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This assignment is formulating an analysis of Absorption and Marginal Costing, strengths and weaknesses with special reference to pricing decisions and the importance of cost behaviour in decisions and the importance of cost behaviour in decision making and preparation of a flexible budget of the company through analysis of the internal, external factors within the competitive situation of the existing global competitive market. To consider the Absorption and marginal costing of the company an analysis of types of budget setting with regards the behavioural aspects of participation, and Responsibility Accounting in budget setting is the most vital factors now a day. In the competitive business situation various factors are present of which a comparative analysis between the traditional methods of apportionment (OAR) and Activity-Based Costing (ABC), used in calculating costs and pricing policy and a assessment of value engineering, Total Quality Management (TQM) and Standard Costing used for cost control methods are needed to be done very intensively. These factors are always affecting the company like Martin Mccoll's business strategic status every moment. So in the assignment the effectiveness of cost control techniques and decision making process in creating value to this organisation has been analysed in a competitive market by using different tools. In the conclusion future cost control methods and its advantages and disadvantages has advised for the company.
Company name: Martin Mccoll's supermarket Ltd.
Absorption and Marginal costing Analysis of the Martin Mccoll's :
Martin Mccoll's sometimes colloquially known also as M&M is a British retailer, with 1060 stores in more than 10 countries around the world. It is one of the most iconic and widely recognized chain stores in the UK with 80 stores as of March 2008 and is the largest grocery retailer in the UK, as well as being a multi-billion pound food retailer. Most of its shops sell both of these categories. It also has a third line of business selling home wares such as bed linen, but this is far smaller than the other two.
In 1990 it became in the top ten British retailer list to make a profit before tax of over £1 billion, though a few years later it plunged into a crisis which lasted for several years. As of 2007, it is growing again and rapidly increasing profitability, but it is now less than one quarter of the size of the UK's largest and most profitable retailer.
Fig: M&M Investing money in different sections
M&M main key strength is ownership. Today they have 70% owned and 30% leased property.
Martin Mccoll's supermarket Ltd. has a strategic position in the retail market in the UK . Cost control methods of the company are playing a vital role behind this achievement. Managing finance for strategic management levels is responsible to establish the company s position strong.
Over the 1060 stores of Martin Mccoll's supermarket Ltd all over the UK have been raising with successfully for its effective use of cost control method. The absorption and marginal costing of the company with special reference to pricing decisions and the importance of cost behaviour in decision making is need to be considered by this regards. So these factors are analysed as follows:
ANALYSIS OF ABSORPTION COSTING :
Absorption costing is a system that attempts to determine a full cost for each unit of output. This is a method, which is used to absorb overheads into the cost units produced in the production cost centres.
Strengths of absorption costing:Â
Absorption costing is widely used and it contributes a significant value to the company of M&M.Â
Defenders of theÂ absorption principle point out that:
1. It is necessary to include fixed overhead in stock values for financial statements;Â routine costÂ accounting using absorption costing produces stock values which include a share ofÂ fixedÂ overhead:Â
2. For small business, using job costing overhead allotment is the only practicable wayÂ of obtainingÂ job costs for estimating and profit analysis;Â
analysis of under/over absorbed overhead is useful to identify inefficient utilizationÂ of productionÂ resources.Â
So from the above discussion it is very clear that by introducing absorption costing in the pricing decisions M&M create value to the organization.
Weaknesses of absorption costing:
The Criticisms of absorption costing can evaluate as follows:
1. Profit per unit is a misleading figure: in the example the operating margin of £2Â per unit arisesÂ because fixed overhead per unit is based on 5,000 units. If another basis was used,Â margin perÂ unit would differ even though fixed overhead was the same amount in total.Â
2. Build-up or run-down of stocks of finished goods can distort comparison of periodÂ operatingÂ statements and obscure the effect of increasing or decreasing sales.Â
Though the above Criticisms of absorption costing exist still it is preferable for M&M.
ANALYSIS OF MARGINALCOSTING :
Definition of Marginal costing:
Marginal costing is the accounting system in which variable costs are charged toÂ costÂ units and fixed costs of the period are written off in full against the aggregateÂ contribution. Its special value is in recognizing cost behavior and hence assistingÂ inÂ decision-making.Â
Martin Mccoll's used marginal costing in its cost control method.
