American Printing publishes magazines, catalogs, and retail inserts for distribu

Question

American Printing publishes magazines, catalogs, and retail inserts for distribution in large metropolitan area newspapers. Its largest customer is the New York News Company, for which American Printing prints sells flyers and coupon inserts.

American has contractual agreements with its customers; its current pricing strategy is cost-plus, and customers also agree to a yearly price escalation based on inflation. American Printing completes the escalation based on cost-of-operations increases.

Recently, Face Social Media proposed a bid to the New York News Company for alternative pricing to counter American Printing’s contract, which will be up for renewal.

To compete against Face Social Media, American Printing will have to employ target costing.

For this discussion:

What are the differences between cost-plus and target costing approaches to developing appropriate pricing? Discuss the advantages and disadvantages of each.

How does the duration of the renewed contract impact the approach?

Are there elements of the value chain that American Printing can leverage to optimize target costing for a mature customer relationship?

How does the goal of a rate of return impact the target under cost-plus?

Explanation / Answer

Target-Costing Benefits

When implementing the target-costing pricing strategy, you must recognize that to achieve the desired profits, your company must focus on controlling costs because this strategy doesn’t pass costs on to customers in terms of higher prices. Because the unit price and profit is set when this pricing model is used, there is no wiggle room for fluctuations in costs. Due to such cost restrictions, inter-departmental cooperation is essential to achieving production goals with the limited budget. In addition, innovative product and supply chain design may evolve to accommodate the cost commitments that are made during the design phase of product development. Also, the focus of a product’s design tends to be the product features that customers have confirmed they are willing to pay for rather than features the company assumes the customer may want.

Cost-Plus Pricing Strategy

The cost-plus pricing strategy ensures that a price is set that will cover the costs of a product or service as well as earn a profit. A company using cost-plus pricing calculates a selling price by first determining the total cost of a product or service. To do so, you add together the direct materials cost, the direct labor costs, the fixed and variable overhead costs, and sales and distribution costs. To obtain the unit cost, you divide the total costs by the number of units. You then add the desired per unit profit to the unit cost to equal the product’s unit price. For example, once again assume that your company is introducing a new line of chairs. The per-unit production and distribution costs are $550 per chair, which includes $250 labor, $150 materials and $150 in fixed and variable overhead. If your company’s typical mark-up is 55 percent above cost, the selling price will be $850.

Cost-Plus Costing Benefits

Simple in its application, the cost-plus pricing method allows you to pass all costs to your customer, regardless of the product or service. The model ignores market and customer data and sets a price based on costs, which best ensures you will recoup those costs and make a profit. The more efficient companies will have lower costs to pass on to the customers, which enables these companies to lower their product prices and remain competitive in the market.

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