Description
The case examines how DCPM, a subsidiary of a multinational company, uses activity cost information to revise its pricing strategy to compete with the generic herbicide products, as the patent protection of its main herbicide product is coming to an end
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1/28/2010
Submitted by
imple Bhat 2008A16 MBA II
Company and its business:The Herbicide Product Company
DCP (M) Sdn Bhd (DCPM) was established in 1973 and is a subsidiary of a multinational company which sells herbicide, fungicide and pesticide products and services to the agriculture sector. DCPM is principally involved in selling crop protection products and it is committed to a high level of product safety, health and environment protection starting from the initial stage of research and development to the stage of product distribution and its ultimate disposal. The company works closely with the various agriculture-related government agencies and is recognized for its various efforts such as its bottle recycling project in promoting health and environmental safety.
Scope of the Project:As market competition intensifies as experienced in the new millennium, more and more business enterprises are customizing their products or services and this new strategy often involves expanding the range of their product offerings and increasing the flexibility (and complexity) of their production processes through the use of advanced manufacturing technology. Under the new production environment, the production overhead costs constitute an increasing proportion of total production costs and the traditional costing system of allocating overhead costs using volume-related measures is becoming increasingly less reliable and less relevant for decision making. The traditional costing system often leads to under-pricing of complex and low-volume products and over-pricing of simple and highvolume products. The need to distinguish the different activity-level costs is critical for more accurate cost allocations and to avoid misinterpretation of the product or service cost in making any pricing or strategic management decisions. The detailed segregations of activities and their costs under ABC are the necessary cost system refinements to yield more accurate tracing of costs to specific products, supply channels and customers to facilitate implementation of more effective price differentiation among products, customers and markets. When DCPM’s patent protection in the ornament plant segment expired in 2003, PKB made available generic herbicide products at very low prices to buyers from the ornament plant segment and these generic herbicide products, which are sold at prices substantially lower than the selling price of Metrix, are gaining market share in the ornament plant segment. The management of DCPM was most concerned about DCPM’s market share of herbicide products in the plantation crop segment as the patent protection for Metrix in that segment would cease at the end of 2008. The management was worried that the threat from the generic herbicide products as experienced in the ornament plant segment would similarly surface in the plantation crop segment after 2008. The traditional costing system led to over-pricing of the product with no customization based on customer needs hence the scope of the project lied with the correct pricing and customization of Metrix.
Goals of ABC Project:To determine correct pricing for Metrix and customize it to customer needs and hence increase market share in long run.
Agrochemicals, which are dominasted by herbicides, are widely used, especially in the plantation sector in Malaysia. In 2004, plantation sector used RM462.64 million of herbicide products per year. Metrix, a major herbicide product of DCPM, captured 19% of the sales of herbicide products to the plantation sector and 14.1% of the total sales of herbicide products in Malaysia. DCPM was one of the top suppliers of herbicide products in Malaysia. The growth rate of herbicide usage was originally estimated at 2%, but it was expected to be higher as the perceived long-term price trend of crude palm oil was positive. The increasing market price competition had led to a declining average product selling price and gross profit margin for DCPM. The selling price of DCPM’s major herbicide product, Metrix, had to drop to narrow
the price differential between the price charged by generic product suppliers and Metrix’s price. Market feedback suggested that the price of Metrix had to be reduced from RM68 per kg in 2006 to RM40 per kg in 2008 for it to stay competitive. With the declining selling price, the mark-up for Metrix was expected to decline from a positive of 58.66% as reported in 2006 to perhaps a loss in 2008, if the current strategy continued. The significant increase in competition in the herbicide market was largely due to threats from cheap generic pesticide and herbicide products. Many other multinationals were similarly affected. One multinational company lost about 50% of the market share of its main herbicide product to generic herbicide product suppliers after the patent of it herbicide product ended. The management of DCPM feared the same would happen to the company. The daunting task for the management of DCPM was to formulate a new strategy that could eliminate or mitigate the threats from those cheap generic substitutes to sustain its current market share, as well as to enable the company to earn the targeted minimum 30% mark-up as required by its parent company. It was the policy of DCPM’s parent company that products that could not yield the minimum 30% mark-up would be withdrawn from the range of products currently being offered by DCPM in Malaysia. The key competitor of DCPM was PKB, which was a top generic herbicide product supplier, and PKB had benefited significantly from the activities by the multinationals to promote herbicide product usage to farmers and planters in Malaysia. PKB had adopted the low-cost strategy that priced its products substantially lower than those charged by the multinationals. PKB could afford to sell its products at lower prices because it could source the cheap generic herbicide products from China and it incurred much lower operating costs by using low quality packaging, minimizing its marketing efforts, and most important of all, carrying no research and development activity. In 2004, it was able to capture 9.6% of the market share and earned a gross margin of between 10% and 15%. When DCPM’s patent protection of its herbicide product in the ornament plant segment ended in 2003, PKB immediately registered one of its herbicide products for the ornament plant segment. Since then, DPCM’s sales of herbicide product to the ornament plant segment had been seriously affected.
