KNES 472 Lecture Notes - Lecture 6: Variable Cost, Dynamic Pricing, Predatory Pricing
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Please help me make 2 additional alternative courses of action, kindly state at least one advantage and one disadvantage of each alternative.
Example; Analyn can fully improve the pricing system by introducing cost-based pricing where the price includes the cost of ingredients and cost of operating the business.
Thereby:
⢠include a profit percentage with product cost
⢠add a percentage to an unknown product cost
⢠blend of total profit and product cos
I. SYNTHESIS
Refreshing beverages such as fruit shake and smoothies have become the quickest way to beat the heat, especially during dry season. Over the last two years, Pearly Shake has become known as a quench thirst for people living near Galas Market. Acclaimed to be the only flavored shake business located in the area with its affordable beverages ranging from â±25.00 for the regular size shake and â±30.00 pesos for large size shake with a topping of your choice. According to Ms. Analyn Lim, owner of Pearly Shake, her business makes â± 15,000 to â±17,000 average sales per day. Pearly Shake offers variety of flavors (in powdered form) such as bubblegum, double-dutch, strawberry, vanilla, chocolate and ube.
As what the owner have said âa micro-scale business do not require much investment, an entrepreneur can start his own business with a small capital. Nowadays, customers have high tend to consumption product of milk and sugar but they have few choices to choose from so I set-up Pearly Shake try to create the demand for my customersâ.
In addition, Analyn Cheng employs three personnel for her business. She pays them â± 250.00 per day inclusive of free breakfast, lunch, and dinner. The establishment is open from 10:00 am to 7:00 pm, Monday to Sunday. Ms. Cheng usually travels from Galas Quezon City to Divisoria, once a month to buy powdered shake flavors, straws, plastic cups, sugar, cream, whole milk.
II. OBJECTIVES
⢠To create a strong product awareness.
⢠To achieve an increasing number of loyal consumers.
⢠To maintain a positive, strong growth of the micro-enterprise each year.
III. POINT OF VIEW
This final paper will take the point of view of Pearly Shakeâs owner, Analyn Cheng.
IV. STATEMENT OF THE PROBLEM
This paperâs approach emphasizes the importance of CVP analysis and how it ties directly into planning and control processes management must take in order to manage a successful business.
This paper seek to answer the question: How can Ms. Cheng fully improve the its pricing system?
V. GUIDE QUESTIONS
QUESTION: Using the below information, determine the number of shakes that will need to sell to break even.
| DIRECT MATERIAL INGREDIENTS | Small (8 oz. size) | Large (12.oz size) |
| Condensed Milk (â± 41. 50 for 300 mL) | 20mL or 0.676 fluid ounce | 30 mL or 1.017 fluid oz |
| Sugar (â±500.00 for 15 lb bag = 30 cups) | 1/2 cup of sugar | 3/4 cup of sugar |
| Flavorings | .25 per shake | .40 per shake |
| Specialty Straws | .75 straw | .75 straw |
| Cups (100 8 oz. cups at a cost of â±150.00) | ||
| Cups (100 12oz. cups at a cost of â±185.00) | ||
| Fixed cost: | ||
| Rent : â±5,000 a month | ||
| Cleaning and other miscellaneous supplies | â±2,000 a month | |
| Equipment: Industrial Milk Shake Maker: | â±2,500 per machine X 3 machine = â± 7,500 | |
| Equipment: Refrigerator : â±4,500 | ||
| Licenses and permits: â±1,050 a year | ||
| Owner's salary: â±180,000 a year | ||
| Employees | ||
| Three full-time employees: each receiving a daily salary of â±250.00 Sales Mix: Large 60% , 40% small sized shake | ||
Computation of Variable Cost per Unit :
| Small | Large | |
| Condensed Milk | 2.77 | 4.15 |
| Sugar | 8.33 | 12.50 |
| Flavorings | 0.25 | 0.40 |
| Speciality Straws | 0.75 | 0.75 |
| Cup | 1.50 | 1.85 |
| Direct Material Cost per Shake | 13.60 | 19.65 |
Contribution Margin per Unit :
| Selling Price per Shake | 25 | 30 |
| Variable cost per Shake | 13.60 | 19.65 |
| Contribution Margin per unit | 11.40 | 10.35 |
Total Fixed Cost per year :
| Employee Salary ( 250 x 3 x 365 ) | 273,750 |
| Owners Salary | 180,000 |
| Licenses and Permits | 1,050 |
| Rent | 60,000 |
| Cleaning and other supplies | 24,000 |
| Depreciation ( 7,500 + 4,500) | 12,000 |
| Total Fixed Cost per Year | 550,800 |
At break-even point, Total Contribution Margin = Total Fixed Cost
Let the break-even quantity be Q.
