Measuring Customer Satisfaction

Whether a customer is satisfied or not, depends on the performance of the product. A customer feels satisfied if the product performance is up to the expectation. Dissatisfaction occurs when the product does not produce the desired result. Getting more than the expectation delights or highly satisfies a customer.

Nowadays companies aim for higher satisfaction level in their customers because an unsatisfied customer may switch to some other brand and they may loose sales. However, there are fewer chances of switching to some other brand in case of a highly satisfied customer.

A buyer forms his/her expectation by:

•  Getting the information from several sources like friends, relatives, acquaintances,family members, and neighbors
•  Company's reputation in the market compared to other companies
•  Promises and claims made by the company and their correctness 

 Companies are raising customer expectations and trying to deliver the expected output to satisfy every customer. Two different customers may be satisfied with the company's product due to two different reasons. A company can hold the customer by gaining customer satisfaction. A highly satisfied customer:
Stays for a long period

•  Have a good mouth about the company's product and services
•  Do not give much attention to other brands
•  Buys more product (more consumption)
•  Costs less to serve than the new customer

Regular customer satisfaction surveys help a company protect its market share.

Therefore, for a company to run successfully, it should look out all the areas that can satisfy a customer.

Designing and Using Market Research Effectively

According to Kotler, "Marketing research is the systematic design, collection,analysis, and reporting of data and findings relevant to a specific marketing situation facing the company."

Most large companies have a separate department to do market research but for a small entrepreneur it has to be done, mostly on his own. Nowadays there are outside specialized research agencies available that do market research for you.

The market research process involves the following five steps:

1. Define the Problem and Research Objective: It says that the problem should be defined accurately and objectives should be laid down clearly to solve the problem.

2. Develop the Research Plan: This stage involves the plan development to get the needed information like data sources, research approach, research instruments, sampling plan, and contact methods.

3. Collect the Information: This is the most error prone phase. Problem comes when the respondents do not answer properly or they are not available.

4. Analyze the Information: In this phase, collected data is analyzed and the information is used by the researchers to tabulate the data.

5. Present the Findings: This is the last step, where the researcher gives the information to the relevant parties.

Lets us take dairy unit example to understand market research process more effectively: A group of young entrepreneurs are contemplating to start selling of liquid milk in the nearby town. They may start the marketing research by defining the problem statement as -"What are the unmet needs of consumers from existing milk product offering".

To answer this problem statement, they make the research plan that includes a administering a questionnaire to 30 households (randomly selected) in 10 colonies of the town. The questionnaire design is such that it captures qualitative and quantitative information on various aspects like timely delivery, quality of milk with respect to freshness, flavor, smell, packaging quality etc.Subsequently administer this questionnaire door-to-door and collect relevant information. Subsequently, document the outcome. The result could be that the erratic supply is the most important unmet demand of the customer, at present.As a result, entrepreneurs need to focus on supply chain aspect of business to penetrate and be successful in the market with their product.

Distribution Channel Management

Mostly companies do not sell their product directly to the end-user. There are some intermediaries like brokers, sales agents, wholesalers, retailers that constitute distribution channel.

According to Kotler, "Marketing channels are set of interdependent organizations involved in the process of making a product or service available for use or consumption.

"According to Stern and El-Ansary, "Intermediaries smooth the flow of goods and service. This procedure is necessary in order to bridge the discrepancy between the assortment of goods and services generated by the producer and the assortment demanded by the consumer. The discrepancy results from the fact that manufacturers typically produce a large quantity of limited variety of goods, whereas consumers usually desire only a limited quantity of wide variety of goods."

i.Establishing Distribution Channel Management

Designing a channel management involves analyzing customer requirements,establishing channel objectives, identifying and evaluating the channel alternatives.

a. Analyzing Customer Requirements Includes:

•  Number of units permissible to buy at one time by a customer
•  Time taken to deliver the product
•  Convenience of the customer to buy a product
•  Availability of variety of goods
•  Add-on services provided by the channel

There is a direct correlation between the service output quality and the channel cost. If the service output gets better the channel cost increases which increases the product price for the customer.

b. Establishing Objectives: Channel objectives are defined to get the targeted output level. Objectives vary with the product. Some product needs more direct marketing however; some product needs little marketing or no interaction with the intermediary.

c. Identifying Major Channel Alternatives: According to Kotler a channel alternative is described by three elements: the types of available business intermediaries, the number of intermediaries needed, and the term and responsibilities of each channel member.

d. Evaluating the Major Alternatives: Each channel should be evaluated against different criteria. Different criteria are economic, control and adaptive.

ii. Managing Channel Partners
Once the channel is finalized, the next step is to select, train, motivate, and evaluate them.Producers should try to recruit better intermediaries in terms of their capability and knowledge. Companies should train the intermediaries carefully because at the end of the day, they are the face of the company in front of your final customer. A company should motivate the channel partners by finding out their need and should plan and implement some programs to increase their performance.Company should evaluate their performance time to time. They should be rewarded/retrained depending on the performance.

Promotion

Promotion is one of the marketing mix tools. Promotion is communication. It is important for any company to promote its product carefully in the target market because a customer only gets to know about the company's product through promotion.

i Purpose and Elements of Promotion

To sell the product successfully the target group should have knowledge about the existence and availability of the product in the market. This is achieved through promotion. There are two reasons for promotion:

•  To inform the customers about the products and services offered by the company
•  To encourage the customers to buy the product and services

Promotion includes the following:

• Advertising
•  Sales promotion
•  Direct marketing
• Public relations
• Personal selling

Elements of Promotion

ii. Promotion Process and Communication:

The promotion processes includes:

a. Advertising

•  Public presentations
•  Print and TV advertisement
•  Expressive advertisements to gain the customers attention easily

b. Sales Promotion: the various sales promotion tools are contests, coupons,premiums, various offers like buy 1 get one free etc. Sales promotion tools easily gain attention of the customer by providing value and instant buying trigger.

c. Personal Selling: Personal selling is one of the most effective tools of promotion.Personal selling helps a customer to build the trust on the product because a customer is able to observe the product closely. Attending exhibitions is also one of the examples of personal selling.

d. Direct Marketing: It involves direct mail, internet marketing, and telemarketing.

The advantages of direct marketing are:

• A message can be prepared quickly and addressed to a specific target
• person.
• We can change the message according to the person's response and can appeal to the addressed person.

e. Public Relations and Publicity: It involves other ways of promoting the product in the market e.g. providing knowledge to the customer through some article or by telling new features instead of giving information through print or media ads.It helps in case of those customers who do not want to interact with salespeople.

iii. Promotional Campaigns: Now a days marketers use all promotion tools together to promote the product. The factors involved in sales promotion are:

•  Size of the incentive to be given to the customers.
•  Conditions for participation.
•  Promotion duration - it should not be either too long or too short.
•  Choosing a distribution method - For example, discounts coupons can be given to the customer through various methods like newspaper, mail, in malls,or in some stores etc.
•  Time of promoting a product - For example annual or biannual promotions.
•  Total sales-promotion budget - Cost to promote a product consists of administrative cost (market research and analysis, planning, promotion, and channel management cost), and incentive cost (cost of providing offers to the customers) multiplied by the expected number of deals to be sold.
• For example, your total administrative cost/unit is Rs. X, Incentive cost/unit is Rs. Y, and you expect to sell 100 units. Then, the total sales promotion budget would come to (X+Y)*100.

