Costing & Pricing

Expro 100 Engineering

The Hague November 2013

Martin BitterExportant Consultants Ltd.

Agenda

Costing vs PricingDefinitionsManagerial accountingOverheads + exampleTypes of Cost CalculationsPricingCase

Costing ≠ Pricing

CostingCalculating a cost price:- Pure technical administrative exercise?- No creativity?- No imagination?

Needed: Reliable information and a calculator.

PricingSetting a selling price:- creative marketing exercise- strategic decision

Needed: Market knowledge and a clear strategy !

DefinitionsCosting is calculating a cost price on basis of information and with knowledge of production and logistical processes.

Pricing is the strategic choice at which price a product can be sold in the market.

The pricing strategy is an integral part of the market entry strategy and should be in accordance with all other components of the marketing strategy

There are many different pricing strategies, an exporter should choose the strategy that suits his objectives and targets best.

CostingVariable cost : all cost effected by the size of the production or: cost that go down when sales go down

Fixed cost: cost that are made irrespective of the production

Cost price components?Raw materialsUnit Packing, export packingLabour costOverhead expensesInterest and financing costLabeling/markingPre-shipment inspectionsShipment and insuranceExport documentation etc etc etc…..

Costing is no magic, but a calculation job, requiring knowledge of the production process, capacity and logistics.

Export cost price =

Production cost (fixed and variable)+Overhead (fixed)+(export) Logistics and finance (variable)+(export) Marketing and distribution cost (fixed and variable)

Cost price components defined

Fixed production cost: all production cost not directly related to size of production (depreciation, energy for heating, maintenance, fixed workers)

Variable production cost: directly related to production of certain quantity: (raw materials, accessories, packing materials, labour cost, energy for machines)

Overhead expenses : non-production related fixed cost: (administration, maitenance office building, non production personnel, cars, mortgages, representation)Logistic and finance expenses: transport from factory to harbour, sea or air transport, special packing, insurance, bank expensesMarketing and distribution: agent’s commissions, ware housing, promotion, service, trade fair, travelling, brochures

Management Information?

Managerial Accounting (Cost or Management Accounting)

provides information to managers to direct and control operation. In contrast, financial accounting is concerned with providing information to shareholders, creditors, and others who are outside an organization.

Managerial accounting provides the essential data with which the organizations are actually run. Managerial accounting is also termed as management accounting or cost accounting.

Overheads defined

all costs found on the Profit & Lost statement except for direct labor, direct materials, and costs attributable to outside subcontractors that can be billed directly to a customer's account.

Overhead expenses include accounting, advertising, depreciation, indirect labor, insurance, interest, legal fees, rent, repairs, supplies, taxes, telephone, travel and utilities.[1]

Overheads definedOverhead expenses are absorbed by the business and factored into the selling price as a percentage of the direct labour cost. They include indirect costs such as accounting, advertising, depreciation, indirect labour, insurance, interest, legal fees, rent, repairs, supplies, taxes, telephone, travel and utilities.

Calculating the Overhead %in relation to direct labour value

Find the "average" hourly wage paid for direct labour

Find the "average" hourly wage paid for direct labour

Estimate direct labour workdays available

Estimate direct labour workdays available

Estimate billable direct hours for work year

Estimate billable direct hours for work year

Estimate billable direct labor value for work year

Estimate billable direct labor value for work year

Calculate the annual overhead percentage rel. to direct labour value

Calculate the annual overhead percentage rel. to direct labour value

Estimate all overhead expenses for year incl. non-billable direct labour

Estimate all overhead expenses for year incl. non-billable direct labour

Estimate non-billable direct labor value for the work year

Estimate non-billable direct labor value for the work year

Overheads example

Company income statementCompany revenue

Turnover 14,260,000

Company expendituresCost of raw materials 10,000,000cost for prod & services

prod. related 2,000,000non prod. rel. 600,000

salariesprod. Related 336,000non prod. rel. 144,000

depreciationprod. Rel. 300,000non prod. rel. 220,000

========

Earnings before interest and taxes EBIT 660,000

Abbrev. Pay rollIndirect wages 144,000Production related wages 336,000

(16 direct employees, working 36 hrs per week)

Work year: 52 weeks of 36 hrsHoliday: 25 daysPublic holidays 10 daysAv sick leave: 10 days Training and other activities 4 daysWork day = 8 hours, 1 hr spent on non prod work

The % !!Av hourly direct wages: 336,000 / (16x52x36) = 11.22

Available direct labour days: 52 x 4.5 – 25-10-10-4= 185 per man

Billable direct hours185x(8-1) = 1295 per man

Billable direct labour value1295 x 11.22x16 = 232,480

Non-billable direct labour value =total availabe working hours (52x5x8) – billable(1295) = 785 x 11.22 = 8,807 x 16 =141,000

All overheads: 600+144+220+141= 1,105,000Annual overhead %: 1,105,000 / 232,480= 4,75

1. Variable/Marginal/Direct costing

2. Absorption costing3. Activity Based Costing

Types of cost calculation

1. Variable/Marginal/Direct costingis a system under which those costs of production that vary with output are treated as product costs. This would usually include direct materials, direct labor and variable portion of manufacturing overhead. Also regarded as the cost of producing one additional item

Types of cost calculation

Total costs home

market

100 200 300 400 500 600 700 Sales Volume

7

6

5

4

3

2

1

Turn-over

Fixed costs will be covered after + 375 units have been sold. For special one-time orders abroad: calculate only the export variable costs + profit.

