Profitability Pricing – The Rest of the Story

If you read my article in the Lehigh Valley Business Journal

This is the rest of the story on Profitability Pricing

The background of setting the Selling Price.  A company traditionally uses the costing method to accumulate direct materials, direct labor and overhead cost.  When large companies were losing business because they did not set the correct selling price, they started to look at things differently.  How did this happen? Well the competitors may not have had the variety of products that the US Company had.  Competitors were assigning the appropriate cost and therefore possibly a lower selling price.  For example, say you manufacture irons, blenders, and curling irons all at the same facility.  In the old days, (unfortunately many manufacturing companies are still using it), you collect all the overhead.  I call this the bucket method because you put all the cost in one bucket and then divide by three in our example.  Utilities, rent and anything unidentifiable with a product is put in this bucket.  Taking our example, let’s say the irons take up more space and take up more utilities than the other products.  Good news for the irons because the blenders and curling irons are being over-burdened with the overhead cost of the irons.  After manufacturing companies saw what was happening, ABC costing or cost drivers were identified and the cost accountants, now management accountants, went back and priced the items according the electricity they used and square footage they used, then the proper amount was assigned. The new competitive selling price was determined.  This error, in assigning overhead, has contributed to incorrect outsourcing decisions.  Did we learn our lesson?  I don’t know.  Generally Accepted Accounting Principles do not accept ABC costing for inventory valuation so many companies have not changed.  They want to use the same system for inventory and setting the selling price.  Progressive companies understand that they need ABC costing to manage their business and set their selling prices.  The companies that adapt ABC costing, or some form of it using cost drivers, will have a better chance of being competitive and surviving the battle of the selling price.

Leave a Reply

Your email address will not be published. Required fields are marked *