Product Pricing and Market Dynamics - Criticality of Pricing the Product/ Service Correctly

With advent of internet, the availability of choices has increased for consumers and with the emergence of sophisticated analytical tools for very sharp segmentation,the role of non-price factors have increased in recent times. However, price is the most critical element of marketing mix. Particularly in India customer is very sensitive to price. Some of the interesting features of price are:

•  Flexible to change: can be revised from time to time as per the objective and can be adapted differently to different geographic markets.
•  Produce revenue: this is the only element that produces revenue where as the other three Ps of marketing mix produce cost.

Quite often pricing is set independently of other marketing mix elements rather than as an intrinsic element of the overall marketing strategy which is not good.This approach does not result in optimum results.

i.Pricing Dynamics During Different Stages of Product Life Cycle (PLC) 

Any product has different stages in its life cycle. Each of this stage requires a rethink on marketing mix and particularly pricing. Pricing must change based on the different stages of PLC.
 

Introduction - This is initial stage when product is just introduced in the market.Initial fixed costs are higher and company could adopt a cost plus model.

a. Growth - The product awareness is fairly increased and the sales have started increasing. As the competition and sales increases, the fixed cost per unit decreases and the company could adopt a pricing strategy to increase product penetration.

b. Maturity - The awareness level is complete and the sales slow down because of the product's acceptability by the market. As a result, profits decline and pricing decisions are more dependent on the competition with other companies.In this stage, the company matches the price of competing product price in the marketplace.

c. Decline - There are many product substitutes with better value offering and the sales shows declining trend. In this stage, if company believes that under any circumstance the sales will decline with time, the company could cut the price to arrest the decline or continue with same price and not compromise on its profits.

ii. Pricing Options and Strategies

i) Price Setting Methods
a) Cost Plus

This is the most elementary method of setting up a price. Under this method, the company adds a profit margin to the cost of production and decides the price.The cost of production includes variable cost and fixed cost per unit of the product.

For example 

The dairy unit procures milk from farmers, does some elementary processing in its processing unit, and transports it to market for final sales. Therefore, cost is added on actual and marginal profit is taken on the basic cost.

Variable Cost: Procurement price paid to the farmer (Rs 10/ liter)

Fixed Cost: Rent of the processing unit, transportation cost, manpower cost etc(Rs 15000/ month)

The dairy unit is expecting to sell 15000 liter per month. In such a case, the fixed cost per liter is Rs1 and variable cost is Rs 10. Therefore, the total cost of production is Rs 11. Suppose the unit wants to retain a profit margin of 27%. The final price would be:
 

Cost of production/ (1-desired profit margin) = 11/0.73 = Rs 14

Thus, the final price would be Rs 14/ liter.As you would notice, with increase in sale of milk the fixed cost per liter decreased and the unit could earn higher profit margin or could reduce the price and maintain the same profit margin.

b. Value Based Pricing
Under this approach, the company offers a low price for a high quality product.It does not mean that the company compromises on the product quality to lower the price compared to competitor. It means that the company has to work backwards to reduce the cost of production. This approach creates a long-term competitive advantage for the company.

c. Perceived Value Pricing
In this approach, the company tries to estimate the price the buyers would be willing to pay for the perceived value of the product. The companies build up the perceived value of the product through innovative use of advertising and sales promotion.

d. Competitive pricing

Under this approach, the company sets the price very close to the price charged by the competitor. This approach is used in mature products where creating differentiation is difficult. This is quite a popular method of pricing which assumes that the price charged by competitor is a fair price and could leave some profit for the company.In Mumbai, Mother Dairy had launched loose milk in competition to Amul. The price charged by Mother Dairy was same as charged by Amul.

ii) Pricing Objective

An important aspect of pricing strategy is to decide pricing objective. There could be multiple objectives:

•  Maximum Profit: Company is interested in maximizing the profit. It works in markets where product awareness is low and a limited or no competition exists.
•  Market Share: Company wants to increased market share. This could result in lower fixed cost per unit; establish company leadership in the market.
• Companies with good financial strength could use this approach.
•  Survival: This objective is generally adopted in circumstances where
•  the company is having overcapacity or
•  is faced with intense competition, or
•  the consumer preference is changing quite rapidly or
•  Company just wants its presence to be there in the market and is not looking for any major share or profit immediately.

In this approach the company tries to recover variable cost and some or full part of fixed cost.

Price Elasticity of Demand
Elasticity refers to change in demand with respect to change in price. It is critical to know the price elasticity of your product before setting up the price or revising it. In case the demand is less elastic i.e. unlikely to change much with unit change in price, the company can afford to charge a higher price. Demand is likely to be less elastic under following circumstances:

•  Consumers think that higher price is justified by higher quality and a general increase in price level across product categories 
• There is no or few substitute to the product
•  Consumers are slow to change their buying/ consuming pattern. They do not notice the change in price. In sale of loose milk, a small change in price of 25/ 50 paisa per liter is unlikely to change the demand pattern
•  Brand loyalty - consumer is so loyal to the product that even after increase in price he or she would prefer it to other brands. E.g. if Mother Dairy ice-cream is liked by a consumer then even if it is priced higher than the competitors still consumer would buy it.

Managing Product Life Cycle, The Buying Process

The buying process starts with a need or desire. Large companies ask consumers about their buying decision process. Companies do market survey and ask few questions from the customer for example:

 How do they get to know about the product?
 What made them decide to buy a product of a particular brand?
 How satisfied they are with the product performance?

A typical buying process consists of the following five stages:

It is not necessary that one-step should always come after the other step. A customer may skip one or two steps and can directly take the purchase decision.

Now let us discuss the above five buying process stages one by one.

i.Need Recognition: Any buying process starts with a need. Generally, a need arises either due to internal stimuli or due to external stimuli. Suppose, you want to cook food and vegetables are not there. There is a need of buying vegetables;this is an example of internal stimuli. An external stimulus shows the desire. If you are going through a garment, shop and you like a shirt that is an external stimuli or desire to buy that shirt. Marketers need to find out the factors that triggers the need.

ii. Information Search: Once the need is identified, the next step is to search the information about the desired product. The customer can get the information from the following sources :

•  Friends, relatives, neighbors, acquaintances
•  Media, advertising
•  Experienced customers

You should make a strategy such that customer should become aware of the company's product, he/she should shortlist the product, and should be the strong contender to buy the product.

iii. Evaluation of Alternatives: After information searching, a customer evaluates the alternatives. Basically a customer evaluates the alternatives by checking:

The features and attributes of the product Whether product fulfills his/ her expectation

•  Whether it provides some benefits
• Interest in features can vary from one consumer to another.

iv. Purchase Decision: Evaluation gives the idea to the customer about the brand he/ she should go for. Purchase decision is affected by two factors: other's opinion and unanticipated situation. If one or more acquaintance of the customer has bad experience about the brand, customer's decision to buy that product can be negative. Unanticipated situations are the one, which can not be predicted e.g. some miss happening, or emergency to buy some other product, say for example,you are planning to buy an A.C., and fridge goes out of order than the priority may shift to buy a fridge.A customer's purchase decision can be further divided into five parts:Brand decision, vendor decision, quantity decision, timing decision, and payment mode decision. The above-mentioned decisions are taken by consumer at various stages of buying.

v. Post Purchase Behavior: It shows the customer's behavior towards the product after he/she has purchased it and may have consumed as well. A marketer must find out the satisfaction level of the customer, usage of the product and should take action to improve the product if the customer is not satisfied. In case of pouched milk if consumer feels that Mother Dairy milk has some typical flavor whereas Amul milk has natural milk flavor then Mother Dairy must know this problem to rectify it and stop its customers from switching over from their brand.

