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Relevant Information
and Decision Making:Marketing Decisions
Dr Rashmi Soni
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Discriminate between relevant
and irrelevant information
for making decisions.
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The Concept of Relevance
What information is relevant?
It depends on the decision being made.
Decision making essentially involveschoosing among several courses of action.
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The Concept of Relevance
What is the accountants role in decision making?
It is primarily that of a technical expert on
financial analysis.
The accountant helps managers focus on therelevant information.
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Relevant Information
Relevant information is the predicted
future costs and revenues that will
differ among the alternatives.
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Use the decision process to
make business decisions.
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The Decision Process
Historical Information Other Information
Prediction Method
Decision Model
Implementation and Evaluation
Predictions as Inputs
to Decision Model
Decisions by Managers
with Aid of Decision Model
Feedback
(1)
(2)
(3)
(4)
(A) (B)
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The Decision Process
Gather relevant information using
historical accounting information and other
information from outside the accounting system.
Step 1
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The Decision Process
Using the information gathered in Step 1,
formulate predictions of expected futurerevenues or expected future costs.
The predictions formulated in Step 2
to the decision model.
Step 3
Step 2
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The Decision Process
The decisions made by managers, with the aid of
the decision model, are implemented and evaluated.
Feedback is used to make future adjustments
to the decision process.
Step 4
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Decision Model Defined
A decision model is any method used for
making a choice, sometimes requiring
elaborate quantitative procedures.
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In the best of all possible worlds,
information used for decisionmaking would be perfectly
relevant and accurate.
Accuracy and Relevance
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The degree to which information is
relevant or precise often depends
on the degree to which it is...
Accuracy and Relevance
QuantitativeQualitative
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Decide to accept or reject a
special order using thecontribution margin
technique.
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Special Sales Order Example
Solo Company
Income Statement
Year Ended December 31, 2002 (dollars 000)
Sales (1,000,000 units) $20,000
Less: Variable expenses
Manufacturing $12,000Selling and administrative 1,100 13,100
Contribution margin $ 6,900
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Special Sales Order Example
Solo Company
Income Statement
Year Ended December 31, 2002 (dollars 000)
Contribution margin $6,900
Less: Fixed expenses
Manufacturing $3,000Selling and administrative 2,900 5,900
Operating income $1,000
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Special Sales Order Example
Only variable manufacturing costs areaffected by the particular order, at a rate
of $12 per unit ($12,000,000 1,000,000units).
All other variable costs and all fixed costs
are unaffected and thus irrelevant.
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Special Sales Order Example
Special order sales price/unit $13
Increase in manufacturing costs/unit 12
Additional operating profit/unit $ 1
Based on the preceding analysis, should
Solo accept the order?
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Decide to add or delete
a product line usingrelevant information.
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Avoidable and Unavoidable Costs
Avoidable costs are costs that will notcontinue
if an ongoing operation is changed or deleted.
Unavoidable costs are costs that continue even
if an operation is halted.
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Department Store Example
Consider a department store that hasthree major departments:
1 Groceries
2 General merchandise
3 Drugs
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Department Store Example
Department
General(000) Groceries Mdse. Drugs Total
Sales $1,000 $800 $100 $1,900
Variable expenses 800 560 60 1,420
Contribution margin $ 200 $240 $ 40 $ 480
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Department Store Example
Department
General
(000) Groceries Mdse. Drugs TotalContribution margin $200 $240 $40 $480
Fixed expenses:
Avoidable $150 $100 $15 $265
Unavoidable 60 100 20 180Total $210 $200 $35 $445
Operating income $ (10) $ 40 $ 5 $ 35
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Department Store Example
For this example, assume first that theonly alternatives to be considered aredropping or continuing the grocery
department, which shows a loss of$10,000.
Assume further that the total assets
invested would be unaffected by thedecision.
The vacated space would be idle and the
unavoidable costs would continue.
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Dropping Products, Departments,Territories
Total Before Change
Sales $1,900,000
Variable expenses 1,420,000
Contribution margin 480,000
Avoidable fixed expenses 265,000
Contribution to common
space and unavoidable costs $ 215,000Unavoidable fixed expenses 180,000
Operating income $ 35,000
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Dropping Products, Departments,
TerritoriesEffect of Dropping Groceries
Sales $1,000,000
Variable expenses 800,000Contribution margin 200,000
Avoidable fixed expenses 150,000
Contribution to commonspace and unavoidable cost $ 50,000
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Dropping Products, Departments,
TerritoriesTotal After Change
Sales $900,000Variable expenses 620,000Contribution margin 280,000Avoidable fixed expenses 115,000Contribution to common
space and unavoidable costs $165,000Unavoidable fixed expenses 180,000Operating income $ (15,000)
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Compute a measure of product
profitability when production
is constrained by a scarce
resource.
