Activity-based costing (ABC) is used to assess the profitability of products, just
as is TOC. The difference is that TOC takes a short-term approach to
profitability analysis, while ABC develops a longer-term analysis. The TOC
analysis has a short-term focus because of its emphasis on materials related
costs only, while ABC includes all product costs. On the other hand, unlike TOC,
ABC does not explicitly include the resource constraints and capacities of
production operations. Thus, ABC cannot be used to determine the short-term
best product mix. ABC and TOC are thus complementary methods; ABC
provides a comprehensive analysis of cost drivers and accurate unit costs as a
basis for strategic decisions about long-term pricing and product mix. In
contrast, TOC provides a useful method for improving the short-term profitability
of the manufacturing plant through short-term product mix adjustments and
through attention to production bottlenecks.
10-13 TOC is appropriate for many types of manufacturing, service and not-for-profit
firms. It is most useful where the product or service is prepared or provided in a
sequence of inter-related activities as can be described in a network diagram
such as shown in Exhibit 10-6. The most common users of TOC to date have
been manufacturing firms who use it to identify machines or steps in the
production process which are bottlenecks in the flow of product and profitability.
10-14 Target costing is most appropriate for firms that are in a very competitive
industry, so that the firms in the industry compete simultaneously on price,
quality and product functionality. In very competitive markets such as this, target
costing is used to determine the desired level of functionality the firm can offer
for the product while maintaining high quality and meeting the competitive price.
10-15 Life-cycle costing is most appropriate for firms which have high upstream costs
(i.e. design and development) and downstream costs (i.e. distribution and
service costs). Firms with high upstream and downstream costs need to manage
the entire life cycle of costs, including the upstream and downstream costs as
well as manufacturing costs. Traditional cost management methods tend to focus
on manufacturing costs only, and for these firms, this approach would ignore a
significant portion of the total costs.
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-4
10-16 Strategic pricing is used to help a firm develop and implement its strategy for
success as its products and services mature in the market place. The focus for
new products is typically differentiation and there is a heavy focus on research
and development, while cost control becomes more important as the product
matures. In contrast, life-cycle costing is used to manage the costs of the
product over its entire cost life-cycle - from research and development and
product testing to manufacturing and finally distribution and customer service.
10-17 Takt time is the ratio of available manufacturing time for a period to the units of
customer demand for that period. Each unit must be produced within the Takt
time to satisfy customer demand. Takt time is computed for each manufacturing
operation, and those operations with longer Takt times are the constraints in the
manufacturing process.
10-18 Pricing based on the cost life cycle is a common form of pricing. It involves a
markup on full product cost or product life cycle cost. In contrast, pricing based
on the sales life cycle bases the product price on competitive factors, including
which phase of the sales life cycle (introduction, growth, maturity, or decline) the
product is currently in.
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-5
BRIEF EXERCISES
10-19
Takt time = 6,000 x 4 weeks per month/200,000 units per month = .12 hour/unit
or 7.2 minutes per unit
10-24
20 - 1 = 19 days
10-25
10-26
= .1
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-6
EXERCISES
10-28 Target Costing (15 min)
1. The unit cost is currently $548.60 = $13,715,000/25,000
The current profit per item is $610 - $548.60 = $61.40
Thus, the target cost to meet the competitive price is:
$550 - $61.40 = $488.60
2. The target cost can probably be achieved by efforts in two areas:
a. The standard cost analysis shows an unfavorable materials
variance of $500,000 ($7,000,000 - $6,500,000) or $20 per unit, a very
significant variance. Efforts to reduce or eliminate this variance will
make the firm much more competitive. Notice that the labor usage
variance for indirect labor is favorable, and the direct labor variance is
unfavorable. It may be that additional work is needed setting the
standards.
b. The standard cost shows an unfavorable direct labor variance
of $125,000 ($2,625,000 - $2,500,000), or $5 per unit, an opportunity
for cost savings.
c. The remaining manufacturing costs can be considered nonvalue adding costs, since they do not add to the functionality or quality
of the product. Efforts can be made to reduce the total cost of these
manufacturing costs, which now total a significant $4,090,000 or
$163.60 per unit.