ABSORPTION COSTING V MARGINAL COSTING:
The comparative analysis of absorption costing and marginal costing can be executed as follows:
Under absorption costing (also called full absorption costing or total absorptionÂ costing)Â fixed overheads are absorbed into cost units on the basis of
a pre-determined absorptionÂ rate.Â
Absorption costing is a method of costing that, in addition to direct costs, assignsÂ all,Â or a proportion of, production overhead costs to cost units by means of one or aÂ number of overhead absorption rates.Â
Under marginal costing only variable costs are charged to cost units; fixed costsÂ for a period are fullyÂ written off in the profit and loss account of the period in which they are incurred.Â
Importance of cost behavior:
For the change of social environment it is very important for the company to carefully consider the importance of cost behavior in there cost control system.
Except other competitors, M&M will be influenced by social environment. Since the social environment changes at any time, the customer's tastes are also changed. M&M can adjust its products to satisfy different needs.
Relating to the pricing decision and cost behavior analysis, Porter identified three 'generic strategies for competitive advantage, this can represent a distinctive strength of a company.
These are shown in the diagram below:
In the middle
Source: Porter, M.E (1980) Dibb, S & Simkin, L (2001) . P. 239
A cost leadership strategy means that the product is sold at the lowest price compared to similar products in the same market segment. The differentiation strategy is based on creating a product that stands out from the other products in the segment in some relevant aspects. In the focus strategy, the company focuses on a small market segment, which it aims to serve particularly well. Porter argues that companies, which don't adopt one of these three strategies are 'stuck in the middle' which works to the disadvantage of the company. This happened to quite a few big companies, such as Phillips or Olivetti in the past (Kotler, 1996) and the same seems to apply to M&M. They are serving quite a big market segment, however they are certainly not adopting the cost leadership strategy and their products don't seem to greatly differentiate themselves in a relevant way from similar products of their competition.
This might have been true years ago, when Martin Mccoll's were supposed to sell outstanding quality products, but in recent years they lost this image, which is another important reason for their current situation.
Definition of flexible budgeting:
The traditional approach is to base the budget on the current year's results plus an extra amount for estimated growth or inflation next year. This approach is known as incremental budgeting since it is concerned mainly with the increments in costs and revenues, which will occur in the coming period.
Incremental budgeting is a reasonable procedure if current operations are as effective, efficient and economical as they can be.
It is also appropriate for budgeting for costs such as staff salaries, which may be estimated on the basis of current salaries plus an increment for inflation and are hence administratively fairly easy to prepare.
In general, however, it is an inefficient form of budgeting as it encourages slack and wasteful spending to creep into budgets. Past inefficiencies are perpetuated since the relationship between costs, benefits and objectives are rarely subjected to close scrutiny.
Justification for the incremental approach
(a) Easy to use and set up.
(b) Managers understand it.
(c) Results in less change -less risky and has less cultural problems and conflict.
(d) Less costly to operate.
(e) Can be used in a rolling budget system.
(f) Activities may be mandatory.
(g) Past experience built into the budget.
Easy to evaluate ideas and agree targets.
An analysis of types of budget setting:
Analysis of types of budget setting include two important phenomenon. One is the behaviourial aspect of participation and the another is the responsibility accounting in budget settin . both are infuencded by some factors which are known as porter five forces.
The Porter Five Forces Analysis helps the marketer to contrast a competitive environment. It has similarities with other tools for environmental audit, such as PEST analysis, but tends to focus on the single, stand alone, business or SBU (Strategic Business Unit) rather than a single product or range of products.
Figure: Porter Five Forces
Sources: M. E. Porter, Competitive Strategy, Free press, 1980.
Five forces analysis looks at five key areas namely the threat of entrants, the power of buyers, the power of suppliers, the threat of substitutes, and competitive rivalry.
The threat of entry: The threat of entry looks out in terms of differentiation for M&M to the customers' loyalty that can discourage potential entrants. M&M has a long time developed focus that has served as an entry barrier. As such, it is unlikely for M&M to have new entrant in its area. M&M is an expert in this field.
The power of buyers: Martin Mccoll's showed and practiced preference in using British suppliers alone. M & M became dependent on its suppliers. It experienced less power to negotiate because of few close alternatives.
The power of suppliers: M&M patronage of British suppliers made them reliant over giving enough power of the suppliers over M & M.
