Companies use various methods to determine the price of their products. They ensure that the price of the product enables them to have cover the production costs and have a good profit margin. The profit margin should be comparable to other companies in the industry. However, companies may formulate strategies that enable them to earn a higher profit margin than other companies in the industry. The ability to have a higher profit margin gives a competitive edge over its rivals. Target costing is one of the methods that companies use to determine the price of products. target costing refers to setting the price of a product based on what the potential customers of the product are willing to pay. Companies that have a strong brand name may use target costing to set a high price on its products. This enables the company to earn a high profit margin than other companies in the industry (Swamidass, 2002). Apple is one of the companies that have a strong brand name. The company earns a higher profit margin than other companies in the industry, which improves its competitiveness.
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Tostitos Blue Corn Tortilla Chips
Frito-Lay Inc., which is a wholly owned subsidiary of Pepsi, manufactures Tostitos Blue Corn Tortilla Chips. The company headquarters are in Plano Texas. Frito Lay generally engages in the manufacture of snacks. Tostitos Blue Corn Tortilla Chips are made of white corn. They also have an ‘authentic’ Mexican taste, which makes them popular. Tostitos Blue Corn Tortilla Chips have a diameter of approximately 3 cm. Tostitos Blue Corn Tortilla Chips are usually eaten with nacho cheese dip or salsa, which are also manufactured by Frito-Lay.
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The price of a 9 ounce Tostitos Blue Corn Tortilla Chips is $5. Since Tostitos Blue Corn Tortilla Chips is sold by Frito-Lay, which is a subsidiary of Pepsi, it is vital to analyze the operating profit of the division of Pepsi Inc. The sales revenue of the division that manufactures and markets Pepsi Inc. is 14126 million. On the other hand, the operating profit of the division was 3877 million. This implies that the operating profit margin of the division is 27.45%. Therefore, the total cost of producing the product plus overheads is 72.55%. Target costing would help in determining the cost of manufacturing cost of the product. The target cost of the product is approximately 72.5% of the selling price. Since the selling price of Tostitos Blue Corn Tortilla Chips is $5 the target cost of the product is: 5 X 0.725 = 3.625. Below is a table that shows the breakdown in the manufacturing cost of the product.
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| Direct Material | |
| Whole Organic Blue Corn | $ 0.70 |
| Expeller Presses Sunflower Oil | $ 0.07 |
| Sea Salt | $ 0.03 |
| Total Direct Material Cost | $ 0.8 |
| Direct Labor | 0.30 |
| Manufacturing Overhead | $ 1.65 |
| Operating Expense | 0.75 |
| Total cost | $ 3.5 |
The price of a 50 pound bag of whole organic blue corn is $61.98. The quantity of the bag in ounces is: 50 X 16 = 800 ounces.
Therefore, a 9 ounce pack would cost: (61.98 X 9) / 800 = 0.6972, which is approximately 0.7
On the other hand, the price of 64 ounce expeller sunflower oil is $46. Therefore, the price of 1 ounce of the sunflower oil is 46/ 64 = 0.71875, which is approximately $0.72. In calculating the cost of producing a 5 ounce Tostitos Blue Corn Tortilla Chips, the general assumption is that it used 0.1 ounces. Therefore, the price of 0.1 ounce of expeller sunflower oil is 0.07.
The cost of 1 kg of sea salt is $0.3. 1 kg is equivalent to 35.27 ounces. Therefore, the price of 1 ounce of sea salt is 0.3/35.27 = 0.0085. The general assumption is that the 9 ounce Tostitos Blue Corn Tortilla Chips required 3.5 ounces. Therefore, the cost of salt is:
0.0085 X 3.5 = 0.03
To calculate the cost of labor, it was assumed that each worker produces 50 packs of Tostitos Blue Corn Tortilla Chips per hour and the wage rate of the company is $15. Therefore, the total cost of producing each 9 ounce pack of Tostitos Blue Corn Tortilla Chips is:
15 / 50 = 0.3
The direct and indirect cost of manufacturing a 9 ounce Tostitos Blue Corn Tortilla Chips is 0.3 + 0.8 = $1.1
The manufacturing overhead of the company is 150% of the direct and indirect cost of the company. Therefore, the manufacturing overhead is $1.1 X 1.5 = 1.65.