Since the sales mix is 60 % large and 40 % small, the equation can be expressed as,
11.40 x 0.4 Q + 10.35 x 0.6 Q = 550,800
or 4.56 Q + 6.21 Q = 550,800
or 10.77 Q = 550,800 or
Q = 51,142 shakes.
Small shakes: 51,142 x 40% = 20,456.8
Large shakes: 51,142 x 60% = 30,685.2
In value terms, break-even point :
Small shakes : 20,456.8 x 25 = 511,420
Large shakes : 30,685.2 x 30 = 920,556
Total break-even sales = â± 1,431,976
CONCEPTUAL FRAMEWORK AND AREAS OF CONSIDERATION:
The researcher will be using SWOT analysis in assessing the businessâs status.
| SWOT | PEARLY SHAKE |
| STRENGTHS | Strong existing distribution channel Brand strengths and uniqueness |
| WEAKNESSES | Unavailability of some flavorings. Lack of segregation of duties with regards to the different functions of the business. |
| OPPORTUNITIES | Brand is attractive to consumers The location of the business is in a crowdy place. |
| THREATS | Downward Price Pressure Brand susceptibility |
In this study, there are factors which influenced the earning of profit is the level of production (i.e., volume of output). Cost-volume-profit (CVP) analysis examines the relationship of costs and profit to the volume of business to maximize profits. There may be a change in the level of production due to many reasons, such as competition, introduction of a new product, trade depression or boom, increased demand for the product, scarce resources, change in selling prices of products, etc. In such cases management must study the effect on profit on account of the changing levels of production. A number of techniques can be used as an aid to management in this respect.
One such technique is the cost-volume-profit analysis. The term cost volume profit analysis is interpreted in the narrower as well as broader sense. Used in its narrower sense, it is concerned with finding out the âcrisis pointâ, (i.e., break-even point) i.e., level of activity when the total cost equals total sales value. In other words, it helps in locating the level of output which evenly breaks the costs and revenues. Used in its broader sense, it means that system of analysis which determines profit, cost and sales value at different levels of output. The cost-volume-profit analysis establishes the relationship of cost, volume and profits.
ALTERNATIVE COURSES OF ACTION
To properly cite the correct pricing strategies of the business, Analyn will be addressing a lot of problem of that she is facing. To help her address these issues, the researcher has come with the following alternative courses of actions:
Alternative Courses of Action 1: Analyn can fully improve the pricing system by introducing cost-based pricing where the price includes the cost of ingredients and cost of operating the business.
Thereby:
⢠include a profit percentage with product cost
⢠add a percentage to an unknown product cost
⢠blend of total profit and product cost
CASE 2B â MENDEL PAPER COMPANY
Mendel Paper Company produces four basic paper product lines atone of its plants: computer paper, napkins, place mats, and posterboard. Materials and operations vary according to the line ofproduct. The market has been relatively good. The demand fornapkins and place mats has increased with more people eating out,and the demand for the other lines has been growing steadily.
The plant superintendent, Marlene Herbert, while pleased withthe prospects for increased sales, is concerned about costs:
"We hear talk about a paperless office, but I haven't seen ityet. The computers, if anything, have increased the market forpaper. Our big problem now is the high fixed cost of production. Aswe have automated our operation, we have experienced increases infixed overhead and even variable overhead. And, we will have to addmore equipment since it appears that we need even more plantcapacity. We are operating over our normal capacity as it is.
The place mat market concerns me. We may have to discontinueprinting the mats. Our specialty printing is driving up thevariable overhead to the point where we may not find it profitableto continue with that line at all."
Cost and price data for the next fiscal quarter are asfollows:
|
|
|
| |||||
| 30,000 | 120,000 | 45,000 | 80,000 | ||||
| 14.00 | 7.00 | 12.00 | 8.50 | ||||
| 6.00 | 4.50 | 3.60 | 2.50 |
Variable overhead includes the cost of hourly labor and thevariable cost of equipment operation. The fixed plant overhead isestimated at $420,000 for the quarter. Direct labor, to a largeextent, is salaried; the cost is included as a part of fixed plantoverhead. The superintendent's concern about the eventual need formore capacity is based on increases in production that may reachand exceed the practical capacity of 60,000 machine hours.
In addition to the fixed plant overhead, the plant incurs fixedselling and administrative expenses per quarter of $118,000.
