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• Education – Costing: Inventory Valuation or Decision Making • Direct Costing Vision: How does this benefit me? • Strategy of Price
• Definition of Fixed Costs • Definition of Variable Costs • Definition of Direct Costs • Definition of Contribution Pricing Issue: All costs have a certain degree of “fixed” nature in them.
Education • What is a Direct Cost ? • Is Direct Costing used to value inventory? • Is Direct Costing really Variable Costing? • Who can use Direct Costing? • Is Direct Costing really Activity Based Costing? .
.Manufacturing Overhead .Education • • • All prices are a function of cost Costing mechanics and philosophy are essential for determining price. Full Absorption Inventory Valuation is mandated by the 16th Amendment to the Constitution. making Income Taxes permanent. Full Absorption Costing Cost Elements: .Selling.Materials .Labor . General & Administrative • • Full Absorption Costing is mandatory for most US Federal Contracts. adopted in 1913.
Education • Full Absorption Pricing works well in Stable capacity and pricing markets Government Contracts Cost Plus Contracting Full Absorption Pricing formula: .Material Cost + Mfg Overhead + SG&A + Desired Profit Forecasted Volume to be sold The weakness of Full Absorption pricing is the “Sales Forecast”. .
20 1.50 $ 0.30 2.Education • Material Costs & Labor Costs can generally be tuned to capacity Material Cost Labor Cost Mfg Overhead SG&A Total Cost Profit Margin Price Forecasted Units $ $ 5.00 $ 12.000.50 5.10 1.50 0.20 $ 1.000.70 $ 0.000 .000.00 $ 1.40 0.80 $ 2.20 0.000.50 10.00 $ 4.000 $/Unit 0.000 $/Unit $ 0.00 $ 2.000.80 $ 0.20 $ 0.00 $ $ $ $ $ $ $ 10.
00 5.20 $ 5.80 $ 2.50 Forecasted Units 10.30 Price $ 2.40 $ 0.10 Total Cost $ 1.000 Product B $/Unit $ 1.20 Profit Margin $ 1.Education • Complicating the problem with Sales MIX Product A $/Unit Material Cost $ 0.000 .55 $ 0.50 Labor Cost $ 0.20 Mfg Overhead $ 0.25 $ 0.60 $ 2.40 SG&A $ 0.
Machinery Depreciation Supervisor Salaries & Fringe Sales Salaries & Fringe Company Cars Property Taxes Legal Expense .Education Cost Pools Cost Pools Variable Fixed 85% 15% Mixed 100% 0% 100% 0% 100% 0% 100% 0% 100% 0% 0% 100% 10% 90% Mixed 0% 100% 0% 100% 0% 100% 0% 100% Factory Energy Production Labor Fringe Benefits on P Labor Shop Supplies Lubricants/Oils Production Machine Maint.
Education • • • Direct Costing Solves the Forecasting Problem in Pricing Direct Costing focuses on Variable and Incremental Costs With Direct Costing you will be able to calculate: – – – – – – Floor Price Out of Pocket Price Break Even Price Target Profit Price Most profitable sales mix Profitable Sales Strategies • Direct Costing works well for Service Companies and Mfg Companies .
50 $ 0.000 48% 70% 0% .90 10.00 $ 2.000.000.20 $ 0.00 $ 9.00 $ 5.000.90 $ 1.Education • Direct Costing Solves the Forecasting Problem in Pricing Sales (Prior Year) Material Cost Direct Wages & Fringe Other Direct Costs Total Direct Costs Contribution Margin Fixed Costs (Mfg & SGA) Total Cost Break Even Price Target Price Floor Price (OOP) Forecast Units $ $ 25.00 $/Unit $ 2.000.00 $ 3.00 $ 2.00 $ 16.50 $ 0.60 % SP 100% 20% 8% 8% 36% 64% $ $ $ 1.20 $ 0.20 3.000.00 0.000.00 $ 12.000.000.
Education Direct Costing Model Marketing Corp Parent Operations Corp Parent Sector Mgt Entity Bus. Unit Factory Cost Pool Mfg Cell Data Standards Sector Mgt Entity Bus Unit Market Segment Prod Line Cost Driver P&L Part/Article Number .
