Page 232 - DECO101_MICRO_ECONOMICS_ENGLISH

Unit 14: Pricing Decisions

Profi t Planning Notes

To effectively apply the method of contribution, it is necessary to first determine which

costs are variable and which costs are fixed. A further example illustrates how a garment

marketer can make use of this technique (widely adopted in the far-East) to change the
complexion of his bottom line.

Style X produces an additional profit of R 24 per garment. But the capacity of the factory is
limited by the number of workers and the number of workstations installed. On that basis,
and because the labour content of style X is twice that of style Y, the relative revenue of the
two styles is:

Cost per garment Style X Style Y
Fabric cost
Trimmings/material, etc R 180 R 120
Direct labour cost R 120 R 60
Total direct cost R 360 R 270
Fixed costs R 120 R 90
Total cost R 480 R 360
Selling price R 576 R 432

Profit per garment R 96 R 72
The obvious application of this new knowledge would be for the marketer to promote
the sales of product Y in order to achieve greater volume and maximum utilisation of his
capacity. He could well afford, for example, to reduce the sale price of product Y, should
market forces so dictate, and still enjoy an extra contribution.

Main Applications
Although the examples provided here apply to the textile sector, they could just as easily
be applied to any other industry. Only the “restraining factors” change according to the
company’s activity and circumstances. In a machine shop, for example, the “restraining
factors” could be the limitation of a category of CNC units; in a garment factory, the number
of special machines needed for a given style, the area of cutting tables available, or just the
amount the direct labour, i.e., man-hours needed to make one garment or another.

Style X Style Y
Total direct cost R 360 R 270
Selling price R 576 R 432
Contribution per garment R 216 R 162
Output (Nos) 5,000 10,000
Total contribution R 10.80 lakh R 21.60 lakh
In each case, the concept of contribution, allied to that of the “restraining factor”,
produces a costing analysis that refl ects profit opportunities far more accurately

than the traditional “cost plus” methods of pricing, enabling a marketer to polish his
business plan.

This flexibility can be extremely valuable when market conditions are difficult and a

constant pressure on prices is being experienced. It is better to cut prices and maintain
one’s market share than to cut output. A problem of receivables is better than a stockpile.
Question
Evaluate the effectiveness of cost based pricing methods.

Source: Indian Management

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