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‫הפקולטה לניהול‬ ‫בית הספר למוסמכים במנהל עסקים ע"ש ליאון רקנאטי‬

Pricing policy
Case study 1: Wilkerson Company

Submitted by:
Amir Yihie - 024159527 Dror Paz - 028111946 Laure Nmkendall - 90024933 Edan Kertis - 039023452

Submission date: 25-Marc-2012

250). It would be beneficial to use ABC analysis in order to identify the actual cost for each product. the total overhead cost is higher than the combined costs of variable expenses. total manufacturing overhead is $806. most of the manufacturing overhead are strictly related to the products themselves.250+458. 2 . pumps and flow controllers). Valves: Wilkerson had a unique design for high quality valves. They were thus able to distinguish themselves from their competitors and build a loyal customer base for the product. however. Pumps: Since pumps are a commodity product. which is far lower than the planned margin of 35%. Wilkerson should not adopt a contribution margin approach in which manufacturing overhead is treated as a period expense. several competitors have the ability to match Wilkerson's quality in valves. Each product is highly varied in terms of overhead costs. If we treated the overhead costs as a period costs. we would be unable to find the actual cost of each product. Since the prices of valve have been reduced by the competitors. Gross margins for this product have remained 35% as expected and desired. This is due to the fact that the actual manufacturing overhead for each product is significantly different. Wilkerson should therefore take advantage of this opportunity. Furthermore. Wilkerson has recently raised prices 10%. gross margins have fallen below 20%. but presently it is being calculated according to the direct labor expense. According to exhibit 1. while it takes 220 shipments for 4000 flow controllers. which does not vary between products. yet none had tried to gain market share by cutting price. Wilkerson has been forced to match their competitors reduced prices in order to remain a leading pump supplier.Question 1 Wilkerson Company has 3 product lines (valves. for 7500 valves. Flow Controllers: Flow controllers are highly customized there is great variety in the types of flow controllers in the market. This indicates an inelastic market for this product. According to exhibit 4.000 which is significantly higher than the sum of direct labor expense and direct material expense (271. Due to this. Each has different competitive situation with its own market and competitors. the number of shipments required is 10. Wilkerson cannot differentiate their pumps from the competition. Now.000= $729. For example. with no apparent effect on demand. There is strict competition in this market based on priced. Question 2 No. The current way of allocating manufacturing overhead for each product is also an inaccurate measure.

3 .97 .Question 3 From exhibit 1 we see that: Total manufacturing overhead = 806000 Total direct labor expense = 271250 Then the ratio between the total manufacturing overhead and the total direct labor expense = = 806000 / 271250 = 2.> allocation rate = 300%.

00 $ 80. Total Machine hours Machine related expenses Machine expense per hour Production runs Setup labor Single setup expense Receiving and production control Control expense per production run Hours of engineering engineering expense Engineering expense per hour No. of shipments Packaging and shipment expense Single shipment expense 11. Single setup expense.00 1250 $ 100.Question 4 Preliminary calculations: In order to calculate the total cost per unit per product we need to do some preliminary calculation such as: Machine expense per hour.00 $ 500.000.000.200 $ 336.125.000.00 $ 1. Control expense per production run.00 $ 250.00 $ 180. of shipments . Single shipment expense. Engineering expense per hour.000 $ 30 160 $ 40.000.00 4 Source Exhibit 4 Exhibit 1 = Machine related expenses / Machine hours Exhibit 4 Exhibit 1 = Setup labor / Production runs Exhibit 1 = Total control expense / Production runs Exhibit 4 Exhibit 1 = Total engineering expense / Hours Exhibit 4 Exhibit 1 = Packaging and shipment expense / No.00 300 $ 150.

50 625 0.00 $87.67 $12.00 $86. of shipments Units per shipment Shipment expense per unit Hours of engineering Hours of engineering per unit Engineering expense per unit $10.9% with ABC calculation ) .4% and 13.3% instead of 34.033 $2.00 0.6 $2.33 $1.ABC model .50 10 750 $0.5 $15 7500 10 750 $0.1% instead of 19.00 0.18 $27.9% = 1 . $10.030 $2.00 $4.Flow controllers require much more production runs per unit than valves and pumps which causes significantly higher setup and production control expenses per unit.00 $16.6% respectively ( 46.1% $115.38 $62.156 $12. C.5% 33.00 34.00 $22. of shipments / Units per month = Single shipment expense ($500) / Units per shipment Exhibit 4 = Hours of engineering / Units per month = Hours of engineering per unit * Engineering expense per hour ($80) = All costs per unit sum Total cost per unit Original unit costs Actual selling price Previously calculated gross margin (%) Gross margin according to ABC (%) $46. These shifts are caused because of 3 main reasons: Production runs per unit .5% ) .00 0.9% 46. 5 .20 $70.17 $56.00 Exhibit 2 41.3% $58.calculations the cost and profitability of each product line Valve Pump Direct labor cost Direct material cost Machine hours per unit Machine expense per unit Units per month Production runs Average units per production run Setup expense per unit Control expense per unit No.13 220 18.25 $28.40 F.9% and 33.80 375 0.3 $9 4000 100 40 $6. while flow controllers are not profitable at all as opposed to their 41% actual gross margin in the previous method ( -9.67 250 0.125) / Units per production run Exhibit 4 = No.0% Exhibit 2 -9.50 $20.Cost / Actual selling price Difference between calculated ABC cost to reported product costs and profitability According to the calculated cost and profitability we see a significant difference from the reported cost.50 70 178.5 $15 12500 50 250 $1.50 Source Exhibit 2 Exhibit 2 Exhibit 3 = hours per unit * expense per hour($30) Exhibit 4 Exhibit 4 = Units per month / Production runs = Single setup expense ($250)/ Units per production run = control expense per production run ($1.00 Exhibit 2 $105.00 19. Both pumps and valves are more profitable by 11.