The threat of substitutes: Substitution can reduce demand for a particular 'class' of products when customers switch to the alternatives. The alternatives came from Tesco and Sainsbury as they acted on providing added value foods. These alternatives provided threat to M & M.
Competitive Rivalry: Under competitive rivalry, M&M really faced threat as other companies entered the industry with the same quality goods but with affordable price and up-todate fashion. This is the area where M&M failed the most.
(a) Past budgets may contain inaccuracies and bias.
(b) Creativity and effort only focused on 'marginal aspects.
(c) Encourages philosophy of, "1f we don't spend it we don't get it!"
(d) Not objective orientated. ..
(e) May not optimise resources.
(f) Does not consider operational priorities.
(g) Maintains status quo.
(h) Managers may refuse to own the budget -not made up of their ideas
(I) Short termism
To ensure that inefficiencies are not concealed, alternative approaches to budgeting have been developed. One such approach is zero base budgeting.
1. Strategic management level
2. Tactical management level
3. Operational management level
1. Strategic management level:
At this stage high level managers are here. They decide the objectives and when to achieve the objectives for the organisation and explain how they will be achieved to the mid level managers. Management level of the Martin Mccoll's Supermarket Ltd face the high degree of uncertainty and risk. The management deals with complex issues of the internal and external situation.
2. Tactical management level:
The store managers of Martin Mccoll's supermarket Ltd are categorised within this level. This is long range planning level of the company. Budgetary control, cash flow, profit result, labour turn over and so on are the responsibility under such manager. In the Martin Mccoll's supermarket Ltd satisfaction of the employees are growing day by day.
This drives the profit margin to the company. As a result the rate of labour turn over is decreasing now.
3. Operational management level:
They carry on the specific task tasks effectively and efficiently. The line managers, shift
Managers, team leader and supervisor are acting at this level in the Martin Mccoll's supermarket Ltd. Any types of operation in this stage they performed successfully. They assure the customers satisfaction directly in the store.
Zero based budgets
This is a recent phenomenon. Martin mccolls
Definition of ZBB
A method of budgeting whereby all activities are re-evaluated each time a budge is formulated.
Each functional budget starts with the assumptions that the function does not exist, and is zero cost.
Increments of costs are compared with increments of benefits culminating in the planned maximum benefit for a given budgeted cost.
The advantages of implementing ZBB
The advantages of zero base budgeting are as follows
It is possible to identify and remove inefficient or obsolete operations, b)
It forces employees to avoid wasteful expenditure
It can increase motivation
It responds to changes in the business environment;
'obsolescent' items of expenditure are identified and removed
The documentation required makes a coordinated, in-depth knowledge of an organisation's operations available to all management.
It challenges the status quo.
In summary, ZBB should result in a more efficient allocation of resources to activities and departments of the organisation.
The disadvantages of ZBB
The volume of extra paperwork
Short-term benefits might be emphasised to the detriment of long-term benefits.
Management must be able to meet unforeseen opportunities and threats at all times, however, and must not feel restricted from carrying out new ideas simply because they were not approved by a decision package, cost benefit analysis and ranking process.
It may call for management skills in decision analysis which the organisation does not possess
The ranking process can be difficult.
Managers face three common problems.
A large number of packages may have to be ranked.
It can be difficult to rank packages which managers regard as being equally vital for legal or operational reasons,
It is difficult to rank activities which have qualitative rather than quantitative benefits - such as spending on staff welfare and working conditions.
APPLICATIONS OF ZERO BASE BUDGETING
The procedures of zero base budgeting do not lend themselves easily to direct manufacturing costs where standard costing, work study and the techniques of management planning and control have long been established as a means of budgeting expenditure.
ZBB is best applied to support expenses, that is expenditure incurred in departments which exist to support the essential production function.
These support areas include marketing, finance, quality control, repairs and maintenance, production planning, research and development, engineering design, personnel, data processing, sales and distribution.
In many organisations, these expenses make up a large proportion of the total expenditure. These activities are less easily quantifiable by conventional methods and are more discretionary in nature.
ZBB can also be successfully applied to service industries and non-profit-making organisations such as local and central government departments, educational establishments, hospitals and so on, and in any organisation where alternative levels of provision for each activity are possible and where the costs and benefits are separately identifiable.
For the external analysis of Martin Mccoll's we can discuss the PEST analysis. This analysis is a helpful tool to take a closer look at the general environment. Although the PEST analyses rely on past events and experience, it can be used as a forecast of the future (Wilson and Gilligan, 1998).