Education Driving Pools to the Article Number Cost Pools • • • • • • • Mfg Cell Labor Fringe Benefits Mfg Salaries Building Insurance Quality Labor Dept Shop Supplies Repair & Maintenance by Dept Cost Drivers • • • • • • • • Quantity Produced Kilo’s Produced Kilowatt Hours Machine Hours Labor Hours Square Feet Takt Time Linear Meters .
Education Driving Pools to the Article(Item) Number (Example for a Steel Co) Cell Labor Energy KW Hours Takt Time Kilo’s Item Nbr Item Nbr Annealing Bldg Insur Sq Feet Assy Cell Takt Time Item Nbr .
Traditional Standard Costing @ Item # Level •Used for Inventory Valuation Materials & OSS Labor Mfg Overhead G&A •Material is approximated/driven by the Bill-of-material •Standard Hours are an accurate reflection of labor content •Overheads are traced to Item Numbers by the Labor Content •G&A can be traced to Item numbers by the Labor Content •Inventory Valuation objectives are compatible with pricing objectives. Bill of Material Std Hrs x Std Rate % of Labor % of Labor .
•Fixed Costs are traced to the Pool closest to the Article Number •Direct Costs are built up to the Product Line Level and used in Estimating Materials & OSS Bill of Material Actual Lbr in Cell Overheads to Pools Driven Fixed. Order Selection. Make vs Buy. Semi-Var Cost Driver Data Collection .Direct Costing @ Mfg Cell & Product Line Level •Used for Pricing. Market Analysis •Material is approximated/driven by the Bill-of-material to the Article Number •Labor is pooled at the Mfg Cell Level Labor Driven Direct Costs •Direct Overheads are traced to the Pool closest to the Article Number.
00 70.00 50.00 .00 25.00 10.00 Full 100.00 0.00 10.Education Selling Price/Unit Material Direct Labor Direct Overheads Contribution Margin Fixed Overheads Total Cost Direct 100.00 30.00 10.00 95.00 50.00 10.00 30.
Retail generates 46% of the contribution margin but only 18% of the sales.160 $ $ $ $ $ CM% 15% 50% 80% 76% 46% %CM % Sales 14% 43% 19% 17% 37% 22% 30% 18% 100% 100% In the example mix analysis above. The mix analysis gives a strategic direction to the sales effort. Surprisingly. the OEM market generates 43% of sales but only 14% of the contribution margin. given that market saturation has not occurred.Education Mix Analysis DC CM 350 $ 75 80 $ 100 80 $ 200 80 $ 160 590 $ 535 Market OEM Distributor Direct Retail Total $ $ $ $ $ Sales 500 200 250 210 1. .
00 20.12 $ $ $ $ $ $ $ $ DC$ 10.00 15.00 0.00 20.00 19.50 0.00 15.Education Engineer to Order.50 2.00 17.00 35.00 15.00 40.50 • Make to Order Markets are defined by the process • Design + Rough + Mill + Shape + Paint + Elec + TPS = HOURS • Design + Mill + Paint + Elec +TPS = HOURS .00 162.50 1.00 30. Ship Total Hrs/Unit 1.00 8.00 1.50 30. Make to Order Sequence 10 20 30 40 50 60 70 Process Design Rough Cut Mill Shape Paint Electronics Test. Pack.00 2.00 80.50 $ $ $ $ $ $ $ $ DC$/Hr 10.00 10.
• • • .Education What we gain from Direct Costing Upside • • • • • • • • • Target Price BE Price Floor Price Out-of-Pocket Point Consistent Business Analysis Tool Mix Decisions become easier Facts not Fiction Better Knowledge of our Strengths & Weaknesses Reconciliation of Cost Downside • We must continue to maintain Std Cost for Inventory Valuation Drivers are expensive to collect Requires better training & education in pricing Requires IT systems to work.
. • What is a Fixed Cost? No relationship to Volume.Education • What is a Variable Cost? • 1:1 Relationship with Volume • Is a Variable Cost a Direct Cost? Only if it’s knowable with a reasonable degree of certainty.
