Pricing & Costing:

including budgeting
& life cycle costing

Anjana Vivek
anjana@bizkul.com

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Costs: Some terms

Direct

Indirect

 Committed

Flexible

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Costs


Fixed
 Variable
 Semi variable

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Exercise
Revenue- Restaurant A – Rs. 10,00,000
Restaurant B – Rs. 4,00,000
Direct - Restaurant A – Rs. 6,00,000
Restaurant B – Rs. 2,20,000
Indirect - Restaurant A – Rs. 2,00,000
Restaurant B – Rs. 80,000

What is the profit margin ??

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Exercise
Revenue- Restaurant A – Rs. 10,00,000
Restaurant B – Rs. 4,00,000
Direct - Restaurant A – Rs. 6,00,000
Restaurant B – Rs. 2,20,000
Indirect - Restaurant A – Rs. 2,00,000
Restaurant B – Rs. 80,000

 What are your thoughts on the profit so

calculated?
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Exercise
Revenue- Restaurant A – Rs. 10,00,000
Restaurant B – Rs. 4,00,000
Direct - Restaurant A – Rs. 6,00,000
Restaurant B – Rs. 2,20,000
Indirect - Restaurant A – Rs. 2,00,000
Restaurant B – Rs. 80,000

Do you think this is the true profit?
 How has indirect cost been calculated
(allocated)?
 What are your views on the costing?
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Exercise
Revenue- Restaurant A – Rs. 10,00,000
Restaurant B – Rs. 4,00,000
Direct - Restaurant A – Rs. 6,00,000
Restaurant B – Rs. 2,20,000
Indirect - Restaurant A – Rs. 2,00,000
Restaurant B – Rs. 80,000

How does change in basis of allocation

impact profit ?
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Solution
Case I

Amt Rs.
Restaurant A B Total
Revenues 1,000,000 400,000 1,400,000
Direct 600,000 220,000 820,000
Indirect 200,000 100,000 300,000

Margin 200,000 80,000 280,000

% margin 20 20 20

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Alternate scenario
Case II

Amt Rs.
Restaurant A B Total
Revenues 1,000,000 400,000 1,400,000
Direct 600,000 220,000 820,000
Indirect 150,000 150,000 300,000

Margin 250,000 30,000 280,000

% margin 25 7.5 20

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 Costs
 Costs are incurred in a variety of
functions in business
– Establishing business
– R&D
– Production / Delivery of service
– Sales and marketing
– After sales service
– Administration
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Importance of costing

Planning

Controlling
 Decision making
 Implementing

Continuous improvement

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Costs
 Controllable

Joint

Discretionary
 Relevant
 Sunk

Opportunity

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Costs: Analysis
 Useful to decide what is controllable
and what is not

Helps to understand what is relevant
to decision making
 Must be done with care to avoid
incorrect decisions

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 Relevant costs
 Expected future costs to help in making
decisions
 Differ with alternate courses of action
– Managers make decisions based on costs
allocated
– Managers may make short run decisions that
may affect long term business and sales
 Relevant costs help choose between
alternatives

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 Costs - relevant / not
relevant
 Equipment replacement
– Book value of old equipment – not
relevant
– Current disposal price of old equipment
– relevant
– Cost of equipment - relevant

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Costing: Some terms


Contribution margin

Break even point

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Break even point
 Ram Kumar wants to sell Computer
tables and chairs at a conference stall

He estimates that he can sell each unit
for Rs. 10,000 each
 The cost per unit is Rs. 6,000
 The stall rent is Rs. One lakh
 How many units must Ram Kumar sell to
break even?