The operating expense of the company is assumed to be 15% of the selling price of the product. Therefore, it is 5 X 0.15 = 0.75
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Doritos Tortilla Chips
Doritos Tortilla Chips is Tostitos Blue Corn Tortilla Chips’ main rival. Frito-Lay Inc. manufactures Doritos Tortilla Chips. The cost of a pack of the Doritos Tortilla is $3.98. The target cost of the company is 70% of the selling price. Therefore, it is:
3.98 X 0.70 = 2.79
This is approximately $2.80. Below is a table that shows a breakdown of the manufacturing costs of the product.
| Direct Material | |
| Ground Corn | $ 0.09 |
| Expeller Presses Sunflower Oil | $ 0.07 |
| Sea Salt | $ 0.03 |
| Cheese | $ 0.32 |
| Total Direct Material Cost | $ 0.5 |
| Direct Labor | $ 0.30 |
| Manufacturing Overhead | $ 1.20 |
| Operating Expense | $ 0.8 |
| Total cost | $ 2.8 |
A bushel of ground corn costs $4.43. One bushel is equivalent to 70 ounces. Therefore, the price of one ounce of ground corn is 4.43 / 70 = 0.06.
On the other hand, the price of 64 ounce expeller sunflower oil is $46. Therefore, the price of 1 ounce of the sunflower oil is 46/ 64 = 0.71875, which is approximately $0.72. In calculating the total cost of producing Doritos Tortilla Chips, the general assumption is that it used 0.1 ounces. Therefore, the price of 0.1 ounce of expeller sunflower oil is 0.07.
The cost of 1 kg of sea salt is $0.3. 1 kg is equivalent to 35.27 ounces. Therefore, the price of 1 ounce of sea salt is 0.3/35.27 = 0.0085. The general assumption is that the 9 ounce Tostitos Blue Corn Tortilla Chips required 3.5 ounces. Therefore, the cost of salt is:
0.0085 X 3.5 = 0.03
One ounce of cheese is used in manufacturing Doritos Tortilla Chips. The cost of cheese is $0.32 per ounce.
To calculate the cost of labor, it was assumed that each worker produces 50 packs of Doritos Tortilla Chips per hour and the wage rate of the company is $15. Therefore, the total cost of producing each pack of Doritos Tortilla Chips
15 / 50 = 0.3
The direct and indirect cost of manufacturing a Doritos Tortilla Chips is 0.3 + 0.5 = $0.8
The manufacturing overhead of the company is 150% of the direct and indirect cost of the company. Therefore, the manufacturing overhead is $0.8 X 1.5 = 1.2
The operating expense of the company is assumed to be 20% of the selling price of the product. Therefore, it is 3.98 X 0.20 = 0.8
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Difference in Costs
The two products have different prices. The difference in costs may be attributed to the difference in the direct material costs of materials used in the manufacture of the products. The costs of direct materials used in making Doritos Tortilla Chips are cheaper than those of Tostitos Blue Corn Tortilla Chips. Therefore, the low cost of materials used in making Doritos Tortilla Chips makes it have a lower price.
Doritos Tortilla Chips and Blue Corn Tortilla Chips do not compete on the basis of price. They only compete on taste. The two products have different tastes that appeal to different people. It is clear that the pack of Doritos Tortilla Chips is heavier than the pack of Blue Corn Tortilla Chips. However, the price of Doritos is lower than the price of Blue Corn. However, customers prefer the products due to the difference in the taste of each product instead of the weight. Therefore, the two products compete on differentiation.