Mapping out Marketing Strategy and Developing a Marketing Plan

Marketing strategy is a function of market context, competitive landscape, your own capabilities, and your objectives for the business. In this topic, we will see how does competition shapes our marketing strategies. An effective way to formulate a marketing plan would be to conduct a consumer analysis. This analysis consists of:

•  Identifying the major product features that the consumer likes
•  Prioritizing these features in terms of importance for the consumer
•  Rating your and competitor's capability to deliver on important features
•  Assessing your and competitor's performance on each of these features

When Amul had launched ice cream, the market leader was HLL with its Quality Walls brand and there were other regional players like Dollops, Go Cool and Vadilal. All these ice creams were expensive and offered limited choice to the consumer. Amul launched the ice creams in variety of flavors at far lower price to make it affordable to masses; invested in cold chain and gained a significant
market share to become the undisputed market leader.

i.Strategies

Companies in a market may have to follow various competitive strategies. These strategies are a function of relative leadership position of the respective market player.

a. Defensive Strategy

A market leader - a company having largest market share- has to be always attentive to protect its leadership position. It may have to continuously produce innovative products, keep the price competitive, and ensure that its profitability is not hurt. A market leader has to adopt three steps method to retain its number one position:

i) Expand the Market: You can do it in two ways by -

a) Finding new users of the product - Amul entered into many new potential markets and at the same time reduced prices to motivate and get new consumers. It launched the family pack for ice creams. This ensured that it found new users in form of family members, party caterers. It also ensured the increased usage.

b) Promoting more use of the product i.e. increasing per capita consumption Amul did it by reducing per unit price of the product to make it affordable.

This resulted in increase in consumption. Where earlier a person used to have ice - cream once a week increased his consumption to twice or may be thrice a week.

ii) Protect Market Share: For a dominant market player first thing to do,when competition increases, is to protect its market share. Subsequently, it needs to device ways to consolidate its market position. E.g., Kwality Walls has been trying to eat into Amul's share. To prevent any erosion of market share, Amul keeps running new marketing campaigns and many sales promotion schemes like buy 1 get one free.

iii) Increase Market Share: Amul has been investing heavily in building cold chain environment at the retailer level by providing them cool refrigerators to store ice creams and has started opening exclusive outlets selling only Amul products. It helps in increasing awareness, availability of the product, and channel loyalty that in turn results into increased market share.

b. Attack strategy: The companies who occupy second, third, and lower position in a market are called challengers. The challengers adopt different attack strategies.

i) General Attack Strategy: The challenger attacks the leader by matching its product, price, reach, positioning etc. In this strategy, the challenger must have enough financial capabilities to withstand any retaliation from the leader and it must attack the leader on different fronts - better product, better price, enhanced features, greater margin to distribution channel etc. Amul was the market leader in Mumbai market for liquid milk. Mother Dairy lunched a frontal attack on Amul by launching a blitz of brand awareness campaign, better discount to distribution channel, better packaging, and ensuring a reach equal to that of Amul. In some time, Mother Dairy has gained respectable market share in Mumbai market.

ii) Guerilla Strategy: This approach consists of engaging in intermittent attack on the leader to confuse him and use the opportunity to make its foothold strong.According to military strategists, a continuous guerrilla attack is more powerful in creating a permanent impact in competitor organization than a few large attacks.A challenger typically uses guerrilla warfare strategy to attack weak markets of the competitor.

a. Flanking: In this approach, the challenger attacks the weakest spot of the leader in terms of any uncovered geographic market or market segment.The leader is caught unaware in such a situation and it provides the challenger a good opportunity to make its foothold strong. This approach is also used when the marketer spots a shift in the needs of the consumer segment. This shift can be used to reposition the product and gain market share.

b. Niche: Niche refers to a small unique market segment. A company, which is into third or a lower position, may decide to leave the conventional market segment and instead focus on a small market and gain a leadership position there. Niching requires the nicher to clearly identify the market segment that it wants to serve and develop new specialized products for that segment,keep costs low and develop low cost channels to service customers of that segment. In essence, niching is all about specializations. Some of the possible
specializations possible are as follows:

•  Specific customer segment: A milk company may only want to focus on party caterers with bulk supplies.
•  Geographic specialist
• Channel specialist - Like Baskin Robbins sells its ice - cream only through company owned or franchisee parlors.

ii. Strategic Planning Pyramid

Strategic planning shapes your business to gain higher profits and growth. According to Kotler, "Strategic planning calls for action in three areas: The first is managing a company's businesses (Product) as an investment portfolio. The second key area involves assessing each business's (Product) strength by considering the market's growth rate and the company's position and fit in that market. The third key area is strategy.

For each of your businesses or products, you must develop a game plan for achieving its long-run objectives. You must determine what makes the most sense in the light of its industry position, objectives, opportunities, skills, and resources with respect to each product.

Strategic Planning Pyramid

iii. SMART Goals

One of the outcomes of a good marketing strategy should be to spell out goals of that strategy. These should be SMART goals. Each alphabet of the word stands for a word:

(S) Specific - A specific goal should answer six "W"s

•  Who
•  What
•  Where
•  When
•  Which
• Why

(M) Measurable: The goal should clearly state the expected outcome and how will it be measured.

(A) Achievable: The goal should be a stretch one and yet achievable. Setting unachievable goals have the danger of the developing a defeated feeling and not working towards it.

(R) Realistic: The goal should emerge because of your analysis of your strengths,weaknesses and market opportunity and not just based on dreaming.

(T) Time: The goal should clearly state the timelines for achieving each of the sub goals and the overall goal of your business.

iv. SWOT Analysis

SWOT analysis is one of the widely used tools for analyzing the business opportunities and the company's preparedness to capture them. Under this framework, you need to analyze external environment in terms of opportunities and threats to various businesses, product lines and internal environment in terms of organizational strengths and weaknesses. Let us take example of a new dairy unit at village level, which engages in SWOT analysis.Internal analysis: There are three parameters, which are anlaysed and assessed.As per this analysis, the village unit decides that procurement and farmer relationship is its key strength while it is neutral on logistical support and weak on financial capability. This analysis suggests that the dairy unit should keep working to make its procurement strength stronger and leverage it by allying with some other unit,which requires procurement capability.

Internal analysis: There are three parameters, which are anlaysed and assessed.
 

External Environment Analysis:

In this framework, the dairy unit analyzes the external business environment for possible business opportunities and threats. The dairy unit may take up each business possibility and subject it to this analysis to decide the worthwhile ideas.For example, it may analyze the possibility of entering loose milk and milk products market.

Opportunities in Loose Milk

•  Low cost of transportation, therefore pricing could be competitive
•  Freshness can be offered because procurement is your strength
•  Both cow and buffalo milk could be marketed
•  Consistent supply as the procurement centre is closer to market  
• Threats
• The competitor may lower the prices significantly
•  The competitor may package the milk in a more hygienic packaging
•  The Govt. may announce high packaging standards

Marketing A Perspective

Marketing consists of many concepts and tools. Mainly, we can consider marketing as a societal process and a managerial process.

