Learning objectives
Chapter 16 After studying this presentation you should be able to:
The strategic management of
costs and revenues
Learning objectives
After studying this presentation you should be able to:
16.5 describe the characteristics of life cycle costing
16.6 evaluate pricing methods and describe how cost-
based prices and market-based prices are
managed.
Value chain and supply chain analysis
• The supply chain is the flow of resources from initial
suppliers through delivery of goods and services to
customers and clients.
• Supply chains are analysed by determining inventory
level requirements, starting with customer demand for
goods and services.
• Based on demand predictions, organisations can work
with suppliers so that they can adapt their systems to
meet the customer demand predictions.
16.1 explain the value chain activities that provide for
continuous cost improvement
16.2 explain the concept of customer profitability
analysis and suggest qualitative factors for inclusion
in a strategic customer analysis model
16.3 understand target costing principles and
techniques
16.4 communicate the concept of kaizen costing and
explain how it compares to target costing
Value chain activities for continuous cost
improvement
• Value chain analysis can lead to:
• improved relationships between entity and others
• business decisions that either eliminate non-value-
added activities or improve value
• improved communication.
• Value chain analysis encourages managers to consider
outsourcing.
Value chain and supply chain analysis
• Cost savings and revenue growth may be achieved by
rethinking the supply chain and making use of big data
to understand meet customers’ needs and wants.
• Environmental and social considerations are also critical
aspects of supply chain analysis.
 Value chain and supply chain analysis Value chain and supply chain analysis

• Sustainable supply chain management requires firms to
consider a range of issues including:
• the environmental and social performance and
credentials of potential and current suppliers
• the source of raw materials
• manufacturing and human rights, and environmental
protection
• distribution
• retailing.
• Companies committed to managing the environmental
impacts of their supply chains can commit to green
supply chain management (GSCM) principles.
• From a social perspective, much of the interest in
sustainable supply chain management has been
triggered by major industrial disasters.

Customer profitability Customer profitability

• To conduct customer profitability analysis, firm must be

able to identify:
• revenue from each customer
• associated costs of servicing customer
• resources consumed.
• To determine more profitable customers, consider who:
• buys profitable products or services
• demands significantly more resources.

Customer profitability Building desired profit into decisions

• Quantitative customer profitability analysis is one input
into what should be a more comprehensive model for
evaluating and managing customers.
• The following may also considered:
• the nature of the contractual arrangements with
individual customers and potential for related sales
• the life cycle stage of each customer
• threats to the market
• the status of customer relationships
• bargaining power.
• In the short term, the general rule is to sell goods or
services as long as profit is expected. However, in the
long term, firms need to earn a reasonable return on
investment.
• Techniques for long term profitability include:
• target costing
• kaizen costing
• life cycle costing.
 Target costing Steps in a target costing design cycle

• Target costing uses market-based prices to determine

whether products and services can be delivered at costs
low enough for an acceptable profit.
• Competitors’ products are reverse engineered to better
understand the manufacturing process and product
design.
• Product and manufacturing process are then redesigned
so that product meets a pre-specified target cost.

Target costing Kaizen costing

• Target costing performs best in the following situations. • Kaizen costing:

• Product development and design phases are long and
complex.
• The production process is complex.
• The market is willing to pay for differences in quality
or function.
• The manufacturer can push some cost reduction onto
suppliers and subcontractors.
• The manufacturer can influence design of subparts.
• is continuous improvement in product cost, quality
and functionality
• occurs after product has been designed and first
production cycle is complete.
• After targeted cost reduction goals are set, each
department is assigned responsibility for specific
reduction amounts.

Kaizen planning process for revenues and

Target costing compared to kaizen costing
costs
 Life cycle costing Life cycle costing

• Life cycle costing is: • Life cycle costing is:

• a decision-making method that considers changes in
price and costs over the entire life cycle of a good or
service
• used when the initial product is produced and sold at
a loss, but accountants and managers anticipate that
a combination of continued sales volumes and cost
reductions over time will lead to profits in the long
term
• used to focus managers’ attention on the high
development or decommissioning costs during the
product and manufacturing design phase to
encourage them to manage all of these costs as they
develop new products.

