I would like to make my contribution to "Direct Costing." I
have always encouraged businesses to use the direct, variable or
contribution costing. Don't be confused they are all the same just different
terms. This is a better technique for managerial decision-making purposes
especially when the cost of the goods, services includes only those costs
that vary directly with the volume produced.
One of the greatest advantages of the direct costing method is it ability to establish a pricing policy. Your goal in creating prices is to understand the cost combination of selling price versus your sales volume that will cover the variable cost of producing the product and contribute towards fix costs and your ability to earn a decent profit. Direct costing establishes a clearer picture of the cost-volume-price relationship.
Since this forum is mainly for retailers and services providers lets us examine a few retailing pricing concepts.
Let us start with the basic markup or mark-on. I can't fathom a retailer who wants slow moving items sitting in inventory for ever. Retailers want to move merchandise. Only competitive pricing, quality goods and services will accomplish this in this business climate. If we go back to basic, as retailers you want to sell goods and services for more than the cost to produce. The difference between the selling price and the cost is the markup. The markup can be expressed in dollars as a percentage of your cost or your selling price. Most retailers use the percentage of selling price because most of the costs or operating records are expressed as a percentage of sales and not cost of sale. The initial markup calculation is crucial.
When you create your sales plan including sales estimates and the anticipated expenses you are ready to compute the initial markup. This is the average markup required on all merchandise to cover the cost of all items and all expenses.
When you are computing your initial markup you must consider not only the selling price but all costs associated. These include selling, transportation, discounts, markdowns, reductions, cost of stock-outs, expected profit. Special formulation is employed here in the calculation. And a basic excel spreadsheet can be used to achieve this. If your store carries related products a standard markup technique can be used. This is practical for specialty stores. Hats and jewelry stores usually do this. This is rather inflexible but works very well.
A number of stores that carry a variety of merchandise and divergent costs and price range require more flexibility and they use a variety of markup percentage for different types of goods. It would be impractical for department stores to carry a standard markup. Popular items at their peak, high price items requiring transportation and installation and alteration costs are factors that make an above average markup a necessity. Once you have your desired markup percentage you can calculate or set an appropriate retail price. Finally when you establish your price you must ascertain that the price set will cover your cost and generate the desired profit. You also want to make sure it is in keeping with your stores image. Is it competitive and most of all will your customers be willing to pay the price?
Pricing for service firms goes more deeply into direct costing and this technique will have to be explored at another time since we have limited space here.
Derrick W Robinson
"The time is always right, to do right"