The selected article for review is “How to raise prices: Part I” that is written by Chris Carey. The article was published on April 21, 2011, in Forbes Magazine’s online edition. The author uses the cost-volume-profit model to explain how businesses can increase their prices during the recession period (Carey 1). In the article, it is suggested that companies should disclose information on their costs including variable and fixed costs to their customers. Moreover, companies should overcome their operational inefficiencies to achieve its performance goals. Finally, companies need to deliver higher value to their clients (Carey 2).
If a company incurs high costs that are not sufficiently covered by its prices, then it should negotiate higher prices with its customers. It is important that a business estimates these costs accurately. The business can use data of its revenues from the last 12 months and then forecast its variable costs. It could help the business to estimate its profit margin on future sales. If the business expects that its variable costs will increase in the coming periods that will affect its sales volume and profit, then it should consider increasing its prices to avoid losses. The cost-volume-profit can help the business in this regard (Carey 6).
Polaris provides vehicle maintenance and repair services to its customers. The service department of Polaris incurs different types of costs including variable, mixed, and fixed costs (Weygandt, Kimmel and Kieso 209). These costs are identified in the following table.
Table 1. Types of costs of Polaris.
|Variable Costs|| |
|Mixed Costs|| |
|Fixed Costs|| |
From the table provided above, some of the costs incurred by the business are fixed, and others are variable. The fixed costs remain constant, and they do not vary with the change in the activity level (Kinney and Raiborn 649). It is important for the business to generate sufficient sales and contribution margin that could cover the fixed costs of the company. If the company incurs high fixed costs, then it becomes difficult for it to achieve break-even and generate profit. Furthermore, it could be highlighted that variable costs change with the change in the level of business activity. It implies that if the company provides maintenance services to a higher number of customers, then the variable costs of the company will also increase and vice versa.
The mixed costs have both variable and fixed cost elements that could be divided between different business functions (Garrison, Noreen and Brewer 225) including the administrative department and workshop of the company. Fixed costs do not change with the level of business activity, and the company incurs them even when there is no business activity. The cost element related to the administrative department of the business is fixed. The activities of the administrative department are not directly related to the business operations. Its costs do not vary with the level of business activity. Therefore, this portion of mixed costs is fixed. The cost element that can be allocated to the service function of the business is variable. From the table provided above, it could be indicated that the proportion of utility cost that could be allocated to the workshop is a variable cost.
Based on the explanation provided above regarding the three types of costs incurred by the business, it could be stated that the company will incur higher variable costs as its revenues increase. To achieve higher revenues, the company will have to provide maintenance service to a higher number of vehicles than before that implies that the business will be using more spare parts, direct labor hours, and indirect supplies. Moreover, the fixed costs of the company will also increase. The fixed costs including management salaries and rent paid to the owner of the business property will remain the same. If a business does not generate a high contribution margin, then it becomes challenging for the company to generate profits and sustain its business position.
It is understood that the variable costs of the business are unlikely to increase by a constant amount when the business volume increases (Gowthorpe 440). The types of services differ for each customer, and it is not possible to charge the same price for different services. Therefore, the company incurs variable costs that are not constant for every vehicle. In the case of Polaris, the use of a simple contribution margin is not possible. If the company provided standard services and used the same parts, supplies, and labor hours for each customer, then it was possible to use a simple contribution margin ratio (Warren, Reeve and Duchac 887).
Carey, Chris. How To Raise Prices: Part 1. 2011. Web.
Garrison, Ray H., Eric W. Noreen and Peter C. Brewer. Managerial Accounting. New Delhi: Tata McGraw-Hill Education, 2009. Print.
Gowthorpe, Catherine. Business Accounting and Finance for Non-specialists. London: Cengage Learning EMEA, 2005. Print.
Kinney, Michael R. and Cecily A. Raiborn. Cost Accounting: Foundations and Evolutions. Mason: Cengage Learning, 2011. Print.
Warren, Carl S., James M. Reeve and Jonathan Duchac. Financial & Managerial Accounting. Mason: Cengage Learning, 2008. Print.
Weygandt, Jerry J., Paul D. Kimmel and Donald E. Kieso. Managerial Accounting: Tools for Business Decision Making. New Jersey: John Wiley & Sons, 2009. Print.