Marketing is a societal process, which fulfills the customer's requirement through creating, presenting, and exchanging products/services with others. Marketing is a managerial process planned by the organization to meet the customer needs and organizations goals through conceptualisation, pricing, promotion, and distribution of goods/ services and ideas.

Marketing Vs. Sales

Normally people think marketing is selling the product. However, Selling comes after marketing. Marketing is to find and convince the customer for buying the product. Selling means getting the deal signed by the customer (or closing the deal).Both are equally important for the success and growth of a business. Marketing prepares the customers for the sales. It mainly consists of advertising, promotion,and direct mail.

Marketing function involves:

•  Identifying the prospective customers Market research and analysis - identifying the customer's requirement and desire
• Product identification- offering the desired product that fits into the customer's requirement.
• Strategic planning to penetrate the market
• Packaging and Pricing - providing benefits and satisfaction to the customer. Advertising the product

The Sales process involves converting the prospects into the customers. The Sales function includes:

• Selling the identified, packaged, and priced product in the marketplace. 
• Being responsible for the revenue generation and profits

ii. Marketing Mix - 4Ps
To get the desired response from the market, marketers use several tools known as marketing mix. McCarthy divided these tools into four groups called as 4Ps of marketing: Product, Price, Place, and Promotion. Marketing variables of each P are shown in Figure.

Variables Under Each P of Marketing Mix
(Adapted from Philip Kotler)

A brief description of 4Ps is-:

a. Product: According to product concept, the consumer prefers products that give the most in terms of quality, performance, and modern features.

b. Price: Price element generates revenue. In small companies, the company's boss can set price of a product but in large companies, separate department handles the pricing. It is the most critical element for any company. To set the price, company has to decide wholesale and retail prices, discount credit terms,and allowances.

c. Place: Once the production is over, the next step is the movement of the product.Place consists of distribution channel, outlet locations, transportation, inventory levels and locations where the product would sell.

d. Promotion: Promotion includes the activities like marketing campaigns, sales schemes, print ads etc. that are required by the company to promote and communicate the features and utility of the product to the target market.

iii. Segmentation, Targeting and Positioning (STP)

Any business should generate a profit while giving value to the market. The value to the market is a function of perceived value by the consumer of the product.One of the mantras of marketing is to identify customers with different state of same need and provide products suiting those variations in need. If done effectively,it would ensure that consumer sees value in the product and the business would generate profit. This process is called Segmentation, Targeting, and Positioning.

There are two types of marketing processes:

1. Mass Marketing: It is a process, which presumes that there is one market and one product would suit the requirement of all the customers. This strategy works for those companies where all the customers have the same need. For example,marketing for liquid milk.

2. The Value-delivery process: In this process a company follows a three step marketing strategy :

a. Segmentation: Segmentation is a process in which the company divides the marketplace into subsets of same consumer needs.

As a milk producer, a dairy unit may segment the consumers into various segments like:

i. Children:

 Infants who may need milk in powder form with different health supplements
 Grown up infants and kids who may need milk with high fat content

ii. Health Conscious Adults

•  Adults who may need low fat content in milk
•  Adults who may not like milk flavor and may want milk in other flavors like banana; elaichi etc

iii. Travelers

This segment may want milk to be packaged such that its shelf life increases and it can be used over few days

b. Targeting: It is the process of reviewing the market and selecting the appropriate target segment. Suppose after review it comes out that there are three different segments exist e.g. one segment wants very low fat milk, the second wants milk that has moderate level of fat, and the third wants to have milk with very high fat content for their consumption. Then, there must be three different product lines that would cater to each segment. The product lines can be double toned milk,toned milk, and the full cream milk. Now, each product would target each customer segment individually.

However, identifying separate segments does nnot necessarily mean catering to all segments. You may have to review your capability, analyze the viability of serving each segment and finally arrive at the target segment. This target segment would be the most suitable for your business with respect to several factors like growth prospects, competitors, pricing, market demand etc. A large dairy company like Amul, has capability to produce for each segment and can target each segment.

For example, it provides powder milk brand for infants; pouched milk; flavored milk and tetra pack milk with long shelf life. However, for a small regional player like "Parag", marketing it may not be possible to have so many offerings for the various segments in the market. Hence, they target the segment that consumes liquid milk only as the company may not have the capability to produce milk powder etc.

c. Positioning: It involves defining product attributes and then highlighting them during marketing or promotional . campaigns to generate interest and sales volumes for the business. Defining clear positioning by highlighting certain product attributes helps differentiate a product in the marketplace.

Let us take example of ice cream. When Amul launched its ice - cream some years ago in India there were many challenges e.g. establishing manufacturing facilities, distribution, establishing cold chain, and then marketing. The biggest of them was how to position its ice - cream in the market place vis-à-vis its competitors, which were big established names in the ice - cream industry like Quality Walls, Vadilal and Go Cool. Amul positioned its ice - cream as "Real Milk, Real Ice - Cream" against competitors who were using vegetable fats in their ice - creams. This positioning strategy helped Amul gain very big market share in no time across India.

Fundamental of Marketing,Understanding Consumers,Market Survey,Sale Forecasting and Assessment

Marketing is a process of identifying human needs and fulfilling those needs.According to Philip Kotler, marketing is "meeting needs profitably".Marketing involves creation, promotion, and delivery of goods to consumers. Now a day's companies do strategic planning before starting the production.
 

Marketing concept involves identifying customer's requirement, targeting a segment to serve the customer need and plan to meet the requirement. Companies should use the marketing concepts to meet the customer needs profitably.
 

For a business to run successfully, it is important to get market information. The
information is required to analyze the market, find out the needs and requirements of the market and depending on the company's capability target a particular market segment. In this unit, we will learn various aspects of marketing.

Case Study on Product Costing in a Dairy Plant

A study was conducted in a dairy plant under the co-operative set-up in Erode district of Tamilnadu to estimate the cost of production of different products. The dairy plant is a feeder-balancing dairy. It collects milk from its own milk-shed area in Erode district. In addition to it, milk from other milk-producers co-operative unions and State Federations is diverted to this plant for conversion into milk and other dairy products. During the period April 99 to March 2000, 725 lakh litres of milk was received at the plant. Data on various aspects like milk inflow, raw materials consumed, expenses incurred in generation of utilities, manpower employed, products manufactured and other expenses for the financial year 1999-2000 were taken from the dairy plant. Process costing technique was applied to estimate cost of production of different products.The following criterion was adopted to allocate /apportion costs. 

Skim milk powder (SMP) was the highest contributor in revenue generation with 42.93 per cent share obtained from 477.5 tonnes of output. Butter and Ghee were other significant products accounting for 39.48 percent and 16.37 per cent of revenue respectively. Standardised milk, Dudh Peda, Flavoured milk and other products individually had less than 1 per cent share in total revenue. 

Product Mix of the Dairy Plant (1999-2000)

The cost of manufacture of different dairy products is displayed in Table

Cost of Manufacture of Various Dairy Products (1999-2000)

It could be easily seen that in all the products manufactured, the major item of cost was on account of raw materials followed by processing and packaging cost in that order. The cost of production of SMP worked out to be Rs.70.19 per Kg.The respective share of raw materials cost, processing cost and packaging cost in the total cost was 83.25 per cent, 15.36 per cent and 1.39 per cent.The average manufacturing cost of Butter was Rs.91.23 per Kg.. Manufacturing activities added cost to the extent of Rs.8.58 to the raw materials worth Rs.82.65.Packaging cost constituted one per cent of the total cost.The longer shelf-life and returns associated with Ghee manufacture has attracted many entrepreneurs, especially in Tamil Nadu to initiate dairy business with this product line .The average cost of Ghee was found to be Rs.113.05.The relative share in cost on account of raw materials processing and packaging was 87.92 per cent, 7.29 per cent and 4.79 per cent.