Marginal costing : assume Fixed costs will be covered by home market sales

Fixed costs

Variable Costs

Variable

costs export

Home market sales

Export sales

Marginal costing: no margin

Margin added

2. Absorption costing (or full costing system):is a system which treats all costs of production as product costs, regardless whether they are variable or fixed.

absorption costing allocates a portion of fixed manufacturing overhead cost to each unit of product, along with the variable manufacturing cost.

Types of cost calculation

3. Activity Based Costing

all costs are allocated according to the amount of activity and resources needed to sell/produce a product.

Types of cost calculation

3. Activity based Costing

Activity-Based Costing (ABC) is a method of assigning the organization's resource costs through activities to the products and services provided to its customers.

It is generally used as a tool for understanding product and customer cost and profitability.

ABC has predominantly been used to support strategic decisions such as pricing, outsourcing and identification and measurement of process improvement initiatives.

Can a Cost Price be manipulated?YES

When exporter is not competitive in specific export market:

shifting fixed cost.

Fixed production cost and overhead are absolute amounts.

If local market sales cover all fixed cost and overheads,

these cost can be omitted from export pricing

PricingSetting a selling price:- creative marketing exercise- strategic decision

Needed: Market knowledge and a clear strategy !

Pricing...• Creative marketing exercise

by marketing manager.• Is taking decision what price

to quote in market.• Marketing manager decides

on price levels.• Domestic sales: may decide to undercut competition by 5%

without calculation. (little competition)• Export sales needs consideration of:

• Market segment• Promotional activities to penetrate segment• Price levels comparable competing products• Anticipation of strike back from competition• High price/max profits or lower price/growing market share• Total strategy• Actual cost price

Pricing - methodsCost-plus, cost price plus margin: disadvantage: may be very different from price that could be obtained in the export segment, or is simply too high.

Cost-plus is used by companies without market information: change quickly.Profit oriented pricing: profit percentage or absolute profitTurnover oriented pricing: sets amount of turnover to be achieved, turnover has higher priority than priceSurvival strategy: temp. oversupply strong competition: weak companies disappear, strong companies survive, depends on profits that are made in other markets, or if no other profitable market on financial stamina.

Pricing – methods continuedCompetition oriented pricing: discourage competition to enter market or relate prices to market leaderImage oriented pricing: pricing has to be in accordance with image of product.Variations:• Enter very low (penetration and try to raise over time, in

combination with turnover oriented)• Enter very high: get image of high quality, technologically

advanced, prices can be lowered to increase volume later.

Market pricing

Average market price

(market leader’s)

Penetration pricing

Skimming

Perceived value pricing

Cost price

Dumping

Question:

What pricing method do you use?

Setting prices for price followersHow to set a price:

Bottom-up: You can start calculating from the cost-price up: by adding the costs of getting your product to the customer

Top-down: by deducting all costs from the market price until you have arrived at the cost-price

Break!

Top-down 1.establish the current market pricing for comparative and/or substitutive products in the target market;

2.establish all the elements of the market price, like VAT, margins for the trade and the importer, import duties, freight and insurance costs etc.;

3.make a top-down calculation, deducting all the elements of the expected market price of your product(s) in order to arrive at the price “Ex Works” ( “Ex Factory”) or ex warehouse;

4.see if you can meet this price;

5.if not, re-calculate your own cost price by finding ways to decrease costs in your own factory or organisation. Or decrease your marketing budget, which also burdens your export-market price;

Bottom-up1.Estimate total sales in the plan year in numbers of units.2.Set factory cost price* per unit and multiply with total number of units to be sold,3.Gives total cost price for planned sales volume.4.Add: targeted profit (or feasible profit indicated by top-down calculation); also add: total budget for export marketing support, or export promotion.5.Add: total transportation costs factory to port of shipment (plus possible costs in port),6.Gives total (planned) turnover at FOB level.7.Add: total transportation costs to port of destination, also add insurance costs,8.Gives total turnover at CIF-destination level.9.Add: import duties and handling costs in port of destination,10.Gives total (planned) value of sales at LCP level (Landed Cost price).

Bottom-up, cont.

11. Calculate sales price of the importer

12. Calculate sales price of wholesaler

13. Calculate net sales-price (excl. VAT) of the retailer

14. Calculate consumer price, or retail price including VAT per

unit.

15. Compare with general market pricing. Adjust (sales target,

profit target or promotion budget) if necessary.

Multiplier

In a given situation for consumer goods, the price Ex Works (295) = 25% of the consumer price (1,118). The Multiplier is: 4.

This ‘multiplier’ is a calculation aid (typically for consumer goods’ prices), cutting short lengthy calculations when price alternatives are considered. It may vary from sector to sector.

When using the multiplier, keep in mind that it may cause slight calculation deviations.

Case :BQI Automotive S.A.

Since 1987, BQI Group of Santa Cruz in Bolivia has been offering its consistent quality automotive products at competitive prices, on-time delivery and excellent services to global markets.

With the employment of more than 190 people, BQI Group is one of its kind in ANDEAN market, manufacturing and marketing finished products that include a variety of accessory articles and complete after market ranges…….read profile)

Case :BQI Automotive S.A.

Have a look at the costing & pricing requirements……………..Get together with your group and make the required calculations to assess export possibilities.