Last month, Mars announced that its king-size Mars and Snickers chocolate bars will be cut down to size in 2005 in response to growing pressure about portion distortion and rising levels of obesity. It seems that confectionery manufacturers update their product lines more than almost any other industry. British consumers have a choice of 5,000-plus chocolate lines available from around 150,000 outlets.
Over the years, as manufacturers battled it out for market share, product proliferation has multiplied. When Nestlé launched the Kit Kat Chunky bar in 1999, it sold 50 million-plus bars in its first year of production. But for every successful new flavour, size and type of bar, there are many that do not make it.
Most companies know that when pricing a product, you have to get it right – over-pricing can lead to lost sales while under-pricing may lead to revenue but without profit. But some manufacturers unknowingly price many of their products at a loss, because they do not understand the true cost of production and sales. It is not unusual for 80% of a firm’s products to be loss-making which raises two important questions. Do makers understand the cost and profitability of these product variants? Is their pricing strategy justified?
A key requirement in formulating any pricing strategy is to understand exactly how much a product costs. While chocolate is considered one of life’s simple pleasures, its manufacture, distribution and marketing can be anything but. Most everyday products are sold via a variety of distribution channels, some perhaps requiring different pack sizes, promotions and sales support material. Product sales also vary by season, with higher sales for specific products occurring in conjunction with holidays or events.
Product packaging is often changed in line with the product’s seasonality or the latest marketing campaign, such as a competition. Add to this costly production set-ups required for manufacturing the different variants and the complexity becomes apparent.
Standard costing techniques do not allow for this level of complexity, as they do not provide enough information to enable the user to control the overheads and other indirect costs related to the product. The management approach Activity-Based Costing (ABC) provides a way to gain this level of understanding, enabling managers to make informed pricing decisions and improve product profitability. ABC g identifies the precise activities, costs and resources that go into making a product – covering both direct and indirect costs. Here, this would include the costs of downtime and set-up for producing batches of each new variant, marketing costs for developing packaging and promotions, as well as all the back office costs needed to support each new product line.
Besides helping organisations manage costs, research from consulting organisation Accenture shows that ABC can help firms improve revenues by 10% to 15%, by focusing on the most profitable products and having better information to inform pricing and discounting. ABC is hardly a new concept and has, in the past, been criticised for being overly complex. Analyst Gartner put the issue succinctly when it said: “There is renewed interest in Activity-Based Costing. Although many enterprises dismissed it in the 1980s and 1990s as too complicated, many see themselves as needing ABC now to support better planning and profitability analysis.” With web-based applications, much of the tedium of collecting and collating non-system driver data from around the organisation has been eliminated.
ABC has two main benefits: helping make more insightful decisions to improve future performance and gaining a deeper understanding of business conditions to optimise efficiency. ABC can help managers across a business. Whether it is a marketing manager deciding how to price a new chocolate bar, or the key account director looking to improve the profitability of a major logistics contract, ABC can help managers make the right decisions to improve future performance. n
Richard Barrett is vice-president, Global Marketing, at ALG Software.
Tel: 01565 687000.