Standardized milk is not a major revenue-earning product of the plant. But to cater to the demand of the consumers, standardized milk is processed in the plant for sale in nearby towns. During the study period the plant processed 4,86,258 litres of standardized milk at an average cost of Rs.10.91 per litre. The cost on raw material, being 91.86 per cent of the total cost, was highest among all the products. The processing and packaging cost were 4.75 per cent and 3.39 per cent respectively.

Dudh Peda, a desiccated indigenous product is popular in the region. It commands high demand throughout the year. The plant manufactured 45700 Kg. of Dudh Peda during the period under consideration. The cost of production turned out to be Rs.47.41.Raw materials cost was Rs.30.67 (64.68%) followed by processing cost, Rs.12.60 (26.59%) and packaging cost of Rs.4.14 (8.73%)The cost of manufacture of different dairy products has been analyzed from other angle segregating total cost into fixed and variable costs. These costs are produced below

Cost of Production of Different Dairy Products (1999-2000)

 The above cost figures are indicative only and applicable to the case dairy plant.These cost figures may vary from plant to plant depending upon factors such as fixed costs on land and building, plant and machinery, equipments etc. Installed capacity and capacity utilized, input costs and productivity of the resources also have a strong bearing on the cost aspects and these factors should be taken into consideration while working out cost of manufacture of dairy products.(The case study is based on research work conducted by Mr. P.Murali in partialfulfilment for the award of Degree in Master in Science in Dairying (Dairy Economics) to the N.D. R.I. Deemed University, Karnal, Haryana).

Cost Measurement

Product costing is the process of tracking and studying all the various costs that are incurred by the firm on its products or we can say what it costs to make the product. To determine the total cost of a product you need to calculate both the direct and indirect costs. The total cost is the sum of all costs associated with a particular unit or process or department or batch. It comprises of cost of production, selling and distribution expenses. It is also called cost of sales.Product costs are traceable to the product and include direct material, direct labour and overheads. As already mentioned that for the purpose of formulating various strategies and policy matters, the total cost of the product must be ascertained. This means allocating the direct materials cost, direct labour cost, other direct expenses and allocation / apportionment of burden of manufacturing overheads, Office overheads and Selling and Distribution overheads to the product.

How product costing is accomplished in any manufacturing unit becomes easy if we understand what types of departments do we generally have in any organization. In a manufacturing concern there are generally two types of departments

i) Production Departments and
 

ii) Service Departments.

A production department is one that is engaged in the actual manufacture of the product by changing the shape, form or nature of material worked upon or by assembling the parts into finished product.. In a dairy plant or dairy factory, the departments which are manufacturing ghee, butter, ice cream, flavoured milk,lassi, milk of different grades like skim milk, double toned milk, toned milk,
standardized milk, full cream milk are production departments A service department, on the other hand, is one, which is rendering a service to production departments. It contributes in an indirect manner to the manufacture of the product but it does not itself change the shape, form or nature of material that is converted into the finished product. To process milk or make butter and other dairy products we require steam, chilled water, refrigeration system,maintenance of machinery and equipments. The departments, which are providing these services, are known as service departments. Service departments provide services to production departments and some service departments in addition to it also provide services to other service departments.

Assignment of Direct Costs to Departments and Products

The direct costs of accomplishing an activity or producing or distributing a product generally are routinely charged to that activity or product by the company’s accounting system. For example, direct labour would be charged to a product if only single product is produced. However if more products are manufactured in a department, the time spent in manufacturing a particular product and its quantity produced is ascertained to work out direct labour cost. The process of estimating direct labour cost becomes easy if time cards for doing the job or activity are kept in the department. If no records of this type are maintained, time studies can be conducted and used to determine the average time that a unit or sub unit takes to process the product. Direct material costs also may be routinely charged to products.Where a department processes only one product, the average product direct cost can be determined by dividing the total amount of direct cost of the department by the number of units produced (adjusted for work- in- process)

Allocation and Apportionment of Overhead (Primary Distribution)

The major problem arises when we are to decide how overheads ought to be allocated or apportioned among products in a multi-product firm or when joint products are produced what method should be adopted? This necessity arises as we are to consider the indirect costs’ share that should go to the product in its manufacturing. In addition there is the problem of joint costs involved in some
processes. How to account for such costs are some of the other relevant points.The theory of cost accounting suggests that the basis of the apportionment of overheads to the cost center should be on equitable basis. The procedure adopted for the distribution of overheads involves the following steps.

(i) Classification and collection of overhead.

(ii) Allocation and apportionment of overhead to production departments and service
departments

(iii) Re-apportionment of service department costs to production departments.

(iv) Absorption of overhead of each production department in cost units.

(i) Classification and Collection of Overhead

overheads need to be collected from various sources like i)Invoice ii)Stores requisitions iii)Wages Analysis Sheet and iv)Journal entries and classifying them where they are occurring.

(ii) Allocation and Apportionment of Overhead (Primary Distribution)

There are certain expenses which can be allocated directly to different departments or cost centers or products since these costs can easily be identified and allocated to a cost centers. But some expenses cannot be allocated to a particular department. Such expenses require division and apportionment over two or more cost centers or cost units.Different products pass through a number of departments and receive benefits from them in varying degrees. A Product must bear an equitable portion of expenses relating to it. These expenses might have been incurred in various production and service departments. The process of assigning the expenses to departments is known as departmentalisation.

Principles of Apportionment

Apportionment of overhead to various production and service departments is based on the following principles:

1. Service or use. This is the most common principle of apportionment of overhead costs. It is based on the theory that greater the amount of service or benefit received by a department/product, the larger should be the share of the cost to be borne by that department/ product.

2. Survey method. This method is used for those overhead costs that are not directly related to departments and survey may be conducted to find out the share of overheads to the cost centre.

3. Ability-to-pay method. This is based on canon of taxation, which holds that those who have the largest income should bear the highest proportion of the tax burden.

(iii) Re-apportionment of Service Department Costs to Production Departments

Not all items of the factory overhead are amenable to direct allocation. While some items can wholly be allocated to specific departments of cost centers, there are certain expenses, which need to be apportioned amongst different departments on an equitable basis. Costs of service cost centers (Service departments) are apportioned to productive cost-centers (Production departments) on equitable basis The effort related transfer price method assigns service costs to a department or product according to the amount of effort incurred.

Bases of Apportionment

The following bases are most commonly employed for apportioning items of overheads expenses among production/service departments.

(iv) Absorption of Overheads of Each Production Department in cost Units.Absorption is the allotment of overhead to cost units, may be a product, or process or an activity. It is the charging of overhead to individual product or units.The amount of overhead allocated and apportioned to the production department is to be borne by all cost units pertaining to that department. This is known as overhead absorption. Terms such as ‘recovery’, ‘application’ are also used. For the purpose of absorption of overhead to individual jobs, process or products,overhead absorption rates are applied. The term ‘overhead rate’ refers to the rate at which the overheads are to be charged to different cost units. It may be in the form of a percentage or a rate per unit.It may be based on actual cost or on the basis of estimated cost. or a pre-determined overhead rate or a blanket overhead rate for the entire factory. The blanket rate is computed as follows

Blanket rate = (Total overheads for the factory)/Base for the factory

Blanket overhead rate should not be used except when output is uniform.Otherwise it will result in over-costing or under-costing of certain cost units.Multiple Rates also may be applied for each department, cost center etc. For instance, separate rates may be calculated for each of the these Production department, Service department, cost center , product, fixed overhead and variable overhead.