The political environment is stable and reliable, even if Britain fails to achieve total agreement with some EU policies from time to time. At the present no EU directives are known which will have a direct effect on the UK clothing retail. Industryinthenearfuture
Due to the EU membership a trend can be seen towards stricter environmental protection legislation. This may have a direct or indirect effect on Martin Mccoll's or his suppliers.
Looking at the economic environment, it is rather tricky since on the one hand there is the strong sterling compared to the Euro. EU encourages imports and activities to hold domestic prices at an attractive level. But on the other hand it is difficult for the UK to be competitive outside its boundaries because of the high pound sterling exchange rate against the Euro. As M&M is a UK leading company and it sells most of the product in the UK marketplace, this may currently only have a limited effect, but could be more important in the future when thinking globally.
Another issue is the falling unemployment rate. For the UK population this is good news but for companies like M&M, this has different implications. For M&M it means higher expenditure on wages, as well as greater difficulties in recruiting good employees.
Nowadays life style is changing. Average working hours per week have decreased and people get more spare time. This means they have time to compare prices in the High Street and the quality of goods and services from the retailers.
At present people are more conscious about the production process. They wants to know the factories are environmentally friendly or not, where the product was build. Child labour may be the one problem in the clothing retail sector. There are a lot of company who rely on it in order to be competitive in their domestic market. But once the customers become aware of such practices, companies get into real trouble if they do not respond immediately.
Another issue is the speed of technological transfers which also has an impact on the industry - it is not comparable with the fast growing internet business, however it is important. New technology allows new products to be developed. Existing materials can be produced quicker and cheaper. Adopting these technologies can be a decisive factor as to whether a company is ahead of his competitors or whether it lags behind.
For external analysis of Martin Mccoll's supermarket Ltd. we can also use BCG Model which will help us to find out which strategic business unit is provide significant revenues or losses now and expected to continue to do so in the future. A business within a corporation is generally termed a strategic business unit(SBU). A SBU may be defined as a unit that has a distinctive business mission, offers a well defined market and able to manage its strategy in a manner that is independent of other businesses. So BCG model can be executed as following manner:
ACTIVITY BASED BUDGETINGÂ
Is a method of budgeting based on an activity framework and utilizing cost driver
data in the budget setting and variance feedback processes.
At its simplest, activity based budgeting (ABB) is merely the use of costs determinedÂ using ABC as a basis for preparing budgets.
Implementing ABC leads to the realisationÂ that the business as a whole needs to be managed with far more reference to the behaviourÂ that the business as a activities and cost drivers identified.
For example, traditional budgeting mayÂ makeÂ managers 'responsible' for activities which are driven by factors beyond their control:Â theÂ cost of setting-up new personnel records and of induction training would traditionallyÂ beÂ the responsibility of the personnel manager even though such costs are driven byÂ theÂ number of new employees required by managers other than the personnel manager.Â
More formally, therefore, ABB involves defining the activities that underlie theÂ financialÂ figures in each function and using the level of activity to decide how much resourceÂ shouldÂ be allocated, how well it is being managed and to explain variances from budget.
Claimed results of using ABC:
Different activity levels will provide a foundation for the base package and incrementalÂ packages of ZBBÂ
The organization's overall strategy and any actual or likely changes in that strategyÂ willÂ be taken into account because ABB attempts to manage the business as the sum of itsÂ interrelated parts.Â
Critical success factors (an activity in which a business must perform well ifÂ it is toÂ succeed) will be identified and performance measures devised to monitor progressÂ towards them
The focus is on the whole of an activity, not just its separate parts, and soÂ there is moreÂ likelihood of getting it right first time. For example, what is the use of beingÂ able toÂ produce goods in time for their despatch date if the budget provides insufficientÂ resources for the distribution manager who has to deliver them.
An Evaluation of the options:
To evaluate the options and find out the best one we need to consider two things. which are :
.1.Feasibility: Feasibility means financially viable ie capable of being done or carried out the project successfully. It depends on the Martin Mccoll's management decision. if they find that they have enough fund to run the clothes project then they can invest in the clothes project.
2.Acceptability: Acceptability means the decision that made by management is accepted by shareholder. Shareholders are the main owner of the business. they are accepted the project when they think that the project will profitable in the near future. So Martin Mccoll's Shareholders think clothes project will be attractive for the young kids and will made more money for company then they will also accept it.