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-7
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-8
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-9
Current
A-10
A-25
143.76 $
66.44
121
92
6
4
1
0.6
0.7
0.4
2
1
Revised
A-10
A25
$
78.65 $
42.45
110
81
5
2
1
0.5
0.7
0.2
1
1
Activity-based Costs
Direct Materials
Materials Handling
Mfg Supervision
Assembly
Set-ups
Inspection and Test
Packaging
Total
$
$
$
$
$
$
$
$
143.76
272.25
141.00
308.55
89.20
35.00
10.50
1,000.26
$
$
$
$
$
$
$
$
66.44
207.00
94.00
234.60
44.60
21.00
6.00
673.64
$
$
$
$
$
$
$
$
78.65
247.50
117.50
280.50
44.60
35.00
10.50
814.25
$
$
$
$
$
$
$
$
42.45
182.25
47.00
206.55
44.60
17.50
3.00
543.35
Price
Margin
$
$
1,050.00
49.74
$
$
725.00
51.36
$
$
825.00
10.75
$
$
595.00
51.65
3. The solution uses Goal Seek or trials in the Excel sheet. The number of
parts must be reduced to 101 or fewer to get at least $50 margin.
Cost and Activity Usage for Each Product
Direct Materials
Current
A-10
A-25
143.76 $
66.44
Number of parts
Machine hours
Inspecting time
Packing time
Set-ups
121
6
1
0.7
2
Revised
A-10
A-25
$
78.65 $
42.45
101
92
4
0.6
0.4
1
81
2
0.5
0.2
1
5
1
0.7
1
Activity-based Costs
Direct Materials
Materials Handling
Mfg Supervision
Assembly
Set-ups
Inspection and Test
Packaging
Total
$
$
$
$
$
$
$
$
143.76
272.25
141.00
308.55
89.20
35.00
10.50
1,000.26
$
$
$
$
$
$
$
$
66.44
207.00
94.00
234.60
44.60
21.00
6.00
673.64
$
$
$
$
$
$
$
$
78.65
227.25
117.50
257.55
44.60
35.00
10.50
771.05
$
$
$
$
$
$
$
$
42.45
182.25
47.00
206.55
44.60
17.50
3.00
543.35
Price
Margin
$
$
1,050.00
49.74
$
$
725.00
51.36
$
$
825.00
53.95
$
$
595.00
51.65
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-10
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-11
Unit Cost
Jamaica
Quantity
Cost
Quantity
Cost
$30
$180
$120
$5
$7
$10
$15
$10
$200
(Cancun),
Airfare (round trip
$355 (Jamaica)
from Miami)
Transportation to $15 (Cancun),
and from airport $10 (Jamaica)
TOTALS
7
7
6
4
5
35
49
60
60
50
5
5
0
2
2
25
35
0
30
20
200
355
15
$649
10
$595
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-12
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-13
Method:
Markup on full manufacturing cost
Markup on life cycle costs
Price to Achieve Desired GM %
Price to Achieve Desired LCC %
Price to Achieve Desired ROA of
$ 2,500,000
1,760,000
3,410,000
850,000
4,260,000
113.67
142.00
Desired Rate
for Markup
55%
30%
40.00%
25.00%
15%
42.25%
$
$
$
$
$
Price
176.183
184.600
189.444
189.333
202.000
ANSWER TO PART 6.
Contribution
Gross Operating
Margin
Margin
Profit
$ 2,785,500 $ 1,875,500 $ 1,025,500
3,038,000
2,128,000
1,278,000
3,183,333
2,273,333
1,423,333
3,180,000
2,270,000
1,420,000
3,560,000
2,650,000
1,800,000
6. The contribution margin, gross margin, and operating profit are shown in
the right-hand portion of the table above. For example,
$2,785,500 = $176.183 x 30,000 - $2,500,000
The pricing methods yield prices from $176.00 to $202.00 The
highest price, $202, has the advantage that it provides the desired return on
investment, a more precise statement of the firms goal than in the other
methods. On the other hand, the lower price might be an advantage if the
firm is trying to achieve sales growth and is concerned about maintaining or
improving market share during turns in the business cycle for its customers.
