Static Pricing in a Dynamic Market – a Dangerous Policy
Written by West Coast Partner, Gerry Michael
In the past few years, the dynamics of the economy have changed in ways that are sometimes overlooked because so much attention is paid to the weakened overall level of demand. However, it’s clear that even when the economy is fully recovered, changes have occurred which are likely to continue to exist well into the future, resulting in a changed competitive environment. Firms not prepared to deal with these changes may find that after surviving a number of difficult years in the economy, the “recovery” leaves them far behind. Others will be prepared to take advantage of the new economic realities and the opportunities they represent.
The pricing of products or services is an area that has had tremendous change. For many privately held firms, too much emphasis has been placed on estimates of product or job costs in setting prices and too little attention has been paid to market pricing pressures. While this approach may work fine when demand is high and few direct competitors exist, it’s now clear that those conditions are the exception, and not the rule. Many firms have learned new and much more agile pricing techniques in response to changes in the marketplace. They have refocused their attention in pricing away from total costs and taken more of a marginal costing approach to certain classes of business, primarily products or customers that they have not had previously. This allowed them to preserve their current base of customers at historic price levels, while adding new
business at prices that reflect marginal rather than total pricing. Of course, there is some danger if current customers become aware of this variable approach to pricing and seek lower prices themselves. However, if marginal pricing is applied to only certain types of business, or levels of customer service, it can be accomplished without disruption to the current base of business.
The key to this approach is recognizing that in today’s economy, very few firms are operating at anything like full capacity. Most firms have aggressively reduced costs over the past few years in the face of reduced demand for their product or service, but the result has also reduced capacity utilization. This represents a real opportunity with the ability to fully understand their cost structures, and the willingness to use this knowledge. Increasing the level of utilization, rather than capacity, is the key to making marginal pricing work for a company. In the very dynamic market firms find themselves, such pricing may be the secret to not only success, but survival in coming years.
One way to implement this approach is to separate customers and prospects into different groups based on their characteristics and their attitudes on price, quality, and service. A simple example might have two classes: one demanding the highest levels of quality and service and is willing to pay for it, and the other being more price conscious, therefore willing to accept slightly lower levels of both quality and service. Many companies pride themselves on serving the first group, but these are often hard to find in sufficient volume to utilize capacity fully. Nonetheless, a policy identifying potential business in the second group and developing pricing designed to take advantage, can offer a firm the ability to utilize much more of its capacity without increasing fixed or period costs.
For example, assume a custom manufacturer sells its principal machine time at $100 per hour, and that the costs of this machine (including allocated fixed costs) are $85 per hour, $20 of which represents variable costs like direct labor, etc. Also assume that the market for this output at $100 per hour is barely enough to fill a single shift, but that considerable work could be attracted if the company could lower its price to $70 per hour, enough to support a second shift. If this analysis is done based on the total costs, the company will pass on the extra work, but is this the right decision? Absolutely not.
All of the fixed costs for the company are already being covered by the first shift, so the real marginal cost for the second shift is closer to the $20 per hour in variable costs, not the $85. Even if additional costs arise in opening a second shift such as additional supervision, etc., it’s clear that pricing the second shift output at $70 per hour will be highly profitable for the company.
Of course no actual analysis is ever this simple, and confidence in the knowledge of a firm’s costs is critical to this method. There are also many concerns related to how this might affect a firms markets. But the simple truth is that by focusing on policies that maximize the utilization of a firm’s capacity, and not simply trying to maximize the return from the current level of sales, most firms will achieve much higher levels of profitability and financial strength.
back to top
Tax Update 2012
The following is a summary of the most important tax developments that have occurred in the past three months that may affect you, your family, your investments, and your livelihood. Please call us for more information about any of these developments.
Payroll Tax Cut Temporarily Extended. The Temporary Payroll Tax Cut Continuation Act of 2011 was enacted late last year. It temporarily extends the two percentage point payroll tax cut for employees, continuing the reduction of their Social Security tax withholding rate from 6.2% to 4.2% of wages paid through Feb. 29, 2012. Shortly after its passage, the IRS instructed employers to implement the new payroll tax rate as soon as possible in 2012 but not later than January 31, 2012. The law also includes a “recapture” provision, which applies only to those employees who receive more than $18,350 in wages during the two-month period (i.e., two-twelfths of the 2012 wage base of $110,100). This provision imposes an additional income tax on these higher-income employees in an amount equal to 2% of the amount of wages they receive during the two-month period in excess of
$18,350.
In addition, under the new law, the social security tax rate for a self-employed individual remains at 10.4%, for self-employment income of up to $18,350 (reduced by wages subject to the lower rate for 2012). Congress is going to try to negotiate a deal to extend the payroll tax cut for all of 2012. If a deal is struck to extend it for the full year, the recapture provision for employees would not apply.
The Vow to Hire Heroes Act of 2011
A new law enacted extended and enhanced a credit for hiring qualified veterans from November 21, 2011 through January 1, 2013.
The new law expands the definition of qualified veteran:
Any individual who is certified by a state employment security agency (SESA):
-
as having served on active duty in the US Armed Forces for more than 180 days,
-
discharged for a service-connected disability,
-
not having been on extended active duty within 60 days of hire date.
Enhanced provisions and increased credits.
-
A family member receiving assistance under a food stamp program for at least three months, maximum credit is $2,400.
