Chapter 13Cost-related ConceptsCost BehaviorCost Behavior PatternsSlide 5Slide 6Total CostSlide 8Slide 9Slide 10Overhead Cost AssignmentSG&A ExpensesSlide 13Prices, Profit, and RevenueSlide 15Slide 16Slide 17Slide 18Price/Cost ManagementGoals of Price/Cost ManagementApproachesSlide 22Market-based PricingMarket-based Pricing ApproachesReverse Price AnalysisCost-based Pricing - Non-collaborativeCost-based Pricing - CollaborativeSupplier Pricing IssuesPricing StrategiesSlide 30Pricing VariablesMeasures of Price Management EffectivenessProblems with Traditional Cost AccountingAssigning Indirect CostsCost BehaviorsWhich supplier would you rather do business with?Relationship Between Sales and CostsProduction Cost SchedulesAverage Cost CurveTotal Cost CurvePrice ReductionsWhat Happens to Profit?Slide 43Slide 44Slide 45Slide 46Framework for Cost ManagementGenericsCommoditiesUnique ProductsCritical Products1Chapter 13Strategic Cost ManagementIDIS 424Spring 20042Cost-related ConceptsA cost driver is any factor that affects costs. A change in the cost driver will cause a change in the total costCost management are actions that managers take to satisfy customers while continuously reducing and controlling costs3Cost BehaviorCost behavior refers to the way costs change with respect to a change in an activity level or cost driverTypical cost behavior patterns include:Fixed costsVariable costsMixed costsSemifixed costsSemivariable costs4Cost Behavior PatternsFixed costs are costs that do not change with changes of a cost driverVariable costs are costs that increase directly and proportionately with changes of a cost driverMixed costs are costs that have both a fixed and a variable component5Cost Behavior PatternsSemifixed costs are costs that increase with the level of activity, but by intermittent jumps, rather than continuously Semivariable costs are costs that increase with increasing levels of activity, but not at a constant rate. Can be separated into costs that:increase at an increasing rateincrease at a decreasing rate6Cost Behavior PatternsFixed CostsVariable CostsSemifixed CostsSemivariable Costs7Total CostTotal cost is the sum of all costsTotal costs increase as the volume of production or service increases, while the cost to produce each unit or provide each service decreases8Total CostTotal cost specifics:Total fixed costs do not change with volume increases or decreasesUnit fixed costs decrease as volume increasesTotal variable costs increase with volumeUnit variable costs may or may not change with volume changes9Cost-related ConceptsDirect costs are costs that are related to the cost object and can be traced to it in an economically feasible mannerDirect materials (e.g., raw materials, purchased components, expendable packaging associated with a given product) Direct labor (e.g., all labor traceable to a given product)10Cost-related ConceptsIndirect costs are costs related to the cost object but cannot be traced to it in an economically feasible way. Indirect costs are allocated to the cost object using a cost allocation method (e.g., overhead costs)Indirect costs may have both a fixed and a variable component11Overhead Cost Assignment Three common overhead assignment approaches include:Overhead cost per direct labor hour Overhead as a percent of direct labor costOverhead per machine hour12SG&A ExpensesSG&A expenses that are associated with supporting the interface between buyer and the supplier as well as those expenses that are not directly related to the organization’s primary operations but are required to support these operations13SG&A ExpensesSG&A will typically include:Sales salaries and commissionsAdvertisingAdministrative salariesResearch and developmentSG&A is usually presented as a percentage of annual net sales14Prices, Profit, and RevenuePrice is the amount that a buyer is willing to pay for a given product or serviceProfit is the difference between the total cost to produce a product or service and the selling priceRevenue (sales revenue) is the product of price multiplied by the quantity sold15Cost-related ConceptsSunk costs are those costs already committed to a project or decisionAn economic cost is the value of a good when employed in an alternative use. For example, specialized tooling used for a discontinued project that has no other alternative use or scrap value has an economic cost of zero16Cost-related ConceptsDifferential costs refer to cost differences between two or more decision alternativesControllable costs are those costs under the direct control of a manager. A manager should be accountable for only those cost items that he or she has the ability to control17Cost-related ConceptsDiscretionary costs include any cost that can be avoided in the short termContinued cost avoidance, however, can result in the deterioration of a firm’s competitiveness or contribute to higher long-run costs18Cost-related ConceptsRelevant costs include only those costs having a direct impact on a decisionRelevant costs have three necessary characteristics:They must be differential (costs associated with two or more decision alternatives are different or unique)Future oriented (costs will not occur until after the decision is made concerning how to proceed)Quantifiable19Price/Cost Management Price analysis examines price proposals without examining elements of cost and profitCost analysis addresses actual or future costs20Goals of Price/Cost ManagementDevelop accurate price/cost information to enhance negotiating effectivenessDrive continuous price/cost improvementEffectively beat out the competitionDetermine type of supplier relationship21ApproachesPrice/Cost Management ApproachesMarket Based Pricing Cost Based PricingNon-collaborative Collaborative22ApproachesMarket-Based Pricing The price the buyer pays is not linked to the supplier's cost structureCost-Based Pricing The price the buyer pays is directly linked to the supplier's cost structureHybrid Some elements of cost may be known by the buyer23Market-based PricingBased on supply and demandSuppliers and buyers determine the price according to what either suppliers are asking or buyers will offerDollarsSupplyDemandBuyer's MarketSupplier's MarketVOLUMEPRICE24Market-based Pricing ApproachesMarket testing