Increasing batch Increasing the batch size will reduce the costs of the shipping and packaging size of a FC Close some FC The company should reduce the number of FC models it offers to its customers. Pumps and Flow Controllers) than the figures presented in exhibit 2 which are based on Cost+ pricing model. That might bring us to assume that additional raise in the price might be accepted as well.Flow controllers require more engineering hours per unit.50 Shipment expense per unit Engineering hours . Question 5 The ABC pricing model developed in Q#4 showed significant differences in the profitability of each of the products (Valves.50 Pump $1.Setup expense per unit Control expense per unit Valve $0. while the valves and the pumps are more profitable. $12. C. $6.Flow controllers require more shipments. understanding the potential of 6 . which causes significantly higher shipment expenses per unit.67 Pump $2. with small (if at all) changes to the demand. which causes significantly higher engineering expenses per unit. We therefore can consider that the market has relative inelastic elasticity. C. Valve $0.50 Engineering expense per unit In the reported method the overhead expenses were allocated according to direct labor costs and distributed between valves and pumps making their profitability appear lower while flow controller's profitability had deceptively appeared much larger. lines leaving only the ones with a potential to become profitable again.00 $4. The main differences show that the Flow Controllers (FC) is not profitable at all.50 F.40 F.80 F. Valve $2.25 $28.13 Shipments . Based on the above the following actions are recommended for Wilkerson management to consider in order to improve the company’s profitability: Action Increase price Reason FC The case describes a previous raise in the price of the FC (Page 2 paragraph 2) that was accepted by the market with no effect on the demand.67 Pump $2. C. $27. That requires deeper analysis of the market.33 $1.

Wilkerson should try to reduces those deliveries by offering some benefits (some discount) for customers using the ‘fixed schedule’ delivery method. the FC was the #1 product in profitability (41%). for example. Last point is that when we are only looking at the cost of specific product we are missing the market prospect of view. maybe the fact that we producing both Valves and Flow centers has helped the company to gain a very big and important costumer. in case the major part of flow controllers is ordered by a specific costumer using only one shipment. and the FC are far behind with negative profit. in case that producing the N unit is more costly than producing the first unit some of our conclusions might be wrong. Question 6 On our ABC analysis we assumed that there is no connection between number of produced units and the cost for each unit. One more issue that we should address when inspecting our ABC analysis is distorts that might be hidden when only looking at the statistics.income of each customer. Reduce ‘Just-in. It is then recommended to change the commission plan in a way that the sales team will sell more valves and pump. It is very important to understand if there is any kind of linkage between the 3 products in the eye of the costumers in order to understand the true profit from each product. leaving Sales Valves and Pumps behind (34.Just-In-Time deliveries are known to be more expensive due to the inelasticity Time’ deliveries of the shipments schedules. We must address all these market issues when strategically analysis all products cost.9% and 19. this will be wrong in case the marginal cost for every more unit is getting higher and higher. we presented the cost of each product unit as equals to all other produced unit. by increasing the commissions for FC sales. it might be still profitable to continue working with this costumer and abandon all other costumers who order small amount of flow controllers but enforce the company to do many different shipment with high cost. It is crucial for the ABC analysis to have that kind of information in order to make it more accurate. stop producing flow controls for this costumer might cause the company to lose it. That will allow the company to consolidate shipments and save in the cost of the shipment and packaging Promote Valves In the Cost+ model.5% respectively) Due to the above it is reasonable to assume that the management was trying to promote the FC sales within the sales team. The ABC pricing model shows that the above was wrong and that the valves are the #1 product. short behind are the pumps. 7 .

the company should compensate the salesmen proportionally to the contribution margin of the products which they sold. the second would be for pumps. and the lowest would be for flow controllers. For example. Doing this will give employees incentive to sell the products which have the highest contribution margin. Because of this. One possible way of implementing this would be to differentiate the commission between products. the gross margin for pumps is significantly lower than that of valves. The highest commission percentage would be allocated to valves. 8 . All of the compensations will remain on a gross base as before (gross volume per product less returns).Question 7 Each of Wilkerson Company’s products contributes a unique gross margin.