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Value Chain Concept
Value chain concept helps in differentiating the useful activities, which enable a company to have a competitive edge in the industry, from useless activities, which prevent a company from advancing. A company should ensure that it focuses on value creating activities. This would improve the performance of the company. Value-creating activities include the ability to charge higher prices, having low production costs, and having the ability response to various threats and opportunities that the company faces.
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Value chain comprises of primary activities and support activities. Some primary activities include inbound logistics, and operations. Some support functions include the infrastructure of an organization, human resource, and procurement. Companies use the value chain concept to gain a competitive edge in the market. Value chain is manifested differently to different companies. It is also manifested differently in different products. Despite the fact that the activities in the value chain add value to the finished product, they incur certain costs to the organization. In addition, certain activities that are significant in the value chain lie outside the boundaries of the organization (Papp, 2001).
In the case in question, the products create different values according to the tastes and preferences of the customer. The major activity of the value chain that helps in improving the competitiveness of Doritos is weight. Doritos is heavier than Blue Corn. Therefore, it enables customers to have a heavier product at a less price. On the other hand, the main activity in the value chain that helps in improving the competitiveness of Blue Corn is taste. The high price of the products required to make the Blue Corn is the major cost in the value chain of Blue corn. On the other hand, the major cost in the value chain of Doritos is the cost of purchasing the higher quality of ingredients.
Critical Ingredient in the Snack
The critical ingredient in blue corn Tortilla Chips is whole organic blue corn. The price of price of 9 ounces of blue corn is $0.7. The price of blue corn is not expected to increase in the near future. However, climate changes may have a significant effect on the prices of blue corn in the market. Draught may lead to an increase in the prices of the blue corn. In addition, diseases may reduce the yield of blue corn. This would lead to an increase in the price of blue corn (USDA, 2014).
The critical ingredient in Doritos is cheese. The prices of cheese have been on an upward trend in the recent past. The prices are expected to continue increasing the foreseeable future (Schmahl, 2015). This would lead to an increase in the production costs of Doritos. This would necessitate Frito-Lay to increase the prices of Doritos.
Same Price
Increase in inputs would require the company to pass over the price increase to customers by charging higher prices. This would be the simplest strategy that the company may use. However, increase in the price may have an effect on the demand of the products. Generally, price increase leads to a decrease in the demand of a product. This rule is not applicable to certain products that are necessities. The demand elasticity of chips is high. Therefore, a significant increase in the price of chips would reduce demand. Increase in price would make Doritos lose its competitive edge in the market. This is due to the fact that it uses price to compete with other products in the market. On the other hand, increase in price would not have a significant effect on the demand of Blue Corn Tortilla Chips. This is due to the fact that Blue Corn Tortilla Chips competes on the basis of taste.
Since increasing the price of products would have a negative impact on the company, it is vital for the company to ensure that it undertakes measures that would enable it maintain the current price of the product while ensuring that it maintains its gross margin. The company may formulate measures that would help in improving the productivity of employees. Currently, one employee makes 50 packs of tortilla chips in an hour. If the employees make more than 50 packs per hour, the company would reduce its labor costs, which account for a significant percentage of the total costs of the tortilla chips.
The products may also be sold at the same price if the cost of the packaging material used to make the tortilla chips is changed. Using a cheaper packaging material would enable the company sell the products at the same price while maintaining the gross margin. Reducing operating expense would also help in maintaining the price of the products while maintaining the gross margin of the products. The company may reduce the operating expenses by reducing the number of employees required in administration of the products. Improvement in the efficiency of the operations of the company would also help in reducing wastes within the company. Improvement in the cost structure would enable the company maintain the gross margin of the co
Conclusion
It is vital for companies to ensure that the price of their products enables them to earn a good profit margin. Analysis of the two products determined that the products have a good profit margin. Blue Corn is the most profitable product since it competes on taste. On the other hand, Doritos competes on price, which necessitates it to have a low price.
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