Reforms in the Costing and Pricing Techniques - Essay Example

The Finance Director Management Trainee Reforms in the Costing and Pricing Techniques Introduction This report deals with the reforms in the costing process of the company in order to maximize the profits of the company through introduction of new costing methods which can reduce the cost. Background Our company, Enzymes Limited, is one of the leading manufacturers of surgical instruments and equipments in the United Kingdom. The company is experiencing a rise in demand of its products over the past few years in the areas of both private and public sectors. Despite the fact that the company has renewed a 3 year contract with the National Health Services (NHA) in previous March, the company foresees a reduction in the spending of the public sector in the future, due to which the business will be adversely affected. In order to deal with the crisis at hand and to keep with the competition, the company has taken up the decision to focus more on the new costing and pricing techniques to keep their focus on the customer and on maximization of the profit through cost reduction. Evaluation of Traditional Methods and Suggesting new The company uses the traditional costing methods to base the cost of their surgical equipments which are quite outdated and are therefore show a lesser profit as compared to the new costing methods which can help a company to maximize their profits. Shortcomings of traditional methods: The currently used traditional costing methods have certain shortcomings which are discussed below: The traditional method used by the company does not focus on the reason for the occurrence of the cost i.e. whether the cost is directly linked with the production of the equipment or the cost is merely an overhead cost. (Exact Cost n.d.) Therefore, the cost is incorrectly charged to the product which decreases the profit margin for the company. It does not differentiate the cost on the basis of their use. As a certain material used in the production of equipment may be more costly than the other but is required in a limited quantity while the other may be cheaper but required in huge quantity. The traditional methods absorb the indirect costs in to the cost of the direct costs on a basis in which it cannot be understood about the product to which the cost relates to. Costs cannot be properly allocated on the basis as to which department has provided the maximum amount of service to the particular department and the large amount of cost may be allocated to a department which has provided no service at all thus increasing the cost of that particular equipment. Suggestion of alternative method: In contrast with the traditional costing methods which have certain deficiencies, a modern costing method can be used. This method is known as Activity Based Costing (ABC). Some points regarding this method are discussed in detail below: This method is based on the actual costing of a particular department as people who are connected to the department are involved in the costing process extract the data of cost to be allocated and allocate the cost to the production or service department as per the level of service provided. As the name suggests, it allocates the cost according to the level activity performed by the department. Since the costs are properly allocated to the respective departments in the correct proportion, therefore the company can look forward to more efforts where they can reduce the cost of those materials and services which are not generating enough profit for the company. (Value Based Management 2010) It keeps an eye on the level of stock for the company as material which is expensive but is used in less quantity for the production is kept in stock according to the level of need of the department. Life cycle costing and Target Costing Life cycle costing and target costing can also serve as an approach to reduction of cost for the company. Life Cycle costing: Life cycle costing is a costing technique that calculates the future cost which would be required to be incurred to be calculated by keeping in view the time value of the money. (Dhillon n.d.) It can be understood that the value held by a certain sum of money would not be the same in the coming years as the value of money deteriorates with the passage of time. There are a number of ways through which Life-Cycle costing can prove to be beneficial for the company in the production of surgical instruments: Life cycle costing takes under consideration all the initial costs related to production as well as the costs which would be incurred during the period of production, therefore the company would be able to keep a watch at the future cots of the equipments. A discount rate is used for calculations of the Present Value of the costs that would be incurred in the future, due to which all the effects of the inflation are properly accounted for during the initial process and a more accurate cost can be quoted for the sale of the equipments to the buyer thus reducing the total cost. Energy and other overhead costs are calculated at the initial stage which saves a lot of expenditure from the company point of view which helps in forecasting and correct evaluation. (Photo voltaics 2002) Target Costing: Target costing is a costing technique which is used to diminish the cost of a product over its life cycle by the management as a tool. The management of a company can utilize this technique to not only meet the profit targets of the company but also the demands of the customers. (Sakurai 2001) There are a number of methods as to how target costing can be used as a cost redution tool: In contrast with the traditional costing methods, target costing determines the cost of the product on the basis of the design of the product then includes the mark-up to it and establishes a price of the product. In short, it sets up a selling price after deduction of the companys target income to predict the cost. The target costing approach pays attention towards the cost reduction process at the planning and design stage of the product, in our case the surgical equipments, to which certain cost reduction methods are used such Material Requirement Planning, Just-in-Time and Value Engineering etc. Target costing focuses on an approach which is proactive in nature i.e. it determines at the planning and design stage whether the production of a certain good would yield a profit which is more suitable approach for a Assembly oriented Industry. (Management & Accounting Web 2001) Pricing Techniques to charge the customers There are several pricing techniques that the company may use to charge its customers for the surgical equipments it manufactures, four of which are discussed in detail. Economic pricing: This is one of the basis strategies of pricing a product i.e. to charge an economical price to its customers despite the rise in demand of the product. Through this marketing strategy, the price of the equipment can be kept low and made the equipment affordable to the private customers as well. This will help the company to