This latter concern is especially important given that the demand for the
firms product is a derived demand, and there is little that Johnson can do to
influence total auto sales.
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-14
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-15
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-16
Source: The Right Stuff for the GIs of the Future, Business Week, August
15, 2005, pp 74-75.
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-17
Source: Geoffrey Colvin, Pricing Power Aint What it Used to Be, Fortune,
September 15, 2003, p 52.
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-18
2. The cost index for wait staff is somewhat less than the importance index,
which indicates that Hannah should consider increasing the resources
applied to wait staff more wait staff, higher pay etc. In contrast, customer
satisfaction does not appear to reward the level of expenditure for food
ingredients; perhaps savings could be made here.
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-19
PROBLEMS
10-40Target Costing in a Service Firm (20 min)
1.
ICU 100
Unit Cost Quantity Cost
Video camera $ 150
1
$150
Video monitor
75
1
75
Motion detector
15
5
75
Floodlight
8
3
24
Alarm
15
1
15
Wiring
.10/ft
700
70
Installation
20/hr
16
320
Total
$729
ICU 900
Quantity Cost
3
$450
1
75
8
120
7
56
2
30
1,100
110
26
520
$1,361
ICU 100: ($810 - $729 total costs)/$ 810 = 10% profit margin
ICU 900: ($1,520 - $1,361)/$1,520 = 10.46% profit margin
2. ICU 100: ($750 - $729 total costs)/ $750 = 2.8% profit margin
ICU 900: ($1,390 - $1,361)/$1,390 = 2.09% profit margin
3. The installation costs are the largest component of cost and this
category could have room for improvement. By redesigning the layout
of the systems or finding components that integrate more readily, the
installation times could then be reduced. Also, costs could be lowered
by contractual bargaining with electricians to reduce the per hour rates
for installation.
The video equipment and motion detectors are sources of
significant costs, but decreasing the quality or quantity of these items
would substantially change the effectiveness and value of the security
systems.
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-20
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-21
Manufacturing
Cost
Marketing Cost
GSA Cost
Total Cost
Currently
$1,000
With Cost
Reductions
$835
Savings
$85-25+105 = $165
200
225
$1,425
200
175
$1,210
$50
$215
The cost savings of $215 are not sufficient to get the product total cost
($1,210) down to the desired target cost of $1,200. Given that National
might be willing to pay a higher price, and since the cost difference is
relatively small, it seems that Morrow should in fact pursue the order. Here
are some other considerations:
a. Morrow should consider the short versus the long term issues of taking
on the order. In the short term, as noted in chapter 3, the fixed costs of
manufacturing the order will not change and therefore can be considered
irrelevant for the order if it is a one time special order. Thus, for a short term
analysis, Morrow should determine that portion of manufacturing, marketing,
and GSA costs that are fixed and exclude them from the analysis. In
contrast, if Morrow expects this to be a regular customer, that Morrow will be
supplying National these parts for several months or years, then the total
costs including fixed costs are relevant, as in the calculations above. In the
longer term, Morrow must cover all costs of production and sale, while in the
short term only the variable costs are relevant.
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-22
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-23
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-24
$1,800,000
320,000
$1,480,000
$980,000
105,000
37,500
$250,000 1,372,500
$ 107,500
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-25
10-45
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-26
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-27
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-28
Receiving and
testing
Machining
Assembly
Final Assembly
Time Required
PEC-1
PEC-2
40x10 + 40 x 15x25=375
25=1,400
40x80=3,200
40x45=1,800 15x(45+30)
=1,125
40x60=2,400 15x40=600
Total
1,775
Time
Available
2,000
3,200
2,925
3,500
2,000
3,000
3,500
Price
Materials cost
Throughput margin
Constraint time (min)
Throughput/minute
PEC-2
$250
137.50
112.50
75
$1.50
PEC-1
40
40
40x45=1,800
2,000 -1,800=200
40 x $90 = $3,600
200/75=2.667; round to 2
2 x $112.50 = $225.00
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-29
PEC-2
15
Second, identify the constraint. In this case the constraint is staining time,
where there is a need for 85 more hours of capacity
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-30
Finally, determine the most profitable product mix. Since sofas are the
most profitable through the staining constraint, we fill the sofa demand first,
and then with the remaining staining capacity, fill as much of the table
demand as possible. See below for calculations.
