0 CHAPTER 9 Relevant Costs and Product Planning Decisions © 2009 Cengage Learning

1 1 Introduction How does a manager decide: The selling price of a product? Whether to accept a special order? Whether to add or drop a product? Which products to put on the shelves? Whether to hire an employee or outsource? Whether to make or buy a product?

2 2 Special Orders Special order decisions are Short-run pricing decisions Affected by Excess production capacity Relevant costs associated with each specific special order Qualitative factors

3 3 Special Orders Should Sunset provide 150 seats (for corporate executives attending a convention in San Diego) for $125 instead of the normal fare of $275?

4 4 Special Orders What information do we have? Full cost per passenger is $ BUT… what costs are relevant to this decision? Consider only variable costs not fixed costs. Variable costs are only the cost of meals ($6.50). NEXT… consider capacity, do they have excess seats? THEN… consider qualitative factors AND… make decision.

5 5 Special Orders The price of a special order must be higher than the additional variable costs incurred in accepting the special order plus any opportunity costs incurred. Key Concept

6 6 Outsourcing and Other Make-or- Buy Decisions Outsourcing is using another company to provide labor or produce a component rather than using company employees For example contracting with another company to provide janitorial and repair services instead of using employees of the company

7 7 Factors Affecting Outsourcing Decisions Impact of taxes Payment of fringe benefits to salaried employees Impact on the attitude of the remaining work force

8 8 Vertical Integration Vertical Integration Accomplished when a company is involved in multiple steps of the value chain.

9 9 Make-or-Buy Decision Birdie Maker currently makes all golf clubs in the set but is considering acquiring the putter from Ace Putters, a manufacturer of custom putters Cost to make: $26.50 Cost to buy: $34.50

10 The Make-or-Buy Decision Based on Information Given: Continue making putters IF they believe they can manufacture a putter of acceptable quality and keep up with technological changes.

11 Make-or-Buy with Relevant Fixed Costs With Relevant Fixed Costs Due to a change in fixed costs (leased equipment being returned) Cost to make: $26.50 Cost to buy: $29.00

12 Make-or-Buy with Relevant Fixed Costs With Relevant Fixed Costs Make internally considering: Quality of the putter Changing technology Dependability of the supplier

13 Make-or-Buy with Relevant Opportunity Costs With Relevant Opportunity Costs Opportunity Costs Rent out the factory space now being used to make the putters, adding $10 opportunity costs per putter Cost to make: $36.50 Cost to buy: $24.50

14 Make-or-Buy With Relevant Opportunity Costs With Relevant Opportunity Costs Buy the putter Considering qualitative factors

15 Make-or-Buy Decisions A product should continue to be made internally and labor incurred internally if the avoidable costs are less than the additional costs that will be incurred by buying or outsourcing. Key Concept

16 The Decision to Drop a Product or a Service One of the most difficult decisions a manager can make Must analyze relevant costs Must also consider qualitative factors Must consider contribution margin

17 The Decision to Drop a Product or a Service A product should be dropped when the fixed costs avoided are greater than the contribution margin lost. Key Concept

18 Resource Utilization Decisions Constraint: The capacity to manufacture a product or provide a service is limited in some manner. Examples include skilled craftspeople, special machinery, and limited space often times are short-run constraints.

19 Resource Utilization Decisions Resource utilization decisions hinge on an analysis of the contribution margin earned per unit of the limited resource. Key Concept

20 Theory of Constraints Identifies bottlenecks in the production process. Bottlenecks limit throughput: the number of finished goods that result from the production process.

21 Decision to Sell or Process Further A Furniture Manufacturer Can Sell its Furniture: Unassembled and Unfinished Assembled and Unfinished Assembled and Finished

22 Decision to Sell or Process Further A product should be processed further if the additional revenue is greater than the additional cost. Key Concept

23 ABC and Relevant-Cost Analysis Uses multiple cost drivers to trace costs directly to products Focuses on changes in costs associated with a variety of different activities Helps managers identify what costs are really avoidable in a relevant-cost analysis