Pricing decisions & Financial contributions

Pricing of the end product or services plays the most vital role in revenue generation and driving profitability.

The pricing decisions, which are usually taken by the sales team, are driven by many factors, such as below in any Industry :

·      Competition pricing

·      Profitability target

·      Costs

·      Type of customers

·      Established market or new market

·      Break-even point 

·      Target sales volume & % market share

·      Demand elasticity equation

·      Current model or obsolete model in case of product

·      The stage in which the product is there vis a vis product life cycle

This article highlights the Finance & accounts team's significant role in helping the sales team make the right pricing decisions to avoid loss situations and includes the following concepts.

·      Financial Contribution -working methodology at the company level

·      Financial Contribution -working methodology at the individual Product level

·      Manufacturing variable costs -Elements

·      Marketing variable costs -Elements

·      Financial contribution applicability -types of Industries

What is the Financial contribution working methodology at the company level?

At the company level, the contribution is to be computed by F&A based on the following formula as the aggregate of all products sold.

·      1. Sale Revenue based on the Price net of taxes

·      2. Less Direct marketing variable costs borne by the company

·      3. Less Direct manufacturing variable costs of the company

·      Contribution, which is =1-(2+3) i.e. Revenue less (marketing variable costs+, manufacturing variable costs)

                                       Or

Contribution

·      % contribution=     ……………………... X 100

Sales revenue

·      The contribution must be positive and align with the overall % contribution in which Industry operates and the company’s own internal policy and profitability plans.

·      Further computation of contribution must be accurate based on the latest (at least previous quarter ending costs) and hence reviewed periodically.

The Sales value computation must conform with AS 9.1 and Guidance note (GN)numbers, as summarised below.      

·      (GN) 9.1( revenue from operations).

·      (GN) 10.8.1 &(manufactured goods).

·      (GN)10.8.2(Traded goods).

·      GN)10.8.3(services

Further Costs determination (for the cost elements)must conform with the applicable Guidance note on the revised schedule VI to The Companies Act 1956 issued by the ICAI-Institute of chartered accountants of India, such as below.     

§  Guidance note(GN)  9.5.1(cost of material consumed)

§  (GN) 9.5.2( purchase of stock in trade)

§  (GN) 9.5.3 (changes in inventories)

§  GN)   9.5.4( employee benefit expenses), GN)  9.5.7 (other expenses) 

Financial Contribution -working methodology at the individual Product level

·      The formula is the same as for the company level.

·      1. Sale Revenue based on the Price net of taxes for a specific product model.

·      2. Less direct marketing variable costs the company bears for a specific product model.

·      3. Less Direct manufacturing variable costs of the company the company bears for a specific product model.

·      Contribution for the product-model , which is =1-(2+3) i.e. Revenue less (marketing variable costs+, manufacturing variable costs)

                                       Or

Contribution

·      % contribution=     ……………………... X 100

Sales revenue

What are the elements of direct manufacturing variable costs?

Manufacturing variable costs elements comprise of following costs per unit of specific product-model produced based on the:

·      Current landed costs of the direct bill of materials -BOM consumed

·      Cost of direct consumables, oils, lubricants.

·      Cost of direct labour

·      Cost of direct power

·      Cost of direct tools etc.

·      Cost of direct inspection & testing  

·      Cost of Quality Standard marking (like Indian Standard number ) on the packing /label   

·      Cost of  rejections of BOM

·      Cost of job working paid to out-sourced manufacturer /service provided

Sub-total = sum of above

What are the elements of direct marketing variable costs?

Similarly, marketing variable costs elements comprise of following costs per unit of a specific product model & sold based on the current costs of the direct sale & marketing expenses related to the product, as summarised below.

·      The  direct cost  of packing

·      The  direct cost  of logo/brand on the packing

·      The direct costs of the owner’s manual and  service manual in hard or soft copy

·      The cost of pre-dispatch inspection

·      The cost of warehousing before dispatch

·      The direct cost of out-ward freight & forwarding

·      The direct cost of outgoing marine insurance

·      The discount on the price

·      The incentives payable  to the customer or channel partner  for the product model

·      The  commission payable to the channel partner/agency

·      The cost of free services rendered, including spares and labour

·      The warranty costs

                     Subtotal = sum of above

Financial contribution  applicability in other industries

Similar models can be developed & applied in other industries to arrive at logical pricing decisions such as below:

·      Assets manufacturing & selling industry, e.g., Plant & machinery

·      Components/spares manufacturing and selling Industry

·      Real estate Industry selling apartments, buildings of any type

·      Service Industry, including consultancy of any type

Way Forward

·      The F&A team  must provide inputs to promoters /MDs to arrive at Policy directions for the Minimum % financial contribution, below which products sale may not be permitted without documented approval by   

           CFO+CEO/MD vis a vis sale of specific models to :

§  Channel partners in the domestic market

§  Retail customers in the domestic market

§  Direct OE customers in the domestic market

§  Channel partners in the International  market -country wise

§  Retail customers in the International  market -country wise

§  Direct OE customers in the International  market -country wise

·      So the minimum  % contribution can differ for different customer categories/countries.

·      The F&A  team must do periodic computations of the Manufacturing variable and marketing variable costs  -Model wise for each end product and share with the sales team to review the existing prices of each product model. Computation could be at least quarterly or six monthly, depending on the Industry in which the company operates and cost fluctuations. 

·      No product model or spares should be sold at a Negative contribution, particularly fast-selling models.

·      Similarly, the F&A  team must provide similar inputs to the sales team in other industries, enabling sales price review to avoid selling at a loss due to negative contributions or lower % margins.   

 Potential activities (including unethical) that can adversely impact business.

·      Missing out a few direct cost elements in determining manufacturing variable costs.

·      Missing out a few direct cost elements in determining marketing variable costs.

·      Inaccurate computation of the manufacturing variable costs due to non-timely updating of  applicable costs

·      Inaccurate computation of the marketing variable costs due to non-timely updating of  applicable costs

·      Not following the authority norms for announcing the pricing of end products, services, apartments, or buildings as relevant in the Industry.

·      Not following higher authority norms for invoicing the identified end products or services etc., which have lower % contribution or Negative contribution models.