Chapter 7 Costing and Pricing Strategies Check for updates on the web now! Click anywhere on the slide to view the next item on the slide or to advance.

Chapter 7Costing and Pricing Strategies

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2

Net Income

• Equals excess of revenues earned over related costs incurred for an accounting period

• Prime determinant of success• Total sales for a period determine revenue• Related costs determine profit or loss


3

Mark Up and Margin

• Gross margin (GM)• Gross margin return on inventory (GMROI)• Adjusted gross margin (AGM)• Maintained (margin) markup• Required departmental markup


4

Pricing

• Establish wholesale selling price for each garment• Responsibility of merchandiser• Requires accurate cost calculation


5

Costing

• Calculate associated c osts for each style

• Responsibility of merchandiser

• P roduct costing is one of the most important

planning functions for garment company


6

Financial Responsibility• Merchandiser Responsibilities

– Develop line– Adopt styles– Meet market objectives– Forecast sales– Sourcing– Control inventory– Mark downs– Dispose of excess inventory– Achieve target profit or gross margin

• Product Managers Responsibilities– Develop line– Adopt styles– Meet market objectives– Forecast sales– Control inventory– Achieve target profit or gross margin


7

Pricing Formula

• Cost of goods + markup = W holesale selling pric

e• M aterials + direct labor

+ factory overhead = Co st of goods

• M arketing and selling co sts + product developm ent costs + distribution

costs + general and ad ministrative costs + prof

it = Markup (gross profit margin)


8

Markup

• Can be represented as percent of wholesale sellin g price– Sales commission based upon % of selling price– Profit is planned as % of sales– Marketing, product development, distribution, and gener

al and administrative costs are budgeted items that can b e expressed as % of sales


9

Wholesale Selling Price

• Price manufacturer charges the retailer or wholesaler for each garment style

• Wholesale “net” selling price includes discounts in payment terms (e.g., 8/10 net 30)

• Delay payment or “dating”


10

Retail Selling Price

• Product managers establish retail selling price based on the needs of their consumers

• Product managers work backward to determine target materials and labor costs based on the established selling price and the required margin


11

Shortcut

• Cost of goods divided by the reciprocal o f markup equals wholesale selling price


12

Example

Cost of goods = $6.60Markup = 40%Calculate wholesale

selling price (WSP)WSP = $11.00


13

Pricing Rule

• No matter how pricing formula is adjusted to accommodate different manufacturing methods, sales discounts, and company structures, it must ALWAYS cover all costs generated within company

• Costs not covered in formula result in reduced profit or financial loss


14

Income Statement• Financial statement that relates sales revenues to expenses• The example below illustrates effect of elements covered in sample pricing formula on profitability of company

• Actual gross margin (markup) = 38%• Pricing formula uses 34% markup


15

Pricing Strategies

• Pricing is a calculation and determination of wholes ale selling prices

• Calculation is objective• Determination is subjective• Product managers must also consider these factors


16

Rigid Calculation

• Price is based on rigid calculation similar to Figures 7.1 and 7.2

• Assumes all cost data and sales expectations will be consistent with estimates used to develop:– Variable direct labor and materials costs– Variable and fixed factory overhead– Variable and fixed costs included in markup

• Process adequate for basic styles


17

Subjective Pricing

• Pricing according to what the market will bear• Allows merchandiser to evaluate:

– Current selling prices of similar competitive styles– Uniqueness of style– Current value of brand name– - Advertising plans (pull through marketing)– Effect of price on potential sales volume– Current market trends– Gross profit to sales volume


18

Subjective Pricing cont.

