Contribution Margin Approach to Pricing. E. Berg & Sons manufacture custom-made pleasure boats ranging in price from $10,000 to $250,000. For the past thirty years, Ed Berg, Sr. has determined each boat’s selling price by estimating the costs of materials, labor, and a prorated portion of overhead and by adding 20% to these estimated costs.
Contribution Margin Approach To Pricing, For example in a recent price quotation was determined as follows:
Direct materials $ 5,000
Direct labor 8,000
Plus 20% 3,000
Selling price $18,000
The overhead figure was determined by estimating total overhead costs for the year and allocating them at 25% of direct labor.
If a customer rejects the price and business is slack, Ed Berg, Sr. is often willing to reduce the markup to as little as 5% over estimated costs. Thus, average markup for the year is estimated at 15%.
Ed Berg, Jr. has just completed a pricing course and believes the company could use some of the modern techniques he has learned. The course emphasized the contribution margin approach to pricing, and Ed Berg, Jr. feels such an approach would be helpful in determining the selling prices of their custom-made pleasure boats.
Total overhead (including marketing and administrative expenses for the year) has been estimated at $150,000, of which $90,000 is fixed and the remainder is variable in direct proportion to direct labor.
Required: Assuming that a customer rejected the $18,000 quotation and also rejected a $15,750 quotation (5% markup) during a slack period and then countered with a $15,000 offer, (a) the difference in net income for the year between the acceptance or rejection of the offer, and (b) the minimum selling price Ed Berg, Jr. could have quoted without reducing or increasing net income.
(2) The advantages that the contribution margin approach to pricing has over the approach used by Ed Berg, Sr.
(3) The pitfalls, if any, to contribution margin approach to pricing. To know more further visit here.