Models and Concepts on Pricing Decision - Essay Example

Finance and Accounting Table of Contents Introduction 3 Models and Concepts on Pricing Decision 3 Role of Standard Costing and Variance Analysis in Management Accounting 5 Activity Based Costing System: Advantages and Disadvantages 5 Advantages 6 Disadvantages 6 Evaluation and Analysis 7 Conclusion 8 References 9 Introduction A company whether large or small, has to deal with different type of issues. The issues come in different forms and impact the organization’s operation. However the common issues that a company has to deal with are financial constraints and intense competition within the industry (Sundararajan, 2005). In this context of the study, the company, Manac Plc is presently facing with issues pertaining to the target profits. The target profit of the company is not being achieved and as a result of that it is impacting the entire organization. The company has also adopted several cost cutting methods, which impacted the production and reduced competitive advantage of the firm. The report will mainly focus on three areas of strategic management accounting. In the first part, it will mainly emphasize on the models and concepts on pricing decision. In the second part, the study will primarily focus on role of standard costing and variance analysis in management accounting. The third part is about uncovering the pros and cons of activity based costing. The report will then conduct an in depth analysis of the strategic management accounting. On the basis of that a conclusion will be drawn and some recommendations will be made. Models and Concepts on Pricing Decision The organization is currently dealing or facing challenge pertaining to the issue of profit maximization. The problem is that company is not achieving its target profit. According to several authors, maximization of profit is only possible only when the organizations are able to implement the models and concepts used in pricing decision. Hence before getting further deep into the study, the pricing methods followed by organizations will be uncovered. Every firm from the initial stages of its operation works hard towards the pricing decision. The pricing decision is one of the most essential factors for a company. However at times companies fail to take proper pricing decision and get highly affected by it. In order to cite an example, if the products of a company are priced higher than its competition; it may suffer losses and slow income growth. Such firms ignore the impact of pricing, but later understand when it gets actually affected. Similarly, if the prices of products and services of a company are extremely low, their return of profit will be also low. Hence it is important for every firm that they should consider adopting some of the best models or principles based on which they can make pricing decisions. The model should also satisfy the two objectives of pricing. The first one is to achieve maximum profit and the second objective is to meet the market demand. One of the most common models that are considered by the companies is consumer’s preferences and behaviour. According to this model, it is the consumers who make the purchasing decision and other factors hardly play any role (Heidhues and K’oszegi, 2005). Therefore if the firms closely monitor the buying behaviour of the consumers, companies will be able to take its pricing decisions with ease. For example, if the study of consumer behaviour reflects that consumers prefer products that are priced low, the companies will be able to make the prices of their products low by reducing the overall cost. The next model pertaining to pricing decision of a firm is about the market equilibrium. Market equilibrium is actually a situation considered by the firms while developing the pricing strategies. This is actually the stage where the market demand and market supply overlaps with each other. The market equilibrium (demand and supply) is highly responsible for driving price changes (Vives, 2010). For example, if the price of a 3D TV is low in a particular market, the product will have high demand. On the other hand if the same product has higher price, the demand for the product will be less. Consequently, to make a balance between the supply and demand companies either increase or decreases the price of the products (Evans, 1997). Hence this model of pricing is almost similar to that of the consumer behaviour. The only difference among the two approaches is that consumer behaviour is evaluated on the basis of buying preferences and needs, while market equilibrium solely depends upon the price. The third model is about price stickiness. In this context, the price of products of a firm depends upon their own set prices (Heidhues and K’oszegi, 2005). Such pricing models are mainly utilized by the companies which operate in a monopoly market. However, the intention of the firms towards maintaining price stability is extremely high. This is primarily because of the factor that companies are tied in certain situation which prohibits or resists them to increase price. As the price remains mostly stable, the expectation of the customers increases exponentially, which forces companies to increase price and maintain stability between supply and demand. In this context, the economic activity model is not considered by the organization for pricing their products primarily because of the fact that this model represents an image of inconsistent economic activities and at times it become too much consistent that economists find it difficult to cope up with the external situations. Pricing strategies and distribution are formulated depending on either demand side or consumer behaviour side. It is also important to think over the product that the customer is considering to purchase. Hence organizations should consider and resolve values while developing the pricing decision (Clemen and Gregory, 1995). The notion of pricing is heavily dependent upon the elements such as market condition, and consumer buying behaviour. The aforementioned factors play a major role in pricing strategy of a firm and are also important for consumers to decide whether or not to buy the product. Role of Standard Costing and Variance Analysis in Management Accounting The employment of standard processes in the strategic management accounting such as absorption costing system and standard costing can have huge impact on the managerial cycle of the organization (Mestas, 2005). At the beginning it is essential that variance analysis and standard costing computation remains precise. It is primarily because of the fact that assessment of their roles is important to determine the application process of the entire organization. Standard costing can be defined as a method which is used in accounting process and determines the ways of cost control (Needles, Powers and Crosson, 2010). It takes into account the calculation of the actual variance or the differences and performances. Standard costing measures the activities on the basis of past cost, workers input and estimation of the employees. In addition, it also takes into account the quality and the type of material needed to carry out the production (Drury, 2005). In managerial cycle, the role of standard costing is to plan and develop budgets by considering the factors such as labour, materials, and also monitoring of the production costing. A firm can get the best results from standard costing when the actual data pertaining to cost is collected. Standard costing is primarily utilized by the managers and executives to measure the effectiveness of a firm’s operation. Meanwhile, variance analysis can be defined as the process of calculating the difference between the actual cost and the standard cost (Drury, 2007). Apart from that it is also responsible for identifying the rationale behind their differences. In management cycle, variance analysis plays an imperative role. It helps to control the cost and also identifies certain tasks that overrun the budget of an organization. These are also the key areas which have contributed to the overall profit figure. In addition, when an in-depth analysis of the variance is carried out, managers of the organizations will find it easy to control the cost. The limitations of variance are that it does not avert variance from reoccurring. Variance analysis do not provides the desired result only when the data is not calculated accurately. Activity Based Costing System: Advantages and Disadvantages The activity based costing is a methodology for determining the activities of an organization and allocating cost to each activity. On the other hand the traditional absorption costing directly measures the cost of activity. Most of the firms recommend the implementation of activity based costing as it provides a comprehensive understanding of the cost which emphasizes on the distribution and production process and wasteful supply (Hilton, 2003). However, in general, activity based costing can be portrayed as the modified version of absorption costing system. Many firms make use of activity based costing because it helps firms to address process losses and inadequate cost accounting. In addition, it also helps firms to gain competitive advantages in the field of new product development, product quality, and cost efficient production. The Primary task or function of activity based costing is to allocate or assign the total manufacturing cost of a firm (Edgerly, 1994). Nevertheless, there are advantages and disadvantages for this method of costing. The advantages and disadvantages of activity based costing are detailed below: - Advantages The biggest advantage of activity based costing lies in its accuracy in the costing process. It takes into account the non value activities, and considers the profitability and cost information. Apart from that this method also allows companies to take new and better decision. For example it helps in the process of understanding the concept associated with utilization, allocation and cost. The activity based costing also assist business houses to identify the elapsed business matters like added services and wastes, which some time might turn out as a cause of concern for the business. Hence it large helps companies to monitor the activities and ensure quality control system by implementing costing strategies in the organizational processes and activities. Some of the other advantages of the firm are as follows: - More precise costing of the products and services, SKUs, customers, and distribution channels. Better understanding of the overhead. Easier to comprehend for everyone. Employs unit cost in spite of the total cost Incorporates well with Six Sigma and other incessant development programs Supports performance scorecards and management. Enables costing of procedures, value streams and supply chain. Facilitates benchmarking (Heisinger, 2009). Disadvantages In contrast to the benefits offered by activity based costing, there are some disadvantages as well. The biggest disadvantage of this system is that the system is more time consuming. The data collection process is time consuming. Moreover this system is dependent upon historical data, which has made the implementation and maintenance costly. Activity based costing is highly transparent as well as detailed system and assumes that the benefits from the outcome of costing is proportionate. However in reality, the case always does not remain the same. Some of the other disadvantages of activity based costing are as follows: - Time consuming as compared to other methods. High cost of purchasing, maintaining and implementing activity based system Makes the waste visible which some managers and executives do not want them to be visible (Reyhanoglu, 2004). Evaluation and Analysis The