2. Part one above solves the first two steps of the TOC, to identify the
constraint and determine the most profitable product mix. The third step, to
maximize flow through the constraint, would require Colton to look for ways
to speed up the staining operation, by simplifying it, by training the operator,
or other means. In the fourth TOC step, Colton could consider adding a part
time employee to add capacity at the constraint, though it might be difficult
to find a skilled employee who wanted part time work. Adding a full time
employee would be unnecessary and wasteful, unless the motel contract
works out. In the final TOC step, Colton should consider the possibility of
re-design, by for example using a different type of stain that requires less
time and skill.
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-31
40x(2+2)= 160
40x(2+1)= 120
40x5 = 200
40x 1 = 40
40x3 = 120
280
240
380
160
300
Time Slack
Available Time
320
320
320
160
320
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-32
40
80
-60
0
20
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-33
2
1,000=
500x2
400=
400x1
2,000=
1,000x2
3,400
3,000
(400)
Departments
3
500=
500x1
400=
400x1
2,000=
1,000x2
2,900
3,100
200
1,000=
500x2
0
1,000=
500x2
800=
400x2
1,000=
1,000x1
2,800
3,300
500
1,000=
1,000x1
2,000
2,700
700
2. The best product mix is 400 units of Product 613, 500 units of product 611, and 800 units of product
615.
611
613
615
Price
$196
$123
Variable Cost*
103
73
Throughput/unit
$93
$50
Machine hours in Dept 1
2
1
Throughput/hour
$46.50
$50.00
* For example, variable cost for 611 = $(7+12+21+24+9+27+3)
Production/sales Plan
First:
Second:
$167
97
$70
2
$35.00
3,000
400
1,000
1,600
Third: 800 units of 615; 1,600/2 hours per unit = 800
All 3,000 hours used
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-34
10-51
Xderm
$3,000,000
1,900,000
$1,100,000
(720,000)
(80,000)
$300,000
Yderm
$2,000,000
1,600,000
$ 400,000
(180,000)
(20,000)
$ 200,000
Total
$5,000,000
3,500,000
$1,500,000
(900,000)
(100,000)
$ 500,000
$300,000
$3,000,000
=
10%
Blocher,Stout,Cokins,Chen:Cost Management, 4e
$ 200,000
$2,000,000
= 10%
10-35
$ 500,000
$ 5,000,000
=10%
Operating Profit
1,400
350
60
60
20
1,890
Operating Profit
L50
Revenues
Costs
Research and Development
Prototypes
Marketing
Distribution
Manufacturing
Customer Serivce
Total Cost
2005
800
(1,090)
2005
900
650
300
124
170
85
1,329
(429)
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-36
2006
2,300
2007
3,100
Total
6,200
50
600
120
770
60
1,600
475
130
1,350
85
2,040
1,400
400
1,135
310
2,140
145
5,530
700
1,060
670
2006
1,900
2007
2,200
Total
5,000
30
200
200
700
20
1,150
10
260
410
770
300
1,750
650
340
584
780
1,555
320
4,229
750
450
771
Operating Profit
L50
Revenues
Costs
Research and Development
Prototypes
Marketing
Distribution
Manufacturing
Customer Serivce
Total Cost
Operating Profit
2005
800
0
1,400
350
60
60
20
1,890
$
74.1%
18.5%
3.2%
3.2%
1.1%
0.0%
(1,090)
$
0.0%
3.1%
37.5%
7.5%
48.1%
3.8%
700
2005
900
650
300
124
170
85
1,329
2006
2,300 %
0
50
600
120
770
60
1,600
$
48.9%
22.6%
9.3%
12.8%
6.4%
0.0%
(429)
2006
1,900
0
30
200
200
700
20
1,150
750
2007
3,100 %
0
0.0%
0.0%
475
23.3%
130
6.4%
1,350
66.2%
85
4.2%
2,040
1,060
$
0.0%
2.6%
17.4%
17.4%
60.9%
1.7%
2007
2,200
0
10
260
410
770
300
1,750
0.0%
0.6%
14.9%
23.4%
44.0%
17.1%
450
The analysis shows how the distribution of costs for both products shifts
from research and development in the first year to manufacturing and
customer service in the last year. The shift is most pronounced for L40
which has high development costs.