"I share your concern about increasing fixed costs," thesupervisor of plant operations replies. "We are still operatingwith about the same number of people we had when we didn't havethis sophisticated equipment. In reviewing our needs and costs, itappears to me that we could cut fixed plant overhead to $378,000 aquarter without doing any violence to our operation. This would bea big help."
"You may be right," Herbert responds. "We forget that we havemore productive power than we once had, and we may as well takeadvantage of it. Suppose we get some hard figures that show wherethe cost reductions will be made."
Data with respect to production per machine hour and thevariable cost per hour of producing each of the products are givenas follows:
Computer Paper | Napkins | Place Mats | Poster Board | |
Units per hour | 6 | 10 | 5 | 4 |
Variable overhead per hour | 9.00 | 6.00 | 12.00 | 8.00 |
"I hate to spoil things," the vice-president of purchasingannounces. "But the cost of our materials for computer stock is nowup to $7. Just got a call about that this morning. Also, place matmaterials will be up to $4 a unit."
"On the bright side," the vice-president of sales reports, "wehave firm orders for 35,000 cartons of computer paper, not 30,000as we originally figured."
Questions:
1. From all original estimates given, prepare estimatedcontribution margins by product line for the next fiscal quarter.Also, show the contribution margins per unit.
2. Prepare contribution margins as in part (1) with allrevisions included.
3. For the original estimates, compute each of thefollowing:
a. Break-even point for the given sales mix.
b. Margin of safety for the estimated sales volume.
4. For the revised estimates, compute each of the following:
a. Break-even point for the given sales mix.
b. Margin of safety for the estimated sales volume.
5. Comment on Herbert's concern about the variable cost of theplace mats.
Aside from cost-based system pricing , what better method is appropriate for this case, state reason why.
I. SYNTHESIS
Refreshing beverages such as fruit shake and smoothies have become the quickest way to beat the heat, especially during dry season. Over the last two years, Pearly Shake has become known as a quench thirst for people living near Galas Market. Acclaimed to be the only flavored shake business located in the area with its affordable beverages ranging from â±25.00 for the regular size shake and â±30.00 pesos for large size shake with a topping of your choice. According to Ms. Analyn Lim, owner of Pearly Shake, her business makes â± 15,000 to â±17,000 average sales per day. Pearly Shake offers variety of flavors (in powdered form) such as bubblegum, double-dutch, strawberry, vanilla, chocolate and ube.
As what the owner have said âa micro-scale business do not require much investment, an entrepreneur can start his own business with a small capital. Nowadays, customers have high tend to consumption product of milk and sugar but they have few choices to choose from so I set-up Pearly Shake try to create the demand for my customersâ.
In addition, Analyn Cheng employs three personnel for her business. She pays them â± 250.00 per day inclusive of free breakfast, lunch, and dinner. The establishment is open from 10:00 am to 7:00 pm, Monday to Sunday. Ms. Cheng usually travels from Galas Quezon City to Divisoria, once a month to buy powdered shake flavors, straws, plastic cups, sugar, cream, whole milk.
II. OBJECTIVES
⢠To create a strong product awareness.
⢠To achieve an increasing number of loyal consumers.
⢠To maintain a positive, strong growth of the micro-enterprise each year.
III. POINT OF VIEW
This final paper will take the point of view of Pearly Shakeâs owner, Analyn Cheng.
IV. STATEMENT OF THE PROBLEM
This paperâs approach emphasizes the importance of CVP analysis and how it ties directly into planning and control processes management must take in order to manage a successful business.
This paper seek to answer the question: How can Ms. Cheng fully improve the its pricing system?