Education • What is Contribution? Target Price BE Price Profit Contribution Fixed Costs Unknowable Variable Costs Direct Costs Floor Price (OOP) .
Vision • Cost of Manufacturing • Cost of Distribution • Cost of Service .
Vision Cost to Manufacture Cost to Collect Drivers Horse Power. Direct Factory . Cycle TimeFactor Shots. Mach Hrs HP Connect BTU. Ind Labor Material Cost. Hrs BTU Consumed Coolant Lubricants. Process Man Hours Linear Feet Linear Feet Pool Energy Energy Lubricants Tooling Dir. Energy. Cycles Die Life Man Hours.
Vision Cost to Serve High Cost Order custom products Small order quantities Unpredictable order arrivals Customized delivery Change delivery requirements Manual processing Large amounts of pre-sales support Large amounts of post-sales support Require company to hold inventory Pay slowly (high accounts receivable) Low Cost Order standard products High order quantities Predictable order arrivals Standard delivery No changes in delivery requirements Electronic processing (EDI) (zero Little to no pre-sales support No post-sales support Replenish as produced Pay on time Direct SG&A .
Vision Cost to Distribute High Cost Unique Packaging Special Pallets Heavy Items Bulky Items Requires HVAC Environmentally Hazordous Low Cost Simple Packaging Standard Pallets Light Weight Items Non-Bulky Items Does not require HVAC Environmentally Friendly Direct Distribution Costs .
Market Ceiling Price 4. Other Strategy Information Points: 1. Competitor Position . Market Floor Price 3. Government Intervention 5. Customer Value Chain Analsyis 2.Strategy of Price Direct Costing is only one source of Price Strategy information.
Economic Value or Alternate Products Strategic Pricing Freedom Specialty Products • Where will price move given demand. cost.Strategy of Price Hi • Price Point vs. & capacity Commodity Products Low Low Competitive Intensity Hi .
Commodity Product Underestimation of competitor capabilities and desires Lack of understanding of current point on the demand curve . Competition Too little emphasis on exploiting product/service attribute advantages vs. Skim Pricing Focus on Profit %’s vs. competition Failure to identify product-specific or customer-specific costs (Cost to Serve) Low price on System.Key Strategies & Blind Spots Value Positioning vs. Component/Svc Profits Product Positioning & Cannibalization due to price Risks of a destructive competitor response to a new price initiative Penetration Pricing vs. Profit $…Specialty vs. High price on replacement parts & service (or vice versa) Understanding of Costs Balance System Profits vs.
Strategy What does the customer value? Competitive Advantage Us Them Good Excellent Good Poor Excellent Good Good Good Good Excellent Good Poor Excellent Good Excellent Poor Poor Good Excellent Poor Good Good Good Poor Good Excellent Excellent Poor Poor Good Poor Good Good Poor Excellent Excellent Excellent Poor Customer Values Product Downtime Reduction Material Savings Labor Sav ings Low Failure Potential Inventory Immediate Parts Av ailability Time saved in sourcing Sales Service Ready access to source Ability to ID parts for task Regular Bin Maintenance Minimized Paperwork Relationship w/Sales Staff Ability to solve order errors Ability to solve product problems Customer Service Regular Deliv eries On Time Deliveries No Credit Delays Billing Convenience Packaging fits inventory system Emergency Delv Capability y .
Strategy Customer Transparency Price Elasticity Customer Price Sensitivity Low Same or Higher Price Lower prices may not buy more business Higher Price Lower prices may not buy more business High Lower Price Lower prices will get business without competition seeing it Status Quo Lower price may move the market down Higher price may result in lost business Low High .
Strategy Price change timing Cost vs Competition Low Strong Meet Price Decrease quickly (3 weeks) High Meet Price decrease quickly to protect share (1 Week) Market Share Meet price increase quickly (1 week) Meet Price decrease grudgingly (2 months) Follow price increase quickly (1 week) Weak Increase price grudgingly (3 months) .
Direct Costing Implementation Educate Leadership Create Sector Deployment Teams Identify IT System Deficiencies Establish Centralized Reporting System Develop Sales Mgt Scorecard .
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