study has identified most of the costing tools and has also highlighted their advantages and disadvantages. Based on the findings from the study, the company, Manac Plc., should consider implementing different strategic management approaches. In order to deal with the arising situation, it is important for the firm to implement the changes. As the financial director of the company, I firmly believe that the root cause of the problem lies internally. The company is presently unable to meet the target profits and it is impacting the whole organization. The situation primarily caused due to the failure of the organization to capitalize on the market situation. Moreover in every business, profit is considered as the only fuel for running the venture. The primary intention of this report is to evaluate the factors which may affect the business cycle and can increase the efficiency of the organization. Apart from that, the purpose is to ensure, the company gains competitive advantage. The pricing of the products must be done by considering different factors. It is recommended that, the company should price the products based on the materials used to assemble the end product. The final pricing should also include taxes, shipping charges, and the total cost of labour (Stiving, 2011). The current market condition and the existing rivalry must be also considered in order to avoid issues pertaining to price stickiness. The analysis of the consumer behaviour, it has been identified that a consumer only buys a products when there is requirement of it. Promoting the products by lowering the prices hardly has any impact on the customers. Hence, to generate more revenue, the idea of lowering the prices and ensure large sales volume is not suitable in this context. The issue needs to be sorted out from the internal environment of the organization. The internal operation of an organization is considered as a part of the strategic management process. Therefore it is better that the company makes use of both variance analysis and standard costing to fix the issue. The principal rationale behind recommending the employment of standard costing is its ability to control cost. In addition, it also determines the root causes of the difference between the actual cost and the standard cost. This will give more confidence to the company, in meeting the waste elimination and cost efficiency requirement. Both of these techniques are functioning towards the attainment of the same objective where they can monitor, manage the production and control the cost. Although there are various limitations for both the techniques, such as they are time consuming and needs full accuracy to get the desired result. However with proper technology, the aforementioned limitations can be reduced. It is important for Manac Plc., to implement costing system in the accounting process. According to me, the company should replace traditional absorption method with the activity based costing. Activity based costing is simple, yet analyzes the factors critically. Activity based costing mainly takes into account the cost of the factors which are essential for production. Apart from that Manac Plc., is highly concerned about the total cost of production which is affecting the net revenue and profit of the company. Therefore based on this, the company should consider using cost-effective model. Conclusion The company, Manac Pls., is presently dealing with reduced profit. Profit is considered as a fuel for running a venture. However, the company was unable to meet their target profit and as a result the entire organization was getting adversely affected. The report has evaluated the factors which are affecting the firm’s profit. The study revealed that due to poor pricing decisions, the company failed to earn desired profit. Through this report it has been suggested that the company should consider using standard costing and variance analysis as these two techniques will help the company to control cost and raise profit. In addition, to gain competitive advantage, Manac Plc., must notify each stakeholders about the company’s objective, formulate sound strategies and employ different techniques. With this approach the company will be able to develop core competency for itself in the long run. References Clemen, R., and Gregory, R., 1995. Creative Decision Making: A Handbook for Active Decision Makers. [pdf] Available at: [Accessed 03 January 2012]. Drury, C., 2005. Management Accounting For Business. 3rd ed. Connecticut: Cengage Learning EMEA. Drury, C., 2007. Management Accounting For Business. 7th ed. Connecticut: Cengage Learning EMEA. Edgerly, D., 1994. Opportunities for Innovation: Pollution Prevention. [pdf] Available at: [Accessed 03 January 2012]. Evans, G., 1997. Economic Models. [pdf] Available at: [Accessed 03 January 2012]. Heidhues, P., and K’oszegi, B., 2005. The Impact of Consumer Loss Aversion on Pricing. [pdf] Available at: [Accessed 03 January 2012]. Heisinger, K., 2009. Essentials of Managerial Accounting. Connecticut: Cengage Learning. Hilton, B., 2003. Cost Estimating and Forecasting in the New Era of Smart Procurement. [pdf] Available at: . [Accessed 03 January 2013]. Mestas, G., 2005. Standard Costing and Variance Analysis. Financial and Managerial Accounting. [ppt] Available at: . [Accessed 03 January 2013]. Needles, B. E., Powers, M., and Crosson, S. V., 2010. Financial and Managerial Accounting. 9th ed. Connecticut: Cengage Learning. Reyhanoglu, M., 2004. Activity-Based Costing System Advantages and Disadvantages. [Online] Available at: [Accessed 03 January 2012]. Stiving, M., 2011. Impact Pricing: Your Blueprint for Driving Profits. Wisconsin: Entrepreneur Press. Sundararajan, N., 2005. Effective Business Communication. Chennai: Sura Books. Vives, X., 2010. Information and Learning in Markets: The Impact of Market Microstructure. New Jersey: Princeton University Press. Read More