The following formula is used to calculate the multiple rates:

Overhead rate = (Overhead of department or cos t center)/Corresponding base

A good absorption rate possesses the following characteristics

1. It is convenient to use and involves minimum of paper work

2. It should be according to the nature of the product.

3. It is stable so that comparisons can be made and also be flexible enough to take note of changing conditions

4. It does not bring much difference between recovered overheads and actual overheads

Methods Of Absorption of Manufacturing Overhead

There are various methods of absorbing manufacturing overhead. These methods have their own merits and demerits.

The more common of these are:

1. Percentage of direct materials cost.

2. Percentage of direct labour cost.

3. Percentage of prime cost.

4. Direct labour hour rate.

5. Machine hour rate.

6. Combined machine hour and labour hour rate.

(i) Percentage of Direct Materials Cost:

In this method the cost of direct materials used in the manufacture of a product is used as the base in absorption of factory overheads. The overhead rate is calculated on the basis of the following formula:

Overhead rate = ((Factory overheads)/(Direct material cos t))× 100

(ii) Percentage of Direct Labour Cost:
In this method, overheads are charged as a percentage of the direct wages incurred on jobs. The formula for computing the percentage is as under:

Overhead rate =(Factory overheads)/(Direct wages or labour cost))× 100

For example, when factory overheads are Rs.200000 and Direct Labour Cost is Rs.100000

The percentage overhead rate = ((1000000)/(200000))× 100 = 20%

(iii) Percentage of Prime Cost:

Here direct material cost, direct labour cost and other direct expenses,being all the constituents of prime cost are taken for calculation of the percentage.

The formula is:

Percentage on prime cost =((Factory overheads/Pr ime cost))× 100

For example if factory overheads amount to Rs.200000 and the prime cost is Rs.2000000,

Prime cost percentage comes to =(200000/2000000)× 100 = 10%

(iv) Direct Labour Hour Rate

In this method, the overheads are charged to production on the basis of number of labour hours spent on every job. The formula is


Direct labour hour rate = (Factory overheads/Direct labour hours used for the period)

Thus if total manufacturing overheads for a period are Rs.400000 and number of direct labour hours is 10000, then the labour hour rate works out to be Rs.4/- (400000/10000=Rs4/-). If a job takes 50 hours, then overheads applied will be 50 ́4=Rs.200/-

(v) Machine Hour Rate. It is the cost of running a machine per hour

Machine hour rate =(Factoryoverheads/ Machinehours duringa given period)×100

(vi) Combined Machine Hour and Direct Labour Hour Rate

A combination of machine hour rate and direct labour rate (called as dual hour rate) could also be used in those departments where work is done both manually and on the machine.

Joint Costs: In dairy industry or a dairy factory joint products and by products are obtained from the same raw material. In such cases Joint Costs of facilities or services employed in the output of two or more simultaneously produced commodities are involved . These Joint Costs are Common Costs till the point of split off when joint products and by products are obtained. The methods of apportionment of Joint Costs are based on the following bases

(i) Market Value Bases: under this method joint cost allocations are made on the basis of sale prices of the products provided the products can readily be sold in the markets without further processing. However, if further processing is required to bring the product into saleable form, value additions during further processing are to be assessed and deducted from the sale value to arrive at the basis for the apportionment of joint cost among the products.

(ii) Physical Unit Bases: under this method the joint costs are allocated to individual products on some physical basis, viz weight, volume, or some other common unit used to measure output.

Methods of Absorption of Administrative Overheads
In comparison to production overheads, administrative overheads relatively constitute a small portion of the total cost. There is a popular view that these overheads should not be treated as part of the cost of production because these are the period costs and should be debited to the Cost of Sales Account wholly.The other viewpoint is that it should be apportioned between production and sales departments. In such a case administrative overheads get merged with production and selling and distribution overheads. For the purpose of absorption of these overheads a single overhead rate is computed by any of the following methods

1. Percentage of Works Cost: Administration overhead is generally absorbed as a percentage of works cost. It is computed as follows

Overhead rate =(Admn. Overhead/Works Cost)× 100

2. Percentage of Sales: In this method, Administration overheads are absorbed as a percentage of sales which can be worked out as under

Overhead rate =(Admn Overhead/Sales)×100

3. As a percentage of Conversion cost: This method is not common and is rarely used

Overhead rate = (Admn. Overhead/Conversion cos t )× 100

Methods of Absorption of Selling and Distribution Overhead 

Selling and Distribution overheads may be allocated directly where they can be  identified with specific products. Where they cannot be identified with particular products, they have to be apportioned on some suitable basis, which may be one of the following.

1. Rate per article: Under this method, the total costs are estimated and are divided by the quantity of sales. It gives the rate per article.
 

Rate per article =(Total sellingand distributi costs/Numberof units sold)

2. A Percentage on Sales: In this method on the basis of the previous year’sfigures, a percentage of selling and distribution overhead to the total sales is calculated and the same rate is applied to recover the overheads from the selling price.

3. A Percentage of Works Cost: A percentage of selling and distribution overheads to works cost is arrived at from past records. This percentage rate is applied for the absorption of selling and distribution overheads

Overhead rate =(Selling and distributi on overheads/Works Cost)× 100

An improvement in cost measurement has been made by introduction of Activity-Based Costing (ABC). It is generally used as a tool for planning and control.

ABC is an approach to solve the problems of traditional cost management systems.Traditionally cost accountants had arbitrarily added a broad percentage on to the direct costs to allow for the indirect costs. Direct labour and materials are relatively easy to trace directly to products, but it is more difficult to directly allocate indirect costs to products However as the percentages of overhead costs has risen, this technique became increasingly inaccurate because the indirect costs were not caused equally by all the products.

As a result these traditional costing systems are often unable to determine accurately the actual costs of production and the costs of related services. Consequently managers were making decisions based on inaccurate data especially where there are multiple products.
 

Activity-Based Costing (ABC) is a method allocating costs to products and services on more scientific basis. Instead of using broad arbitrary percentages to allocate costs, ABC seeks to identify cause and effect relationships to objectively assign costs. Once costs of the activities have been identified, the cost of each activity is attributed to each product to the extent that the product uses the activity. In this way ABC often identifies areas of high overhead costs per unit and so directs attention to finding ways to reduce the costs or to charge more for costly products.

Classification of Costs

A useful approach for understanding the various aspects of costs consists in examining alternative cost classification schemes. Generally, costs incurred by manufacturers are classified in different ways. Three of these that we come across frequently are

1. By objects of expenditure/nature of elements.

2. By programme (such as cost of Job No.1, No. 2 etc)

3. By responsibility center (condending & drying, packing)

Each classification serves a specific purpose. In this section we shall discuss the first one in detail

I. Cost classification by Objects of Expenditure/ Nature of Elements In this classification costs are recorded according to the factors upon which expenditure is incurred viz., material cost, wages (labour cost) and expenses

Material cost: The term material refers to all those commodities that are consumed in the process of manufacture. Materials can be further classified into direct materials and indirect materials.Direct materials are those whose consumption may be identified with specific production units. Direct materials usually become integral part of the finished product. Direct materials thus include:
 

All materials used in production are wholly consumed in the production processes.For example milk used in making products such as butter, ghee, cheese or Ice cream. Sugar used in Ice cream or colour used in flavoured dairy drink. The cost on those items shall form direct material cost. Component parts used in product. Any primary packing materials such as LDPE film for packing milk or ghee.