V. GUIDE QUESTIONS
1. Using the below information, determine the number of shakes that will need to sell to break even.
| DIRECT MATERIAL INGREDIENTS | Small (8 oz. size) | Large (12.oz size) |
| Condensed Milk (â± 41. 50 for 300 mL) | 20mL or 0.676 fluid ounce | 30 mL or 1.017 fluid oz |
| Sugar (â±500.00 for 15 lb bag = 30 cups) | 1/2 cup of sugar | 3/4 cup of sugar |
| Flavorings | .25 per shake | .40 per shake |
| Specialty Straws | .75 straw | .75 straw |
| Cups (100 8 oz. cups at a cost of â±150.00) | ||
| Cups (100 12oz. cups at a cost of â±185.00) | ||
| Fixed cost: | ||
| Rent : â±5,000 a month | ||
| Cleaning and other miscellaneous supplies | â±2,000 a month | |
| Equipment: Industrial Milk Shake Maker: | â±2,500 per machine X 3 machine = â± 7,500 | |
| Equipment: Refrigerator : â±4,500 | ||
| Licenses and permits: â±1,050 a year | ||
| Owner's salary: â±180,000 a year | ||
| Employees | ||
| Three full-time employees: each receiving a daily salary of â±250.00 Sales Mix: Large 60% , 40% small sized shake | ||
Computation of Variable Cost per Unit :
| Small | Large | |
| Condensed Milk | 2.77 | 4.15 |
| Sugar | 8.33 | 12.50 |
| Flavorings | 0.25 | 0.40 |
| Speciality Straws | 0.75 | 0.75 |
| Cup | 1.50 | 1.85 |
| Direct Material Cost per Shake | 13.60 | 19.65 |
Contribution Margin per Unit :
| Selling Price per Shake | 25 | 30 |
| Variable cost per Shake | 13.60 | 19.65 |
| Contribution Margin per unit | 11.40 | 10.35 |
Total Fixed Cost per year :
| Employee Salary ( 250 x 3 x 365 ) | 273,750 |
| Owners Salary | 180,000 |
| Licenses and Permits | 1,050 |
| Rent | 60,000 |
| Cleaning and other supplies | 24,000 |
| Depreciation ( 7,500 + 4,500) | 12,000 |
| Total Fixed Cost per Year | 550,800 |
At break-even point, Total Contribution Margin = Total Fixed Cost
Let the break-even quantity be Q.
Since the sales mix is 60 % large and 40 % small, the equation can be expressed as,
11.40 x 0.4 Q + 10.35 x 0.6 Q = 550,800
or 4.56 Q + 6.21 Q = 550,800
or 10.77 Q = 550,800 or
Q = 51,142 shakes.
Small shakes: 51,142 x 40% = 20,456.8
Large shakes: 51,142 x 60% = 30,685.2
In value terms, break-even point :
Small shakes : 20,456.8 x 25 = 511,420
Large shakes : 30,685.2 x 30 = 920,556
Total break-even sales = â± 1,431,976
VI. CONCEPTUAL FRAMEWORK AND AREAS OF CONSIDERATION:
The researcher will be using SWOT analysis in assessing the businessâs status.
| SWOT | PEARLY SHAKE |
| STRENGTHS | Strong existing distribution channel Brand strengths and uniqueness |
| WEAKNESSES | Unavailability of some flavorings. Lack of segregation of duties with regards to the different functions of the business. |
| OPPORTUNITIES | Brand is attractive to consumers The location of the business is in a crowdy place. |
| THREATS | Downward Price Pressure Brand susceptibility |
In this study, one known factor which influenced the earning of profit is the level of production (i.e., volume of output). Cost-volume-profit (CVP) analysis examines the relationship of costs and profit to the volume of business to maximize profits. There may be a change in the level of production due to many reasons, such as competition, introduction of a new product, trade depression or boom, increased demand for the product, scarce resources, change in selling prices of products, etc. In such cases management must study the effect on profit on account of the changing levels of production. A number of techniques can be used as an aid to management in this respect.
One such technique is the cost-volume-profit analysis. The term cost volume profit analysis is interpreted in the narrower as well as broader sense. Used in its narrower sense, it is concerned with finding out the âcrisis pointâ, (i.e., break-even point) i.e., level of activity when the total cost equals total sales value. In other words, it helps in locating the level of output which evenly breaks the costs and revenues. Used in its broader sense, it means that system of analysis which determines profit, cost and sales value at different levels of output. The cost-volume-profit analysis establishes the relationship of cost, volume and profits.
VII. ALTERNATIVE COURSES OF ACTION
To properly cite the correct costing strategies of the business, Analyn will be addressing a lot of problem of that she is facing. To help her address these issues, the researcher has come with the following alternative courses of actions:
Alternative Courses of Action 1: Analyn can fully improve the cost of Pearly Shake by introducing cost-based pricing where the price includes the cost of ingredients and cost of operating the business.
Cost based pricing is the easiest way to calculate what a product should be priced at. The owner can do it by:
⢠include a profit percentage with product cost
⢠add a percentage to an unknown product cost
⢠blend of total profit and product cost
Alternative Courses of Action 2: Retain the pricing system of Pearly Shake.
Making a profit means structuring the business so that it stands out from the competition and offers customers something they canât get anywhere else. It also means paying attention to costs as well as income, avoiding unnecessary expenses and getting creative in seeking new revenue streams, by retaining the same pricing system of Pearly Shake.
Alternative Courses of Action 3: