Role of cost and management accounting in

strategic planning
Evaluate strategic options
using marginal and relevant
costing

Pricing strategies

Effective use
Discontinue/Closure
of scarce resources
decisions

Make/Buy

Acceptance of
Special order

Pricing strategies
Establish a Pricing strategy that
recognises both economic and noneconomic factors
Factors influencing pricing are:
1.
2.
3.
4.
5.
6.

Mission and marketing objectives

Pricing objectives
Costs
Competition
Consumers
Control

Pricing strategies
1. Mission and marketing objectives

: pricing cannot be separated from mission,

for instance not-for -profit firms, prices for its
products heavily subidised; up-market
organisations charge high prices for quality

2. Pricing objectives

In short-term pricing objectives maybe one

of market penetration (LOW PRICES) or
market skimming (high initial prices)

3. Costs

Any positive contribution to recover fixed

costs
To make a profit revenue must exceed costs

Pricing strategies
4. Competition 4 types of market

Perfect competition: suppliers charge the market price

Oligopoly: a small number of suppliers: little incentive
to reduce price as competitors will follow to maintain
their market share
Monopoly: supplier can charge whatever price is
wished as he is a sole provider.
Monopolistic competition: there are a number of
suppliers of similar but not identical goods. Products
are differrentiated and therefore can command
different prices

Price competiotn means consumers are motivated

primarily by price and suppliers have to offer low prices
to succeed.
Non-price competition means consumers pay attention
not only to price but also other marketing mix, such as
promotion, product features, place.

Pricing strategies
5. Consumers:
Suppliers need to keep in mind what the
consumers are willing to pay.
Common to segment markets in this
situation
Perceived value of goods to consumers

6.

Controls:
some industries are closely regulated by
statute and reguilation, therefore little
power to choose their own prices.

The process of Setting prices

Company will have information about;

Customers
Competitors
The costs, revenue profit relatioship

Setting prices to maximise profits

MR=MC

Setting prices to break-even

Fixed costs/ contribution per unit

Cost based prices:

Cost plus mark-up

Competition pricing:
Match what competitors are charging

Market oriented pricing

Sells a product differentiated by features, quality, design. to avoid perfect
competition

Strategic approaches
Market skimming, market penetration, related product pricing, product line
opricing.


Marginal Costing for short-run decision-making
Marginal costing is a costing principle whereby
variable costs are charged to cost units and the
fixed costs attributable to the relevant period are
written off in full against the contribution for that
period. (CIMA)
In marginal costing all costs are classified
according to how they behave. They are either
variable or fixed.
In the short-run all fixed costs remain unchanged
and therefore treated as irrelevant.
The only relevant costs are variable costs ie.
those costs which increase/decrease as output
increases/decreases.

Limiting factor decisions

Often a company finds that there is a

limiting factor or constraint which inhibits
its capacity to meet the desired production
level.
The limiting factor may be any resource eg.
materials, labour or machine hours.
Management has to decide what is the best
way to allocate the scarce resource among
the product range in the most effective
way so that profits are maximised.

Example
Product

1,000

2,000

500

Selling price per unit

35

25

15

Variable cost per unit

15

10

-----

-----

-----

20

15

10

Desired production (units)

Contribution per unit

A special machine is used to manufacture the three products and

there are only 15,000 machine hours available.
Product X uses 20 machine hours per unit.
Product Y uses 5 machine hours per unit.
Product Z uses 2 machine hours per unit.

Contribution per unit

20

15

10

No. of machine hrs.

20

(3)

(2)

(1)

Contribution per
machine hr.
Ranking

Desired production
level

15,000

Available hours
Product Z

500 units x 2 hrs.

Product Y

2,000 x 5 hrs

Product X

200 x 20

1,000 hrs
10,000 hrs
4,000 hrs

Product Z earns 500 units x 10 =

5,000 contribution
Product Y earns 2,000 units x 15 = 30,000 contribution
Product X earns 200 units x20 =
4,000 contribution
--------39,000 contribution
----------

Make or Buy
Sometimes management may have to consider whether it is best to
manufacture products or components or to sub-contract them out and
purchase them externally.

Example:

A company makes product P. A component Q used in the manufacture of P

can be purchased from a supplier for 8. The costs to make the
component are as follows:

Direct materials
2
Direct wages
3
Variable overheads
2
-----Variable cost of production
7
-----Assume spare capacity and the fixed costs remain unchanged.
Obviously it is cheaper to make than to buy.

However, if the firm is working at full capacity and to make component Q involves moving
some of the capacity from product P then the decision is a little more involved.

The following data applies to product P.

Selling price
16
Direct materials
6
Direct labour
4
Variable overhead
2
-----Contribution
4
-----
The production rate for product P is 5 units per hour and for component Q is 10.
The effective cost of making a unit of component Q is:

Marginal cost of production

7
Plus
Opportunity cost of
2
----The effective cost is
9
----
By switching capacity from product P to component Q there is 2 contribution lost. This is an
opportunity cost ie. it is the benefit foregone by choosing one course of action over the
other.

Applications of marginal costing

Acceptance of a special order

X Ltd. makes a product which sells for 1.50.
The output for the period is 80,000 units of
product which represents 80% capacity . Total
costs are 90,000 and of these it is estimated
that 26.000 are fixed costs. A potential
customer offers to buy 20,000 units at 1.10 and
this will use up the companys spare capacity.

Should management accept this special order?

Special order:

Sales(20,000 units @ 1.10)

Less Variable costs(20,000 @ 80p)
Extra contribution

22,000
16,000
---------6,000
----------

Profits can be increased by an additional 6,000 since fixed

costs are already covered. However management must
consider other relevant factors in arriving at the final
decision.

How will existing customers react? They may wish to buy at
1.10 per unit. Could the spare capacity be used more
profitably rather than accepting the special order?

Shut-down decisions
Often management wish to analyse the performance of their
products, branches, divisions.
Consider the following example.
Product

Total

20,000

50,000

25,000

95,000

Direct materials

1,000

15,000

10,000

26,000

Direct labour

3,000

16,000

14,000

33,000

Fixed overheads

2,000

7,000

9,000

18,000

--------

--------

--------

--------

6,000

38,000

33,000

77,000

--------

--------

--------

--------

14,000

12,000

(8,000)

18,000

Sales
Less

Profit/(Loss)

 With product C making a loss

management might consider
discontinuing this product.
However, using marginal costing
principles, with fixed costs
treated as irrelevant for shortrun decision-making the income
statement can be reformatted.

Prtoduct

Sales

Total

20,000

50,000

25,000

95,000

4,000

31,000

24,000

59,000

--------

--------

--------

--------

16,000

19,000

1,000

36,000

Less
Variable costs

Contribution
Fixed costs

18,000
--------

Net profit

18,000
--------

 Since product C makes a

contribution it may be
inadvisable to close it down. If
Product C is closed down the
company will lose 1,000
contribution and the overall
effect would be to reduce profits
to 17,000.