Indirect Material: All materials which are used for purposes ancillary to the business and which can not conveniently assigned to specific physical units are known as indirect materials. Furnace oil used for boiler, grease and oil for machines, hydrochloric acid and caustic soda for house keeping in dairy industry fall under the category of indirect materials.Material cost includes cost on direct materials and indirect materials.

Labour Cost: The cost of remuneration of the employees of an undertaking fall under this category. It includes wages, salaries, commission, bonuses etc paid to employees. As per the statistics during 2001-2002 there were 865 dairy factories functioning in the organized sector in India having 83623 employees. Their total emoluments stood at Rs. 825.87 crores for the period under consideration. These employees included workers, supervisory and managerial staff and other employees.Employees can be further bifurcated into direct labour and indirect labour and cost associated with them is known as Direct labour cost and the 

Indirect labour cost respectively.

Direct Labour Cost. The wages paid to workers who are directly engaged in converting raw materials into finished products come under this category. These wages can be conveniently identified with a particular product; job or process.Wages paid to a technicians manufacturing butter or ghee or skim milk powder is an example of direct labour cost.

Indirect Labour Cost: Labour employed for the purpose of carrying out tasks incidental to goods produced or services provided is called indirect labour or indirect wages. Indirect labour is not directly engaged in the production operations required for product manufacture but only to assist or help on production operations. Mechanics, boiler attendant watch & ward staff, supervisors,storekeepers are examples of indirect labour and cost on these employees constitute indirect labour cost.

Expenses

All costs other than material and labour fall under this category and are termed as expenses. Expenses may be direct or indirect.

1. Direct Expenses

These are the expenses, which can be identified with and allocated to cost centers or units. Direct expenses can be conveniently allocated to a particular job or product or unit of service. These are also known as chargeable expenses or productive expenses. Hire of special machinery for a particular contract, cost of special drawings, designs and layout, carriage paid for materials purchased for a specific job fall under this category.

2. Indirect Expenses

Expenses which cannot be charged to production directly and which are neither indirect materials nor indirect wages are known as indirect expenses. Rent rates and taxes, insurance, depreciation, repairs and maintenance, power, lighting and
heating are few examples of indirect expenses.
 

The following chart shows the elements of cost mentioned above.

Overheads: Overhead costs are the indirect costs simply referred to as overhead. These cannot be directly attributed to any particular cost unit. The determination of overhead that should be properly associated with a given product is more difficult. It is because overhead costs cannot be identified with individual cost units and there are no accounting means of its exact distribution. Moreover they are generally not assumed to be directly associated with a department or product,either because there is no obvious relationship or because the cost of analysis and record keeping is considered too great.

There are three types of overheads.

1. Factory Overhead: Factory overhead includes all indirect expenses, which are incurred in connection with the manufacture of a product. They are also known as works overheads or factory burden or manufacturing overheads.Salary of plant manager and fee paid to Directors for guidance to solve production problems. Salary and other benefits paid to the Foremen, Timekeeper, Store Keepers and clerical staff of the factory,Cost of consumable stores,. Materials of small value such as cotton waste, small tools etc Rent, municipal taxes, depreciation, insurance etc., of the factory land and building,insurance, depreciation etc. of the factory plant, machineries, and equipment Factory lighting, heating and air conditioning, power and fuel (furnace oil, coal,gas, electric, etc.)Canteen and welfare expenses, telephone charges.Cost of training new employees, cost of experiment and research work.Cost of designing for production and drawing office expenses.Factory overheads may be fixed or variable.Fixed factory overhead are those costs, which do not vary with the volume of production. Examples are rent on factory building, insurance charges, property taxes, depreciation and supervisory salaries.
 

Variable factory overhead vary directly with the level of production. They include cost of fuel and power, repair and maintenance, cost of supplies and most indirect labour.

2. Administrative Overhead: It includes all those indirect expenses, which are incurred in general administrative and management function of an enterprise.
These overheads are of general character and are incurred for the business as a whole. Like factory overheads, administrative overheads tend to be fixed and variable.

The usual items generally included in these overheads are Salaries to Managing Directors, Directors, Executives and their staff, fees of Directors.

Office rent and rates and repairs and depreciation of office premises, power required for office equipment Audit fees, legal charges etc.

Stationary, postage, telephone charges, lighting and heating expenses and other utilities.

3. Selling and Distribution Overhead: Selling expenses are expenses of seeking to create and stimulate demand and of securing orders. Distribution expenses are expenses incurred in moving the goods from the company’s go downs to the customers’ premises. Selling and distribution expenses form no part of the cost of production but they take a considerable proportion of the price of the product.

The usual items included in selling and distribution expenses are :

Fee of Sales Directors, salaries of the Sales Manager and his staff including his office staff and his salesmen.

Traveling expenses and commission payable to salesmen.

Advertising and showroom expenses including rent and lighting.

Printing of catalogues and price lists and general stationary.

Rent of finished goods go downs and their repairs, etc.

Packing and carriage outwards, insurance in transit..

Depreciation, repairs and running expenses of delivery vans.

Telephone and postage etc. of sales department. Subscriptions to different agencies and trade journals.

Bad debts, legal charges for recovery of debts.

Having known classification of cost by elements of expenditure we can now derive various other costs.

The total of the Direct Expenditure comprising of Direct Materials, Direct Labour and Direct Expenses ——is known as Prime Cost or Flat Cost.

Prime cost plus Works or Factory Expenses is known as Works Cost or Manufacturing Cost or Factory Cost.
Product Costing

Works Cost plus Office and Administrative Cost is called Gross or Office Cost or Cost of Production.

Cost of Production plus Selling and Distributive Expenses is known as Cost of Sales. This differs from Selling price. Selling Price is equal to Cost of Sales plus Net Profit (or minus loss).

Methods of Costing

The methods of analyzing and presenting the cost vary from industry to industry.However, the basic principles of ascertaining costs are the same in every system of cost accounting.

1. Job Costing: Job costing is used where production is not repetitive and is done against orders. The work is usually carried out within the factory. Each job is treated as a distinct unit, and related costs are recorded separately.

2. Process Costing: Where an article has to undergo distinct processes before completion, it is often desirable to find out the cost of that article at each process.A separate account for each process is opened and all expenditure is charged thereon. The cost of the product at each stage is, thus accounted for. The output of one process becomes the input to the next process. Hence, the process cost per unit in different processes is added to find out the total cost per unit at the end.

Types of Costing

Various techniques are applied for ascertaining costs. These techniques may be used for special purposes of control and policy in any business irrespective of the method of costing being used there. These techniques are briefly explained below

1. Standard Costing: Standard Costing is a system, which seeks to determine beforehand what should be the cost and then actual cost is compared. The Standard Cost is pre-determined based on technical estimates of material, labour and overhead for a selected period of time and for a prescribed set of working conditions. This is a very valuable technique to control the cost as actual cost is measured against the standard cost. The differences between actual costs and standard costs are analyzed to know the reasons for the deviations. To correct the differences, remedial measures are then taken.