Price management: pricing methods Price management: pricing methods

• Cost-based pricing: • Cost-based pricing can be used in many contexts

• Cost-based prices are determined by adding a mark- including tender bid pricing.
up to some calculation of the product’s cost. • Various strategic factors influence the mark-up for
• The cost base can be calculated in various ways, for tender bids.
example, variable cost, average cost including fixed
and variable costs.
• Mark-up rates may originate from general industry
practice or be found in trade journals.

Market prices, product differentiation and

Price management: pricing methods
degree of competition

• Market-based pricing:
– Market-based prices are determined using some
measure of customer demand.
– Managers strive to identify what customers are
willing to pay.
– Market prices are influenced by degree of product
differentiation and competition.
 Price management: pricing methods
• Under market-based pricing, organisations with
differentiated products can formally/informally
incorporate consumer demand into their pricing policies.
• As prices increase, demand usually falls. This sensitivity
of sales to price increases is called the price elasticity of
demand.
• To develop a price that maximises profit:
1. calculate the price elasticity of demand
2. determine the profit-maximising price.
Price management: pricing methods
• Under market-based pricing:
• historical information is used to estimate the effects of
price changes on sales volume
• the quality of product demand estimates using
historical data depends in part on sales volumes.
• Other market-based pricing methods include using
competitors’ prices to establish own market prices and
using online auction websites for difficult to value
products.
Other influences on price
• Peak load pricing is the practice of charging different
prices at different times to reduce capacity constraints.
• Price skimming occurs when a higher price is charged
when product or service is first introduced.
• Penetration pricing refers to setting low prices when
new products are introduced to increase market share.
• Price gouging is the practice of changing a price viewed
by customers as too high.
• Transfer prices are prices charged for transactions that
take place within an entity.
Computing the profit-maximising price
Cost-based versus market-based pricing
• Cost-based pricing is more common.
• Major drawback is that it ignores customer demand.
• Sales volumes inappropriately influence price, causing
downward demand spiral.
• Prices calculated from readily available cost data.
• Market-based prices lead to better decisions about sales
volumes.
• But it’s difficult to estimate market demand and
prices.
Pricing in not-for-profit entities
• Pricing methods in not-for-profits tend to be more
complex than for-profit entities because major concern is
not profit maximisation.
• Grants, donations and interest from endowments help to
defray costs; therefore, not-for-profits do not always
expect to recover all their costs from prices or fees.
• Prices/fees charged may be based on:
• client’s income (sliding scale)
• achieving organisational goals.
Government regulations, ethics and pricing Government regulations, ethics and pricing

• In Australia illegal pricing practices include:
• Price discrimination: the practice of setting different
prices for different customers.
• Predatory pricing: the deliberate act of setting prices
low to drive out competitors and then raising prices.
• Collusive pricing: when two or more firms conspire to
set prices above a competitive price, which harms
consumer welfare.
• Dumping: when a foreign-based entity sells products
in Australia at prices below the market value in the
country where the product is produced and the price
could harm an Australian industry.
• In Australia illegal pricing practices include:
• price discrimination: the practice of setting different
prices for different customers
• predatory pricing: the deliberate act of setting prices
low to drive out competitors and then raising prices
• collusive pricing: when two or more firms conspire to
set prices above a competitive price
• dumping: when a foreign-based entity sells products in
Australia at prices below the market value in the
country where the product is produced and the price
could harm an Australian industry.

Summary

• Explain the value chain activities that provide for

continuous cost improvement.
• Explain the concept of customer profitability analysis and
suggest qualitative factors for inclusion in a strategic
customer analysis model.
• Understand target costing principles and techniques.
• Communicate the concept of kaizen costing and explain
how it compares to target costing.
• Describe the characteristics of life cycle costing.
• Evaluate pricing methods and describe how cost-based
prices and market-based prices are managed.