Results of the Project:Traditional Costing of the Herbicide Product, Metrix:Metrix is imported in 25-kg drums and re-packaged into 50 gm, 100 gm and 250 gm packs. The 250 gm packs are most popular and constitute about 85% of total Metrix sales. The 50gm packs and 100gm packs contribute about 5% and 10% of total Metrix sales, respectively. Under the DCPM’s existing costing system, the costs related to Metrix were accounted for under the following accounting cost headings: ? Purchasing costs (direct costs) ? Repackaging costs (direct costs) ? Overhead costs (indirect costs) o Product Delivery Costs o Selling and commission costs o Research and Development costs o General administration costs
After 2008, the target selling price for the herbicide product had to be at RM40 per kg or below in order not to price itself out of the market. Based on the cost of RM42.86 per kg as determined by using the traditional costing approach (refer to Table 1), DCPM would not only be unable to meet the minimum 30% mark-up, it would also be making a loss of RM2.86 per kg sold, if Metrix were to be sold at RM40 per kg.
Activity-Based Costing (ABC) to Costing of Product and Value-Added Services:The traditional overhead cost allocation based on quantity (kg) sold is over-simplistic as it fails to identify the costs of the various activities associated with the provision of the different types of value-added services demanded by the customers. Allocating overhead costs based on units (kg) sold would lead to cross-subsidization of products. Moreover, the efforts or services required of the sales personnel vary with products. The management of DCPM decides to adopt the activity based costing approach to analyze and manage activity costs. Moreover, the efforts or services required of the sales personnel varied with products. The major activities related to the sales of Metrix were first identified in a systematic manner. The total overhead costs totaling RM1.52 million, which were categorized earlier under the four account headings, were re-assigned to the seven main activities identified, as shown in Table 2. The cost driver for each activity was determined and the cost driver rate for each activity was computed for the purposes of subsequent allocation of overhead costs to the product and its related services. Figure 1 illustrates the two-stage cost assignment process from the traditional account headings to main activities identified and then, to product and services. The pricing strategy was revised based on the needs and price-sensitivities of customers. Instead of the current approach of selling a lump-sum package which included the product plus all the value-added services offered by DCPM, the product and service costs are now segregated for competitive pricing purpose. Customers are given the option to select from the different combinations of product and services, the combination that is most suited to their needs, and the selling price of the package would be
determined based on the activity cost information related to the combination of product and services selected by the customer.
As shown in Table 3, a customer who requires only the basic herbicide product and no other professional services would only pay RM40 per kg of Metrix. This option meets the needs of the very price-sensitive customers such as the small holders, and it is designed to compete directly with the cheap generic herbicide products. By selling Metrix at the targeted RM40 per kg, DCPM is also able to generate the minimum 30% mark-up as required by its parent company. For the other customers who may require one or more of the three types of value-added services offered by DCPM, the selling price of the combination of product and services would be determined by adding the product basic costs to the costs of activities needed in rendering the services required, as illustrated in Table 4.
Observations, criticism and comments:? The ABC approach to allocating costs based on activities enabled management of DCPM to direct its attention to activities that add little or no value. The management could then re-examine and reorganize the activities to eliminate the non-value-added elements to improve the overall cost efficiency without adversely affecting the quality of service. The activity cost analysis allowed the company to customize the combination of product and services according to the needs and price-sensitivities of customers. In the short run, the ABC approach to costing of product and services, and the re-packaging of product and services to meet the needs of customers with different price-sensitivities could be immediately implemented by DCPM. In the long term, DCPM and group involved in the manufacturing and logistics of the herbicide product would have to re-engineer to further improve their manufacturing and service efficiency. The companies within the group would have to enhance their sales forecasting, supply chain management and research and development efforts. DPCM will also have to work closely with the various regulatory agencies to promote extensively greater awareness and appreciation of environment and health safety to herbicide product users, especially among the plantation companies, and to provide quality service to its core customers in the most efficient manner.
