Dear All,

I am happy to inform that we had a good number of participants registering for the
webinar and actively participated in the discussion. For the benefit of everyone, I am
summarizing our discussion below.
We started our discussion with a summary of case facts. RK Forging is a profit making
company and currently operating at 62% capacity. The marketing department of RK
Forging with great difficulty got an order from a new customer. The order requires Rs.
1.50 million initial investments in addition to material and 72 machine hours. The customer
initially places an order of 1000 units and agreed to place another 2000 units if the price
and quality are good but there is no commitment. At the time of pricing the order, the
marketing department and Accounting department disagree on how to treat the initial
investment of Rs. 1.50 million. Marketing department wants to include only 1/3rd of Rs.
1.50 million whereas Accountant argues the entire Rs. 1.50 million should be charged to
the first order. The outcome of these two pricing scheme is Accountant price is more by
40% of marketing department price.
Marketing Dept

Accounting Dept

Material

500000

500000

Production Overhead [20000 x 72 hours)

1440000

1440000

Product Cost

500000

1500000

Total Cost

2440000

3440000

Mark-up @ 16.28%*

397209

560000

Sale Value

2837209

4000000

Quantity

1000

1000

Selling price per unit

2837

4000

Difference in price (in %)

40.98%

*Mark-up workings
Sales

100

Profit

14

Cost

86

Mark-up = Profit/Cost = 14/86

16.28%

With 41% difference in price, marketing department feels that we will not get the order
and hence loose an opportunity to increase the market share and capacity utilization.
Having understood the core issue, we raised a fundamental question.
What should be our pricing policy? To recover cost or acquire new customer and
business?
Of the 60 participants, many supported the view of recovering the cost, some supported
the view of acquiring new business and others feel that our policy should be somewhere
in between the two. The middle of path approach is bit dangerous and it would be
impractical for an organization to discuss each and every issue and take decision. We
decided to discuss and build a policy that act as a guideline for pricing decision. This
course is on how accounting information is useful for decision making.
Then I posed a different question to the group: Are we going to incur a loss if we go by
marketing department pricing? What cost items are relevant for the current decision
making?
Material: Yes, it is relevant because we need to buy material for the order.
Product initial investment: Yes, it is relevant because we are going to spend. On this,
we are with the accounting department.
Production Overhead: Are we going to incur additional overhead cost? We opened up
this issue for discussion. What are the items that go into the machine center overhead
expenses? Prominent items are depreciation, maintenance, insurance, etc. These are
not likely to increase whether we do this order or not. Most of these items are
fixed. Then the question is: are we doing the right thing in considering this cost for
pricing?

While some participants quickly said we should not consider but many others were not
convinced. Then the question is: are we going to save this cost (Rs. 1.440 million) by
not taking up the order? The answer is No. We have already loaded the overhead to all
our existing customer.
The real issue is not on whether to consider the initial investment in pricing. We should
consider. The core issue is whether to consider the production overhead and our answer
is we should not consider the same. Let us rework our price with this understanding.

Marketing
Material

Accounting

Relevant Cost

500000

500000

500000

1440000

1440000

500000

1500000

1500000

2440000

3440000

2000000

397209

560000

325581

2837209

4000000

2325581

Quantity

1000

1000

1000

Selling price per unit

2837

4000

2326

Production Overhead [20000 x 72 hours)

Product Cost
Total Cost
Mark-up @ 16.28%
Sale Value

The price is still lower than what marketing department wants. Of course, marketing
department will not quote such low price and will try to maximize the price but they get
enough space for negotiation with a floor price of Rs. 2326 per unit.
So what should be our pricing policy?
We should use a principle of INCREMENTAL COST or RELEVANT COST approach in
pricing such special orders.
The case highlights a simple point Tanya and Siddharth representing two functions are
debating on an issue which is not the core issue. Both are missed out another cost item
which is Production Overhead. It is fixed and not relevant for pricing a special order.

Many participants said they got some new insights. I hope after reading this you also
benefit. Some of them said it confusing and probably this note will be helpful.
I suggest the following:

Stay on the course and we are going to discuss many more simple but useful things for managers. Management
is science of commonsense and often we miss it out.

Join with us for the next case discussion, most likely next Saturday. We will find out convenient time since
many of you are outside India.

Tell your colleagues and friends about the course and ask them to join and benefit.

Start thinking about upgrading the course registration as verified learner!!

Rate the course so that it will be useful for others who are looking for feedback before signing up.
I am excited to reach out thousands of you through this technology and share few things
that I know on the subject.
Best wishes,
M S Narasimhan (MSN)