2. Absorption Costing: The practice of charging all costs, both variable and fixed costs to all operations, processes or products is defined as absorption costing.It is also known as traditional costing. In this method costs are ascertained after these have been incurred. Although until recently this was the only technique employed by cost accountants but now a days it is considered to have limited application as it doesn’t help in exercising control over costs. However it is useful in submitting tenders preparation of job estimates etc.

3. Marginal Costing: According to this technique only the variable costs are considered in calculating the cost of the product while the fixed cost is treated as period cost and no attempt is made to allocate or apportion this cost to individual cost centres or cost units. However fixed costs are charged against the revenue of the period. The revenue arising from the excess of sales over variable costs is technically known as contribution. The Marginal Cost includes direct material,direct wages, direct expenses and variable overheads. This technique helps to study the effect of changes in volume on profit and also take policy decisions such as product pricing in times of competition, whether to make or buy, selection of product mix.

4. Differential Costing: The concept of differential cost is based on the fact that in the real world, it is not practicable to employ ‘factors for each unit of output separately as inputs lack perfect divisibility unlike marginal costing.Differential cost is the difference in total cost between two alternatives.Differential costs arise due to the change in product lines, addition of new product or introduction of a ‘new product, replacement of worn out plant and machinery replacement of old technique of production with a new one.Differential costing considers all the revenue and cost differences amongst the alternative courses of action to assist management in arriving at an appropriate decision.

5. Uniform Costing: It is the use of same costing principles and or practices by several undertakings for common cost control or comparison of costs. Uniform costing provides reliable data for making inter firm comparison of cost performance. It facilitates comparison of the cost of production and the production efficiency between one unit and another. The working of a uniform costing depends on the co-operation of constituents of the industry.

Basic Cost Concepts

Cost Objective: It may be defined as any activity for which a separate measurement of costs is desired.

Cost Unit: It is defined as a unit of quantity of product, service or time (or a combination of these) in relation to which costs may be ascertained or expressed.Choice of cost unit depends upon the nature of the product manufactured, methods of production and trade practices.

Average Cost: An average cost is the cost of a product unit computed by dividing total cost by the number of units produced.

Conversion Cost: Conversion cost is the cost of production excluding direct materials, but including wastage in the direct material. It is total of direct labour,direct expenses and works overheads.

Variable Cost: If a given cost changes in total in direct proportion to changes in an activity it is variable cost.

Fixed Cost: Fixed cost remains unchanged for a given time period despite fluctuations in activity

Cost Center: Cost center has been defined as a location, person or items of equipment (or group of these) for which costs may be ascertained and used for the purpose of cost control. Cost Centre is a segment of a plant or in some case an entire plant, which is treated as functional units for the purpose of applying process overhead.

Productive Cost Center: A Productive cost center is directly engaged in productive activity and may consist of similar items of equipments.

Service Cost Center: Service cost centres are those cost centres, which are not directly engaged in productive activities, but provide services to productive cost centres so that production work may be carried out.

Cost Accumulation: It is the collection of cost data in an organized way in an accounting system.

Profit Center: Different cost centers when taken into a group headed by an individual or manager, who will be fully responsible for all cost, revenues and profitabilities of operation, the group is known as profit center.

Product Costing

In our competitive world profitability, growth and survival are the key issues confronting any business organization. No enterprise can survive and grow unless it is profitable in the long run. Profit is the result of two forces- revenue and cost.Revenue is the product of selling price and volume of output i.e., selling price multiplied by output it can sell. Selling price is influenced by market forces and is generally beyond the control of management. Similarly how much the output of a firm can be sold is again dependent upon market structure, price structure,marketing mix of the enterprise and host of other factors like government policies
concerning tariffs and taxes etc. Moreover the information about demand conditions is bound to be scarce and difficult to obtain, the cost information is usually plentiful which should be made use of by the managers. The firm pursuing the goal of profit maximization should endeavor to reduce per unit cost of production. The reduction in cost can be accomplished when cost per unit is ascertained. Therefore,knowing your production cost is critical. In present day economic scenario, accurate costing and pricing are key to success. Accurate costing avoids or minimizes distortions in product costing that result from arbitrary allocations of various costs.Managers want product costs for guiding their decisions regarding pricing and product strategies.

Managers also want product cost for the purpose of inventory valuation and income determination.The product is the smallest unit for which profitability is calculated.Product Costing It aids in arriving at profitability of the various business segments of an organization thus providing its total picture.

Product costing is the process of tracking and studying all the various costs that are incurred by the firm on its products or we can say what it costs to make the product. But before product cost is ascertained and estimated it is more relevant to define cost and other terms frequently used in costing. Cost has different meanings, differing among accounting, economics and engineering. The traditional accounting definition of cost is limited to the amount expended to acquire an asset. A more general concept equates cost with any sacrifice, past or future. In this context cost represents the resources that have been or must sacrificed to attain a particular objective. The concept of cost is multifaceted. The cost concepts shall be more clear if the following basic terms are understood properly.

Approaches to Managing Working Capital

Generally two approaches are followed for the management of working capital :

(i) the conventional approach and (ii) operating cycle approach.

The Conventional Approach: In this approach, each individual component of working capital viz. cash, inventory, receivables, payables etc. are managed efficiently such that, neither there is shortage of funds nor there is accumulation of excess funds. Since the cash position of the forms is affected by the management of the other items of working capital, the basic strategies that can be employed for the management of cash are 

(i) efficient inventory management

(ii) speedy collection of accounts receivables and 

(iii) stretching accounts payment without affecting the credit of the firm. 

An efficient inventory management is one that provides maximum customers service at a minimum cost. The optimum level of inventory is decided on the basis of the trade-off between cost of keeping inventory and benefits from it. As you know that inventory of a firm comprises of various items like, different types of raw materials, semi-finished goods in various stages of production, finished goods etc., it is not necessary for the manager to exercise same degree of control on all the items of inventory. The items which are most costly and/or converted into cash relatively slowly require more control. Hence, in the inventory control process, the inventory items are classified into three categories on the basis of the cost involved according to A B C System of classification. The items included in group A involve the largest investment and C group consists of cheapest items. Therefore,most rigorous and intensive control is required for A group of inventories and C deserve minimum attention. B group stands mid-way. It deserves less attention according to A B C System of classification. The items included in group A involve the largest investment and C group consists of cheapest items. Therefore,most rigorous and intensive control is required for A group of inventories and C deserve minimum attention. B group stands mid-way. It deserves less attention than A but more than C.

For receivable management, the firm has to decide whether or not to extend credit to a customer, how much credit to extend, what should be period for which credit is given, procedure for collection, in case of default etc. Similarly, the extent to which you can stretch your accounts payable will depend upon the credit policy, credit terms and collection policy of the creditor. There is no fixed norm for each of the above questions. The decision of the firm will be guided by the general nature of business, business environment and risk taking ability of the entrepreneur.

The Operating Cycle Approach: Under this approach, the working capital is determined by the duration of the operating cycle and the operating expenses needed for completing the cycle. In other words, this approach views working capital is a function of the volume of operating expenses.

The operating cycle has five major stages, (I) expenditure for purchasing raw material, stores etc. (II) inputs inventory (III) process interval (IV) warehouse(storage) interval and (V) collection interval. The operating cycle maintains circular flow of working capital from stage one through stage five as shown in the figure below. An effective management of working capital is that in none of these stages there is shortage of working capital nor there is excess of it.