Costing & Pricing

1. Costing & Pricing Expro 100 Engineering The Hague November 2013 Martin Bitter Exportant Consultants Ltd.

2. Agenda Costing vs Pricing Definitions Managerial accounting Overheads + example Types of Cost Calculations Pricing Case

3. Costing ≠ Pricing

4. Costing Calculating a cost price: Pure technical administrative exercise? No creativity? No imagination? Needed: Reliable information and a calculator.

5. Pricing Setting a selling price: creative marketing exercise strategic decision Needed: Market knowledge and a clear strategy !

6. Definitions Costing 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.

7. Costing Variable 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

8. Cost price components? Raw materials Unit Packing, export packing Labour cost Overhead expenses Interest and financing cost Labeling/marking Pre-shipment inspections Shipment and insurance Export documentation etc etc etc….. Costing is no magic, but a calculation job, requiring knowledge of the production process, capacity and logistics.

9. Export cost price = Production cost(fixed and variable) + Overhead (fixed) + (export) Logistics and finance (variable) + (export) Marketing and distribution cost(fixed and variable)

10. Costpricecomponentsdefined Fixedproductioncost: allproductioncostnotdirectlyrelatedtosize of production(depreciation, energy forheating, maintenance, fixedworkers) Variableproductioncost: directlyrelatedtoproduction of certainquantity: (rawmaterials, accessories, packingmaterials, labourcost, energy for machines) Overhead expenses : non-productionrelatedfixedcost: (administration, maitenance office building, non productionpersonnel, cars, mortgages, representation) Logisticandfinanceexpenses: transport fromfactorytoharbour, sea or air transport, special packing, insurance, bank expenses Marketing anddistribution:agent’scommissions, ware housing, promotion, service, trade fair, travelling, brochures

11. Management Information?

12. 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.

13. 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]

14. Overheads defined Overhead 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.

15. Calculating the Overhead %in relation to direct labour value Find the "average" hourly wage paid for direct labour Estimate direct labour workdays available Estimate billable direct hours for work year Estimate billable direct labor value for work year Estimate non-billable direct labor value for the work year Estimate all overhead expenses for year incl. non-billable direct labour Calculate the annual overhead percentage rel. to direct labour value

16. Overheadsexample

17. Company income statement Company revenue Turnover 14,260,000 Company expenditures Cost of raw materials 10,000,000 cost for prod & services prod. related 2,000,000 non prod. rel. 600,000 salaries prod. Related 336,000 non prod. rel. 144,000 depreciation prod. Rel. 300,000 non prod. rel. 220,000 ======== Earnings before interest and taxes EBIT 660,000

18. Abbrev. Pay roll Indirect wages 144,000 Production related wages 336,000 (16 direct employees, working 36 hrs per week) Work year: 52 weeks of 36 hrs Holiday: 25 days Public holidays 10 days Av sick leave: 10 days Training and other activities 4 days Work day = 8 hours, 1 hr spent on non prod work

19. The % !! Avhourly direct wages: 336,000 / (16x52x36) = 11.22 Available direct labourdays: 52 x 4.5 – 25-10-10-4= 185 per man Billable direct hours185x(8-1) = 1295 per man Billable direct labourvalue1295 x 11.22x16 = 232,480 Non-billable direct labourvalue =totalavailabeworkinghours (52x5x8) – billable(1295) = 785 x 11.22 = 8,807 x 16 =141,000 All overheads: 600+144+220+141= 1,105,000 Annual overhead %: 1,105,000 / 232,480= 4,75

20. Types of cost calculation • Variable/Marginal/Direct costing • Absorption costing • Activity Based Costing

21. Types of cost calculation • Variable/Marginal/Direct costing • is 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

22. Marginal costing : assume Fixed costs will be covered by home market sales Turn-over Home market sales Export sales 7 6 5 4 3 2 1 Margin added Total costs home market Marginal costing: no margin Variable Costs Variable costs export Fixed costs 100 200 300 400 500 600 700 Sales Volume Fixed costs will be covered after + 375 units have been sold. For special one-time orders abroad: calculate only the export variable costs + profit.

23. Types of cost calculation • 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.

24. Types of cost calculation Activity Based Costing all costs are allocated according to the amount of activity and resources needed to sell/produce a product.

25. ActivitybasedCosting Activity-BasedCosting (ABC) is a method of assigning the organization's resource coststhroughactivitiesto the productsand services providedtoitscustomers. It is generallyused as a tool forunderstanding product and customer costandprofitability. ABC has predominantly been usedto support strategicdecisionssuch as pricing, outsourcing andidentificationandmeasurement of processimprovementinitiatives.

26. 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

27. Pricing Setting a selling price: creative marketing exercise strategic decision Needed: Market knowledge and a clear strategy !

28. Pricing... Creative marketing exerciseby marketing manager. Is takingdecisionwhatpriceto quote in market. Marketing manager decideson price levels. Domestic sales: maydecidetoundercutcompetitionby 5% without calculation. (littlecompetition) Export sales needsconsideration of: • Market segment • Promotionalactivitiestopenetrate segment • Price levels comparablecompetingproducts • Anticipation of strike back fromcompetition • High price/max profits or lowerprice/growing market share • Total strategy • Actualcostprice

29. Pricing - methods Cost-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 profit Turnover oriented pricing: sets amount of turnover to be achieved, turnover has higher priority than price Survival 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.

30. Pricing – methods continued Competition oriented pricing: discourage competition to enter market or relate prices to market leader Image 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.

31. Market pricing Skimming Perceived value pricing Penetration pricing Average market price (market leader’s) Dumping Cost price

32. Question: What pricing method do you use?

33. Setting prices for price followers How 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

34. Break!

35. Top-down establish the current market pricing for comparative and/or substitutive products in the target market; establish all the elements of the market price, like VAT, margins for the trade and the importer, import duties, freight and insurance costs etc.; 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; see if you can meet this price; 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;

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

37. Bottom-up, cont. Calculate sales price of the importer Calculate sales price of wholesaler Calculate net sales-price (excl. VAT) of the retailer Calculate consumer price, or retail price including VAT per unit. Compare with general market pricing. Adjust (sales target, profit target or promotion budget) if necessary.

38. 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.

39. 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)

40. 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.