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-37
$1,000,000
$2,108,000
$5,000,000 x 5 = $25,000,000
$68x3,000,000 = $204,000,000
$380,000 x 5 =$1,900,000
$20 x 3,000,000 = $60,000,000
$1,125,000 x 5 = $5,625,000
$6.50 x 3,000,000= $19,500,000
$2,280,000 x 5 = $11,400,000
$12 x 3,000,000= $36,000,000
$366,533,000
Operating Income
Blocher,Stout,Cokins,Chen:Cost Management, 4e
$338,467,000
10-38
$235
3,000,000
$705,000,000
$1,000,000
$2,108,000
$1,500,000 x 5 =$7,500,000
$80 x 3,000,000= $240,000,000
$380,000 x 5 = $1,900,000
$60,000,000
$1,125,000 x 5 =$5,625,000
$19,500,000
$2,280,000 x 5 =$11,400,000
$36,000,000
$385,033,000
Operating Income
$319,967,000
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-39
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-40
cutting 10 days from the total project schedule because not all of her
crashed activities are included on the critical path. In order to reduce
the completion time for a project, activities along the critical path need
to be chosen to be crashed or reduced. Vanders selection of
activities FJ, EF, and BG, which are on the critical path ABGEFJK, will
reduce total project completion time only by three days but her
selection of activities HJ, GH, CD, and DE have no impact on the
critical path and thus will not reduce project time.
2. Below is a revised accelerated delivery schedule that meets both
objectives: (1) delivery of the first plane two weeks (10 working days)
ahead of schedule, and (2) at least incremental cost to Coastal. All
the paths need to be evaluated when reducing a projects completion
time. However, the selection of activities to crash should be taken
from the critical path first and then the activities should be selected in
order according to the smallest crash cost. The critical path now
becomes ABCDEFJK and will take 57 days, having only reduced the
total project completion date by eight days. Therefore, the activity CD
(the next least costly available activity) needs to be crashed two days
which will then bring all paths to 55 days or less. This analysis is
shown in the tables below.
The first path, ABGEFJK, crashed 10 days would cost $10,200, as
shown below.
Activity
Crashed
Days
Reduced
Incremental
Cost per
day
Incremental
Cost
START
FJ
EF
JK
BG
AB
GE
Total
1
1
1
2
4
1
$ 400
800
900
1,000
1,200
1,300
$ 400
800
900
2,000
4,800
1,300
$10,200
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-41
ABGEFJK
65
64
63
62
60
56
55
Days
Reduced
Incremental
Cost per
day
Incremental
Cost
START
FJ
EF
JK
AB
CD
Total
1
1
1
4
2
$ 400
800
900
1,200
700
$ 400
800
900
4,800
1,400
$8,300
ABCDEFJK
64
63
62
61
57
55
Note that the activities BG and GE are not crashed in the final solution
because they are not on the critical path. Reducing time on these
activities will not reduce the overall project time.
3. The total incremental costs Bob Peterson will have to pay for this
revised accelerated delivery schedule amount to $8,300, or a new
total project cost of $73,400 from the original $65,100, and a saving of
10 days.
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-42
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-43
Defects up
Profit Outcomes
Costs up
Cramped space
Focus on speed
everywhere
(no concern for
downtime or
throughput..)
Reduced
Throughput
WIP up
Increased
holding cost
Blocher,Stout,Cokins,Chen:Cost Management, 4e
10-44