Several internal and external strategic options are used analysing the company successfully. Among these options SWOT analysis and BCG Model provides future strategic pathways to the company. Through the SWOT analysis The Martin Mccoll's supermarket Ltd can evaluate its internal analysis that it can measure the internal strength and weakness. The existing company be conscious to establish its strength
In inside and overcome the weakness that can be attack by the competitors. On the other hand external factors are opportunities and threats. The management has to adopt the external opportunities and consider the potential threats. New products, new competitors are the main threats to the company. So The Martin Mccoll's supermarket Ltd takes the factors seriously to minimise the degree of threat effectively.BCG Model is another best option for the management. It provides company to assess its strategic position, Growth share, revenue status, loosing products and new competitive products in the market. So this two strategic options are available to applied for Martin Mccoll's supermarket Ltd business.
To my point of view I strongly believe that The Boston Consulting Group (BCG) Model can be the best choice for external analysis for Martin Mccoll's supermarket Ltd because it provides the company a number of important issues to assess the risk profile of the products / businesses, the cash demands of the products / businesses, the development cycle of the products, Resource allocation and divestment decisions.
Implementation of the strategy:
To implement the strategy Martin Mccoll's supermarket Ltd need to consider two things which are as follows:
1: Change of management.
2: Change of structure.
1: Change of management: For implementing the selected strategy of clothes project
if they think that they need to made some changes in the management level and that will be effective for this new project then they can do it.
2: Change of structure: Some time change of structure also needed for implementing the selected strategy. The Martin Mccoll's management may be think to change the structure of the organisation, or may think to expand the structure of the business in Asia or Africa depending on the situation
For the future strategic development of the Martin Mccoll's supermarket Ltd company, Internal and external analysis with BCG matrix and PEST analysis will be effective.M&M is a successful multinational corporation. Depending on its high quality, good service, comfortable shopping environment and convenient access, M&M has won a large amount of loyal consumers. There are a few issues Martin Mccoll's supermarket Ltd might address in order to improve their performance and regain their image as an outstanding company.
First of all, they should make a strong decision on what they perceive to be their target group for the clothing department. Quite clearly, the core customers shopping for clothes at Martin Mccoll's supermarket Ltd are middle-aged men and, in particular, women. Putting it more generally, the clothing at Martin Mccoll's supermarket Ltd with its current style and design surely tends to appeal more to an older age group, which as well is happy to shop at Martin Mccoll's supermarket Ltd due to its traditional reputation.
However, that makes it even more important to ensure that the core customer base is appropriately catered for, and the event of an elder lady telling a predominantly male board that she couldn't find anything she was looking for at Martin Mccoll's supermarket Ltd doesn't make for good publicity, especially amongst women. In this regard, it might be a good idea to carry out a little bit more research on customers' wants and needs through questionnaires and looking at market trends.
On the other hand, regarding the clothing department, Martin Mccoll's supermarket Ltd recently tried to increase their appeal to a younger age group, e.g. through the fairly new 'PerUna' range. However, it is quite obvious that particularly the age group between
14-19 is greatly reluctant to even shop at Martin Mccoll's supermarket Ltd and perceive the company on a whole to be unfashionable and 'un-trendy'.
Hence, it is quite debatable whether Martin Mccoll's supermarket Ltd will quickly be able to get rid of this negative image among youngsters and gain a considerable market share within this age group.
Therefore, if the company decided to pursue the approach of appealing to younger customers, it would in any case be highly important to clearly detach these new ranges from the core M&M brand, both in terms of the location (e.g. introducing separate stores) and the actual product (different design, separate brand label etc.).
Alternatively, especially considering the quantity and quality of the well-established competition in this market (Gap, Topshop, Warehouse, Zara etc.); Martin Mccoll's supermarket Ltd could instead of focus on their other businesses, which are more likely to bring them success. They have a profit-making food sector and a loyal customer base in the older age group, who are happy to buy clothes at M&M if appropriately catered for.
Considering that the demographical trend goes towards an ageing UK population with a high disposable income, this might be particularly valuable to concentrate on.
Finally, the financial services offered can turn out to be profitable, if Martin Mccoll's super market Ltd understands to use their well-known and highly trusted brand name to promote these. So finally this is my best recommendation to Martin Mccoll's supermarket Ltd for future strategic development to follow internal and external analysis.