gain a healthy market share and the company can also survive other competitors in the market. Economic pricing is the most common pricing strategies in the market which is carried out by keeping the marketing and other selling costs low in order to maintain the level of profit. This way the company can also gain an edge in the market where the other competitors are still selling their products at the standard price. Value-based pricing: This is one of the methods which the company may employ to charge its customers on the equipments sold. Through this pricing strategy, the company can charge a price according to the value the product creates for its customers. (Entrepreneurs 2009) Let us consider an example, if the surgical equipment saves a certain amount to the users of the equipment, then the company can charge an extra amount below it to is customers which the customers would be happy and eager to pay. The motive of keeping this kind of a price is to charge the customers not for the cost of the product including the profit but to charge the customers for the value of the product delivered to them. This pricing method is also dependent of what value does the product have to the customers and the price that they will be happy to pay in order to purchase the product. This value can be determined by many methods, which can be Surveys, Economic Value Estimation etc. In short, this pricing technique is very useful in situations where there is an excess demand for the product with a rise in the competition and the customers are willing to pay for it. Target-return pricing: The company can also use this pricing technique to charge the customers of their surgical instruments. This is the pricing strategy in which the company may set a target return on their investment to a certain percentage or ratio according to the profit margin that the company is willing to attain. (Entrepreneurs 2009) The company having a certain target in their mind about the profit margin to be attained can set a certain Return-on-Investment target and then raise the price over cost to such a point that the required profit margin can be achieved by the company for that period. If certain equipment costs £1,000 to the company and the company is willing to attain a profit margin of 25%, then the company can charge the customers a certain amount over the cost which would make the target return for the company. This way, the company would be able to maintain the profit margin for all their surgical equipments. Multiple Pricing Strategy: Another powerful strategy which is usually used by the companies all over the world is the multiple pricing technique. It has a two way effect on the sales and the customers also feel privileged. Through this pricing technique, the company sells more than one product along with another at a nominal price to the customers. (Retail 2009) For instance, if the current market price of a certain cardiac ring is £1,500 then the company may sell a combo of these products at a lump sum price which is also affordable to the customers and does not make the company lose any profit. The cost of both the products is absorbed in to one another which makes it easier for the company to make a greater profit by combining a less profit generating product with the one that has a greater profit margin without losing the potential customers. Conclusion Due to the current demand for the surgical equipments, the fact that company needs to be innovative and to remain in competition with its rivals and other companies, the company has to be more focused on its costing and pricing strategies such that it comes of rather stronger and more innovative that any of its rivals. The suggestions given above will help the company to design a better strategy in order to sell its surgical equipments at an attractive price with greater profit margin. Works Cited Dhillon, D.H. Life cycle costing: techniques, models, and applications. Grodon and Breach Science Publishers. Entrepreneurs. 2009. http://entrepreneurs.about.com/od/salesmarketing/a/pricingstrategy_2.htm. Exact Cost. http://www.exactcost.com/Traditional_Costing_vs_Activity_Based_Methods. Management & Accounting Web. 2001. http://maaw.info/ArticleSummaries/ArtSumSakurai89.htm. Photo voltaics. 2002. http://photovoltaics.sandia.gov/docs/LCcost.htm. Retail. 2009. http://retail.about.com/od/marketingsalespromotion/a/product_pricing.htm. Sakurai, M. "Target costing and how to use it." 2001: 39-50. Value Based Management. 2010. http://www.valuebasedmanagement.net/methods_abc.html. Reflective Journal Your name Session date Session number Session topic: Reforms in the costing and pricing techniques What are the things that I read in this session? In this session, I read regarding the traditionally practiced costing techniques and the shortcomings of those techniques. The way these techniques have been reformed and the changes and improvements that have been brought through those strategies. What was the most exciting thing that I read for this session - why was that? The most interesting thing that I read in the session was the different pricing strategies that the companies use to lure the customers in to buying their products and they still manage to keep their profit margin intact. What were the main three things that I learned from this session? The three main things were the improvements in the costing methods, the pricing strategies that have come in place for the relevant industry and ways to use the pricing techniques in order to gain an advantage in the market against the competitors. What were the things that I previously thought were true, but presently know to be wrong? I used to think that when the companies offer discounted prices or offer promotions to the customer, they give up their portion of the profit but that is not true as the companies continue to maintain their profit margin. What was new or unexpected for me in the session? The new ways of pricing of a product those help a company to maintain their different identity from other companies, giving them an extra leverage. What things have I changed my things about, as a result of this session? When a company wants to stay in competition along with maintaining a reasonable amount of profit and market share, they can do so by revising their costing and pricing strategies. One thing which I learned in this session that I may be able to employ in future is the manipulation of costing and pricing strategies in order to maximize profit. I am still irresolute about the ways companies absorb the price of a cheaper product in to an expensive one, without losing their profit margin. Issues that got me involved me a lot, and things I would like to learn in more detail are the pricing strategies for service industries. What I most admired about this session was the learning of application of the costing and pricing strategies on a certain industry along with gaining a practical knowledge of doing so. Miscellaneous exciting facts I learned in this session were the report writing formats which would further help me in the future writing. Read More