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doc_952869127.docx
The case examines how DCPM, a subsidiary of a multinational company, uses activity cost information to revise its pricing strategy to compete with the generic herbicide products, as the patent protection of its main herbicide product is coming to an end
dfghjklzxcvbnmqwertyuiopasdfghjklzx cvbnmqwertyuiopasdfghjklzxcvbnmq wertyuiopasdfghjklzxcvbnmqwertyuio ACTIVITY BASED COSTING pasdfghjklzxcvbnmqwertyuiopasdfghj THE HERBICIDE PRODUCT COMPANY klzxcvbnmqwertyuiopasdfghjklzxcvbn mqwertyuiopasdfghjklzxcvbnmqwerty uiopasdfghjklzxcvbnmqwertyuiopasdf ghjklzxcvbnmrtyuiopasdfghjklzxcvbn mqwertyuiopasdfghjklzxcvbnmqwerty uiopasdfghjklzxcvbnmqwertyuiopasdf ghjklzxcvbnmqwertyuiopasdfghjklzxc vbnmqwertyuiopasdfghjklzxcvbnmqw ertyuiopasdfghjklzxcvbnmqwertyuiop asdfghjklzxcvbnmqwertyuiopasdfghjkl zxcvbnmqwertyuiopasdfghjklzxcvbnm qwertyuiopasdfghjklzxcvbnmqwertyui
1/28/2010
Submitted by
imple Bhat 2008A16 MBA IICompany and its business:The Herbicide Product Company
DCP (M) Sdn Bhd (DCPM) was established in 1973 and is a subsidiary of a multinational company which sells herbicide, fungicide and pesticide products and services to the agriculture sector. DCPM is principally involved in selling crop protection products and it is committed to a high level of product safety, health and environment protection starting from the initial stage of research and development to the stage of product distribution and its ultimate disposal. The company works closely with the various agriculture-related government agencies and is recognized for its various efforts such as its bottle recycling project in promoting health and environmental safety.
Scope of the Project:As market competition intensifies as experienced in the new millennium, more and more business enterprises are customizing their products or services and this new strategy often involves expanding the range of their product offerings and increasing the flexibility (and complexity) of their production processes through the use of advanced manufacturing technology. Under the new production environment, the production overhead costs constitute an increasing proportion of total production costs and the traditional costing system of allocating overhead costs using volume-related measures is becoming increasingly less reliable and less relevant for decision making. The traditional costing system often leads to under-pricing of complex and low-volume products and over-pricing of simple and highvolume products. The need to distinguish the different activity-level costs is critical for more accurate cost allocations and to avoid misinterpretation of the product or service cost in making any pricing or strategic management decisions. The detailed segregations of activities and their costs under ABC are the necessary cost system refinements to yield more accurate tracing of costs to specific products, supply channels and customers to facilitate implementation of more effective price differentiation among products, customers and markets. When DCPM’s patent protection in the ornament plant segment expired in 2003, PKB made available generic herbicide products at very low prices to buyers from the ornament plant segment and these generic herbicide products, which are sold at prices substantially lower than the selling price of Metrix, are gaining market share in the ornament plant segment. The management of DCPM was most concerned about DCPM’s market share of herbicide products in the plantation crop segment as the patent protection for Metrix in that segment would cease at the end of 2008. The management was worried that the threat from the generic herbicide products as experienced in the ornament plant segment would similarly surface in the plantation crop segment after 2008. The traditional costing system led to over-pricing of the product with no customization based on customer needs hence the scope of the project lied with the correct pricing and customization of Metrix.
Goals of ABC Project:To determine correct pricing for Metrix and customize it to customer needs and hence increase market share in long run.
Agrochemicals, which are dominasted by herbicides, are widely used, especially in the plantation sector in Malaysia. In 2004, plantation sector used RM462.64 million of herbicide products per year. Metrix, a major herbicide product of DCPM, captured 19% of the sales of herbicide products to the plantation sector and 14.1% of the total sales of herbicide products in Malaysia. DCPM was one of the top suppliers of herbicide products in Malaysia. The growth rate of herbicide usage was originally estimated at 2%, but it was expected to be higher as the perceived long-term price trend of crude palm oil was positive. The increasing market price competition had led to a declining average product selling price and gross profit margin for DCPM. The selling price of DCPM’s major herbicide product, Metrix, had to drop to narrow
the price differential between the price charged by generic product suppliers and Metrix’s price. Market feedback suggested that the price of Metrix had to be reduced from RM68 per kg in 2006 to RM40 per kg in 2008 for it to stay competitive. With the declining selling price, the mark-up for Metrix was expected to decline from a positive of 58.66% as reported in 2006 to perhaps a loss in 2008, if the current strategy continued. The significant increase in competition in the herbicide market was largely due to threats from cheap generic pesticide and herbicide products. Many other multinationals were similarly affected. One multinational company lost about 50% of the market share of its main herbicide product to generic herbicide product suppliers after the patent of it herbicide product ended. The management of DCPM feared the same would happen to the company. The daunting task for the management of DCPM was to formulate a new strategy that could eliminate or mitigate the threats from those cheap generic substitutes to sustain its current market share, as well as to enable the company to earn the targeted minimum 30% mark-up as required by its parent company. It was the policy of DCPM’s parent company that products that could not yield the minimum 30% mark-up would be withdrawn from the range of products currently being offered by DCPM in Malaysia. The key competitor of DCPM was PKB, which was a top generic herbicide product supplier, and PKB had benefited significantly from the activities by the multinationals to promote herbicide product usage to farmers and planters in Malaysia. PKB had adopted the low-cost strategy that priced its products substantially lower than those charged by the multinationals. PKB could afford to sell its products at lower prices because it could source the cheap generic herbicide products from China and it incurred much lower operating costs by using low quality packaging, minimizing its marketing efforts, and most important of all, carrying no research and development activity. In 2004, it was able to capture 9.6% of the market share and earned a gross margin of between 10% and 15%. When DCPM’s patent protection of its herbicide product in the ornament plant segment ended in 2003, PKB immediately registered one of its herbicide products for the ornament plant segment. Since then, DPCM’s sales of herbicide product to the ornament plant segment had been seriously affected.