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Break even point
 In continuation of the previous example,
assume that Rs.6000 is not cost, ie
assume some raw material which is
anyway spare – eg. wood, is used for this
purpose. So this cost actually may not be
relevant, thou labour cost may be
relevant then what happens to your
decision?
 Try to develop a different perspective
and way of thinking
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Costing: Some terms

Contribution margin

= Sales – total variable cost

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Costs: Analysis

 Identify cost objects / cost centres

 Accumulate costs
 Assign / trace costs to cost objects

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Assignment / Allocation

Selection of
 Activity base – people; machine hours;

material consumed
 Activity level – normal/abnormal

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 Budgets
 Plan performance in advance for a
given time frame

Review performance with budget
 Understand reasons for variation
 Take remedial measures if required

Plan again based on actual
performance and feedback
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Budgets
 Keep company objectives in mind

Long term and short term

Rolling budgets

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 Budgets
 Master budget, comprising of
detailed budgets for eg. budgets for
– Income
– Production
– Direct costs
– R&D
– Administration

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Product budget
 Expected sale

Inventory on hand

Production schedule
 Direct costs
 Indirect costs

Company policies and strategy

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 Life cycle costing
 Considers entire life cycle of product from
start to finish

Provides important information for pricing
decisions
 For example, if a mobile phone is built, if
the R&D costs are high for the company,
the repairs and maintenance cost to the
customer may be low; so the life cycle is
across the life of the product and
considers costs www.bizkul.com
and impact on prices 26
Life cycle costs

Upstream costs
– R&D, design, prototyping, testing,
quality development

Manufacturing/Operations costs
– Purchasing, manufacture/service

Downstream costs
– marketing, sales and distribution,
customer service and warranty
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Life cycle costs

Product life cycle costs vary with
industry and nature of industry
 R&D is not only at start of product
life, this may also occur at other
stages, ie development of additional
features in product
 Life cycle may also depend on
markets targeted, ie country,
region, socio-economic background
etc. www.bizkul.com 28
Implementation of LCC

Identify stages in product life cycle

Identify target customer
 Understand target customers
perspective and estimate need
 Analyse cost and pricing in detail

Educate employees about LCC

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Implementation of LCC
 Develop product and pricing structure
based on LCC
 Create appropriate organisation structure
for implementation
 Educate customer on LCC, eg. mobile
phone referred to in earlier slide
 Focus on strategic marketing to address
customer requirements and needs, stated
and unstated
 Continuous life cycle budgeting and
monitoring and modify/change as
required www.bizkul.com 30
Life cycle costing
benefits
 Optimisation of profit over product
life

Full set of costs associated with
products are ascertained
– Most accounting systems capture
manufacturing costs
– Other areas like R&D at start and
customer service as close do not get
much importance
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 Life cycle costing
benefits
 Differences in percentages in
committed costs at initial stage of
business is highlighted
– The higher the initial costs, the more
critical it is for management to develop
better predictions about revenues

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Life cycle costing
benefits

Interrelationships across cost
categories are highlighted
– Many companies with high R&D &
product refinement costs may
experience less customer service costs
and vice versa. Such costs are often
hidden and affect quality of product

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Pricing

 Intuitive
 Rule of thumb
 Trial and error

Discount
 Premium
 Mark up

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 Pricing decisions
Influenced by

Costs

Competitors
 Customers

 Time horizon – short run or long run

decisions

Strategic reasons
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 Target Pricing

Develop product

Set target price
 Try to achieve target cost

Target cost =
Competitive price – desired profit

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 Pricing for short run
 Decide on relevant costs that should be
used

Compute costs, direct, indirect and total
 Compute any special costs that need to
be incurred and savings that may be
possible

Decide on pricing based on other factors
such as long term impact, competition
etc.
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Pricing for long run
 Important to consider long term
pricing for long term sustainability and
growth of business
 Initial pricing and short term pricing
should keep long term pricing in mind
 Image and brand of business to be
considered in pricing
 Costs to be understood and allocated
 Consistency in pricing in long term
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 …..to trigger thinking

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A cup of coffee
 A cup of coffee costs Rs. 10 to make


HOW will you plan to price this?

……….. continued..

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A cup of coffee


Will you charge based on the price
of coffee in similar coffee shops and
restaurants?

……….. continued..
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A cup of coffee


Will you charge cost plus a margin?

……….. continued..

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A cup of coffee


OR will you think differently?

……….. continued..

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A cup of coffee
For example …


You could charge differently during
the rush hour
 You could have special rates in non
rush hours

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Some thoughts…

You can … if you want

 Think differently about your pricing

 Think differently about your
negotiations for pricing and selling

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