-
Disabled veteran hired within one year of active duty, maximum credit is $4,800.
-
Disabled and unemployed for at least six months, maximum credit of $9,600.
-
Unemployed veteran for at least six months, maximum credit $5,600.
The credit is through the WOTC, Work Opportunity Tax Credit and is a credit against the employer's income tax. The credit is 40% of wages up to the maximum credit allowed. Certification through a SESA is required. A prescreen notice, Form 8850 can be filed prior to hiring and filed within 28 days of the new employee's start date.
New Rules for Deducting or Capitalizing Tangible Property Costs The IRS has issued new regulations for determining whether amounts paid to acquire, produce, or improve tangible property may be currently deducted as business expenses or must be capitalized. The regulations will affect virtually all taxpayers that acquire, produce, or improve tangible property. They are comprehensive, voluminous and virtually rewrite the rules in this area. For example, they provide detailed definitions of “materials and supplies” and “rotable and temporary spare parts” and prescribe new rules and elective de minimis and optional methods for handling their cost. They also have rules for differentiating between deductible repairs and capitalizable improvements, among many other items. The regulations generally are effective in tax years beginning after
December 31, 2011. However, to add to their complexity, some of the new rules in the regulations do not supersede prior IRS guidance. Contact our offices for details.
2012 Asset Purchase Deductions Through Section 179 and Bonus Depreciation For tax years beginning in 2012, the Section 179 annual expensing limit drops to $139,000. Further, larger businesses (those with eligible equipment additions over $560,000 for the year) face a phase-out of the Section 179 limit.
From 2008 through most of 2010, the bonus depreciation deduction was 50 percent of the cost of new assets. But for assets acquired and placed in service from September 9, 2010, through December 31, 2011, it increases to 100 percent. Congress has also extended the deduction into 2012, but at the lower 50 percent rate.
Standard Mileage Rates for 2012 and 2011
The optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks).
-
55.5¢ from July 1, 2011 through December 31, 2012.
-
51¢ from January through June 30,2011.
-
2012 rate for using a car to get medical care or in connection with a move that qualifies for the moving expense deduction is 23¢ per mile.
-
For 2011, it was 23.5¢ for miles driven after June 30 and 19¢ per mile for miles driven before July 1.
Pension Plan Limitations for 2012
-
For 401K, 403b and most 457 plans the elective deferral increased from $16,500 to $17,000.
-
The catch-up contribution limit for those aged 50 and over remains the same at $5,500.
-
ROTH IRA adjusted gross income phase-out range of married filing joint taxpayers wanting to make a ROTH IRA contribution is $173,000-$183,000, up from the 2011 limits of $169,000-$179,000.
-
SIMPLE retirement contribution limitation remains unchanged at $11,500.
-
Traditional IRA retirement contribution adjusted gross income limitations are:
Married filing joint with a participating spouse – phase-out is $92,000 - $112,000.
Married filing joint with a non-participating spouse – phase-out is $173,000-$183,000.
HSA Guidelines and Limitations for 2012
The definition of a "high deductible plan" for 2012 is a plan with an annual deductible of at least $1,200 for self-only coverage or at least $2,400 for family coverage.
The contribution limit in 2012 for self-only coverage is $3,100 and $6,250 for family coverage or $7,250 for employees age 55 or older.
back to top
Accounting Services
Just as our firm grows, so do our services. We've always had a Bookkeeping Department, but with the additional resources in each office, we are now able to offer more services than ever before. Due to growth and the increase in services, we are excited to announce that our Bookkeeping Department is now known as our Accounting Services Department. The following are just a handful of the accounting services we offer.
Payroll Processing: Based on your schedule, we can process your company payroll as well as take care of your deposits and quarterly reports. Our rates are competitive with “big box” services.
Standardized Reports: New hire reporting, prevailing wage, vacation and sick time, workers' compensation insurance.
Accounts Payable/Accounts Receivable: Let us maintain your books, so you can run your business. We’ll send out invoices, pay bills, reconcile your bank accounts…you name, we can do it!
QuickBooks/Peachtree: Our professionals know QuickBooks and Peachtree. We can assist your business at any level, from data entry to your year-end adjustments.
Outsource CFO/Controller: Many businesses are finding it to be cost efficient to “outsource” their CFO/controller duties. We can be a solution; our accounting services professionals have all the tools and resources.
back to top
Feed My Starving Children
In December, a few Carlson Advisors employees partnered with employees from the law firm, Barna, Guzy & Steffen, Ltd. (BGS) staff to network over the assembly and packaging lines of Feed My Starving Children (FMSC). Over the low din of other volunteers, greetings were exchanged and networking connections were established. The team environment and common task brought strangers and co-workers closer and provided easy conversation. By the end of the shift, many meals were packed for starving children around the world, and locally, some friendships were created.
This activity served a few purposes; provided an opportunity to see a networking partner, helped further a noble cause, provided Carlson Advisors a chance to promote itself to the local community and to strengthen teamwork within its participating staff. A perk of this particular visit to FMSC was the presence of Glen Perkins, some of the Twins corporate staff, and the team mascot T.C. Bear.
back to top
Food For Thought
"Work joyfully and peacefully, knowing that right thoughts and right efforts will inevitably bring about right results." - James Allen
back to top
|