Results of the Project:Traditional Costing of the Herbicide Product, Metrix:Metrix is imported in 25-kg drums and re-packaged into 50 gm, 100 gm and 250 gm packs. The 250 gm packs are most popular and constitute about 85% of total Metrix sales. The 50gm packs and 100gm packs contribute about 5% and 10% of total Metrix sales, respectively. Under the DCPM’s existing costing system, the costs related to Metrix were accounted for under the following accounting cost headings: ? Purchasing costs (direct costs) ? Repackaging costs (direct costs) ? Overhead costs (indirect costs) o Product Delivery Costs o Selling and commission costs o Research and Development costs o General administration costs
After 2008, the target selling price for the herbicide product had to be at RM40 per kg or below in order not to price itself out of the market. Based on the cost of RM42.86 per kg as determined by using the traditional costing approach (refer to Table 1), DCPM would not only be unable to meet the minimum 30% mark-up, it would also be making a loss of RM2.86 per kg sold, if Metrix were to be sold at RM40 per kg.
Activity-Based Costing (ABC) to Costing of Product and Value-Added Services:The traditional overhead cost allocation based on quantity (kg) sold is over-simplistic as it fails to identify the costs of the various activities associated with the provision of the different types of value-added services demanded by the customers. Allocating overhead costs based on units (kg) sold would lead to cross-subsidization of products. Moreover, the efforts or services required of the sales personnel vary with products. The management of DCPM decides to adopt the activity based costing approach to analyze and manage activity costs. Moreover, the efforts or services required of the sales personnel varied with products. The major activities related to the sales of Metrix were first identified in a systematic manner. The total overhead costs totaling RM1.52 million, which were categorized earlier under the four account headings, were re-assigned to the seven main activities identified, as shown in Table 2. The cost driver for each activity was determined and the cost driver rate for each activity was computed for the purposes of subsequent allocation of overhead costs to the product and its related services. Figure 1 illustrates the two-stage cost assignment process from the traditional account headings to main activities identified and then, to product and services. The pricing strategy was revised based on the needs and price-sensitivities of customers. Instead of the current approach of selling a lump-sum package which included the product plus all the value-added services offered by DCPM, the product and service costs are now segregated for competitive pricing purpose. Customers are given the option to select from the different combinations of product and services, the combination that is most suited to their needs, and the selling price of the package would be
determined based on the activity cost information related to the combination of product and services selected by the customer.
As shown in Table 3, a customer who requires only the basic herbicide product and no other professional services would only pay RM40 per kg of Metrix. This option meets the needs of the very price-sensitive customers such as the small holders, and it is designed to compete directly with the cheap generic herbicide products. By selling Metrix at the targeted RM40 per kg, DCPM is also able to generate the minimum 30% mark-up as required by its parent company. For the other customers who may require one or more of the three types of value-added services offered by DCPM, the selling price of the combination of product and services would be determined by adding the product basic costs to the costs of activities needed in rendering the services required, as illustrated in Table 4.
Observations, criticism and comments:? The ABC approach to allocating costs based on activities enabled management of DCPM to direct its attention to activities that add little or no value. The management could then re-examine and reorganize the activities to eliminate the non-value-added elements to improve the overall cost efficiency without adversely affecting the quality of service. The activity cost analysis allowed the company to customize the combination of product and services according to the needs and price-sensitivities of customers. In the short run, the ABC approach to costing of product and services, and the re-packaging of product and services to meet the needs of customers with different price-sensitivities could be immediately implemented by DCPM. In the long term, DCPM and group involved in the manufacturing and logistics of the herbicide product would have to re-engineer to further improve their manufacturing and service efficiency. The companies within the group would have to enhance their sales forecasting, supply chain management and research and development efforts. DPCM will also have to work closely with the various regulatory agencies to promote extensively greater awareness and appreciation of environment and health safety to herbicide product users, especially among the plantation companies, and to provide quality service to its core customers in the most efficient manner.
? ? ?
?
doc_952869127.docx