• Calculate price using pricing formula• Adjust price up or down depending on market con

ditions– Adjusting price upward could increase earned markup an

d potential profits– Adjusting price downward could increase sales and absor

b more fixed costs and increase potential profits


19

Subjective Pricing Example

Fig 7.4


20

Subjective Pricing Errors

• Reduced sales if price higher than what market can bear• Decreased markup if lower price does not result in expected incr

ease in sales• Risky practice when used by inexperienced merchandisers• Product managers must consider these factors when

establishing retail prices


21

Costing Principles

• Pricing strategies can only be effective if cost bases are accurate

• Requires precise accumulation and allocation of all c osts reported in company’s financial statements


22

Cost of Goods

• Includes a ll expenses involved in the manufacture of an apparel product

– materials– direct labor– factory overhead


23

Direct Materials

• Fabric, thread, trim, and findings• Quantities must be accurately measured• Prototyping• Cutting marker (company size scale)• All other materials measured in units, sets, or yards/

meters


24

Direct Labor

• Those costs that involve change the condition or physical appearance of raw materials

• Examples: Cutting, bundling, folding, sewing, and finishing• Labor standards (SAMs)


25

SAMs

• The time required for an average operator, fully qualified and trained and working at a normal pace, to perform the operation

• Include allowances for personal time, fatigue, and normally expected work delays (PF&D)


26

Direct Labor Example

Operation calculated to take .86 SAMs per unit to complete

Earnings objective is $6.00 per hourDirect labor cost is $0.086/unit

($6/hr. ÷ 60min./hr. = $0.10/min. x .86 min./unit = $0.086/unit)


27

Importance of Piece Rates

• Fixed cost per piece produced• Direct labor cost is fixed• Hourly wage system or target bonu

s system labor cost per unit varies d epending on worker productivity


28

- Off standard Costs

• - Adjustments must be made for off standard manufa cturing time

– Operator training– Machine down time– Waiting for work– Overtime premium


29

Manufacturing Overhead

• A ll costs of manufacturing except direct materials and direct labor

• Variable costs– Machine oil– Sewing needles– Portion of power– Machine parts

• Fixed costs– Property Taxes– Depreciation of factory facilities– Building maintenance– Light– Heat– Indirect labor (supervision and bundle handlers)


30

General Operating Expenses

• All costs over and above costs included in total cos t of goods

• Marketing and selling expenses• Product development expenses• Distribution expenses• Administrative expenses


31

Costing Strategies

• Information to identify, measure, and allocate costs• Based on cost accounting policies


32

Direct Costing or Variable Costing

• Applies only variabl e costs directly to l

abor and materials• All other costs alloc

ated through gross margins as fixed co

st per garment or a s part of gross mar

gin percentage• Effective for staple

products

Fig 7.8


33

Absorption Costing

• Allocates fixed man ufacturing overhea

d to each unit of pro duction along with v

ariable manufacturi ng costs

• Treats all costs of pr oduction as product

costs• Allocate variable an

d fixedmanufacturing over

head to the product s that generate the

costsFig 7.9


34

- Activity based Costing

• Manufacturing overhe ad and general operati ng expenses are assig

ned to multiple cost pools

• Cost pools are then as signed to styles based

on their use of these pools

• Requires very expensi ve processes to captur

e and allocate costs toproducts

• Requires manager s to evaluate cause and eff

ects of their decisionsFig 7.10


35

Levels of Costing

• Quickie Costing (estimating)• Costing for Sale (calculating)• Production Costing (monitoring)• Accounting Costing (reporting)


36

Quick Costing (Pre-Cost)

• Within +/- 10%• Used to evaluate style alternatives• Use standardized cost data, previous cost

sheets, approximate fabric requirements• Eliminates styles with little chance of

adoption because of pricing parameters


37

Costing for Sale

• Accurate calculations for adoption and final pricing

• Based on actual sample• Fabric requirements based on test

marker of all sizes, actual fabric widths, completed pattern sets

• Labor costs from predetermined time standards or proven piece rates

• Product engineering might take place to lower costs


38

Production Costing

• Actual variable manufacturing expenses for material and labor only

• Actual material used including waste, re-cuts, rejects, and transportation cost

• Adjusted piece rates are used from any calculated standards

• Off-standard manufacturing costs are used to adjust overhead rates

• Purpose is to validate and adjust current cost data


39

Accounting Costing

• Used to create financial statements• Basis for evaluating profit and loss

statements• Measures CGS, variable and fixed

manufacturing overhead, fixed and variable general operating overhead

End Chapter 7


41

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