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Optimal Use of Limited
Resources A limiting factor or scarce resource
restricts or constrains the production or
sale of a product or service. The order to be accepted is the one that
makes the biggest total profit contribution
per unit of the limiting factor.
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Key Factor / Limiting Factor -
* The factor of production which in short supply is called askey factor or limiting factor.
* The decision regarding profitability of the product in suchsituation is based upon profitability of key factor
* Profitability of the key factor =
Contribution per unit / Key Fcator
* Higher the profitability of key factor, better theproduct
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Main key factors
(1) Sales in unit - Check Contribution per unit - higherbetter
(2) Sales in Rs - Check P/V ratio - higher better
(3) Raw Material - Check profitability of raw material -
higher better
(4) Time / Labour / Capacity - Check profitability of labour -higher better
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Product Profitability Example
Constrained by a Scarce Resource Assume that a company has two products:
a plain cellular phone and a fancier cellular
phone with many special features.
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Plant workers can make 3 plain phones
in one hour or1 fancy phone.
Product
Plain Fancy
Per Unit Phone Phone
Selling price $80 $120
Variable costs 64 84Contribution margin $16 $ 36
Contribution margin ratio 20% 30%
Product Profitability ExampleConstrained by a Scarce Resource
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Product Profitability ExampleConstrained by a Scarce Resource
Which product is more profitable?
If sales are restricted by demand for only
a limited number of phones, fancy
phones are more profitable.
Why?
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Product Profitability Example
Constrained by a Scarce Resource
The sale of a plain phone adds
$16 to profit.
The sale of a fancy phone adds$36 to profit.
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Product Profitability ExampleConstrained by a Scarce Resource
Now suppose annual demand for phonesof both types is more than the company
can produce in the next year. Productive capacity is the limiting factor
because only 10,000 hours of capacity are
available.
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Product Profitability ExampleConstrained by a Scarce Resource
Which product should the company emphasize?
Plain phone:$16 contribution margin per unit 3 units per hour
= 48 per hour
Fancy phone:
$36 contribution margin per unit 1 unit per hour
= $36 per hour
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Discuss the factors that influence
pricing decisions in practice.
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Pricing Decisions
Among the many pricing decisions to bemade are:
setting the price of a new or refinedproduct
setting the price of products sold underprivate labels
responding to a new price of a competitor
pricing bids in both sealed and openbidding situations
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The Concept of Pricing
Inperfect competition, a firm can sell as
much of a product as it can produce,all at a single market price.
In imperfect competition, the price a firmcharges for a unit will influence the
quantity of units it sells.
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The Concept of Pricing
Marginal costis the additional cost resulting
from producing one additional unit.
Marginal revenue is the additional revenue
resulting from the sale of one additional unit.
Price elasticity is the effect of price changes
on sales volume.
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Influences on Pricing
Several factors interact to shape themarket in which managers make pricing
decisions: legal requirements
competitors actions
customer demands
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Compute a target sales price
by various approaches
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Role of Costs in Pricing
Decisions Two pricing approaches used by
companies are:
1 Cost-plus pricing2 Target costing
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Target Sales Price
There are four popular markup formulasfor pricing:
1 As a percentage of variable manufacturingcosts
2 As a percentage of total variable costs
3 As a percentage of full costs
4 As a percentage of total manufacturingcost
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Relationships of Costs toSame Target Selling Prices
Target sales price $20.00Variable costs:
Manufacturing $12.00Selling and administrative 1.10
Unit variable cost 13.10Fixed costs:
Manufacturing $ 3.00Selling and administrative 2.90Unit fixed costs 5.90Target operating income $ 1.00
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Relationships of Costs toSame Target Selling Prices
Markup percentages
% of variable
manufacturing
costs:
($20.00$12.00) $12.00= 66.67%
% of totalvariable
costs:
($20.00$13.10) $13.10
= 52.67%
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Costing Techniques
Target costing sets a cost before the
product is created or even designed.
Value engineering is a cost-reduction
technique, used primarily during design.
Kaizen costing is the Japanese word for
continuous improvement.
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Use target costing to decide
whether to add a new product.
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Target Costing and
Cost-Plus Pricing Compared Suppose that ITT Automotive receives an
invitation to bid from Ford on the anti-lock
braking systems. The current manufacturing cost is $154.
ITT Automotives desired gross margin
rate is 30% on sales. The market conditions have established a
sales price of $200 per unit.
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Target Costing and
Cost-Plus Pricing Compared
What is the bid price using cost-plus pricing?
Bid price = Cost Cost % = $154 0.7
Bid price = $220
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Target Costing and
Cost-Plus Pricing Compared
Target cost = Market price Cost %
= $200 0.7
Target cost = $140
Bid price = Market price = $200
What is the bid price using target costing?
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Thanks