Managing Resources and Pricing

STUDY UNIT TWO
MANAGING RESOURCES AND PRICING

2.1 Inventory Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2.2 Supply Chain Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
2.3 Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
2.4 Managing Human Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
2.5 Study Unit 2 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
This study unit continues the treatment of business processes that began in the first study unit. The
first two subunits concern the management of resources in the supply chain, particularly inventory. The
third subunit addresses the objectives and factors that influence the pricing of the organizations
products and services. The last subunit covers the management of human capital.
Core Concepts
I Inventory management applies to the acquisition, use, and distribution of inventory.
I Purchasing is the inventory management function that concerns the acquisition process. It
encompasses choice of suppliers, contract negotiation, the decision whether to purchase centrally
or locally, and value analysis.
I The basic EOQ model minimizes the sum of ordering (setup) costs and carrying costs.
I The just-in-time (JIT) inventory model limits output to the demand of the next operation. JIT
systems are based on a manufacturing philosophy popularized by the Japanese that combines
purchasing, production, and inventory control. Minimization of inventory is a goal because many
inventory-related activities are viewed as nonvalue-added.
I In a JIT system, the dependability of suppliers is crucial. Organizations that adopt JIT systems
therefore have strategic teaming agreements with a few carefully chosen suppliers who are
extensively involved in the buyers processes.
I Modern manufacturing environments impose control and improve quality through automation,
whether involving one piece of equipment, a cell, or an integrated plant.
I The supply chain consists of flows from sources of (1) raw materials, (2) components, (3) finished
goods, (4) services, or (5) information through intermediaries to ultimate consumers. These flows
occur across the value chain.
I Distribution is the transfer of goods (and, in other contexts, services and information) from
producers to customers or from distribution centers to merchandisers.
I The objectives of pricing are maximization of profit and target margins, achievement of sales
volume objectives, enhancement of firm image, and market stability.
I Many factors affect price, for example, (1) supply and demand, (2) marketing strategy, (3) costs,
(4) capacity usage, (5) nature of the market, (6) competitors actions, and (7) timing.
I Pricing policies vary with the stage of the product life cycle.
I Michael E. Porters generic strategies model is based on the concept that each of a firms
competitive advantages ultimately may be categorized as either a cost or a differentiation
advantage.
I Market leaders, market challengers, market followers, and market nichers adopt different
strategies that affect their pricing decisions.
I Managing human resources means acquiring, retaining, and developing employees.
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2.1 INVENTORY MANAGEMENT
1. Inventory management applies to the acquisition, use, and distribution of inventory.
a. An organization carries inventories because of the difficulty in predicting the amount,
timing, and location of supply and demand. Thus, one purpose of inventory
control is to determine the optimal level of inventory necessary to minimize costs.
b. Although traditional inventory management minimizes inventory and the related
holding costs, many companies use inventory as a hedge against inflation as well as
a guarantee of future availability.
c. Inventory carrying costs are sometimes transferred to suppliers or customers.
1) If a manufacturer knows exactly when materials are needed, orders can be
placed so that they arrive no earlier than actually needed (just-in-time, or JIT).
a) This practice relies on a supplier who takes the responsibility for storing the
needed inventory and shipping it to arrive on time.
b) Suppliers with strong competition are more likely to provide JIT delivery.
2) Customers sometimes carry large quantities of inventory when given special
quantity discounts or extended credit terms.
3) If customers are willing to accept long lead times, inventory can be
manufactured to order to avoid storing large quantities.
4) Although these measures can reduce inventory carrying costs, additional costs
might be incurred by adopting them. Shortage (stockout) costs may be
incurred when an item is out of stock. These include the lost contribution
margin on sales, customer ill will, and production interruptions.
d. Order costs include all costs associated with purchasing and receiving inventory other
than the costs initially recognized in the balance sheet.
e. Carrying costs include rent, insurance, taxes, security, depreciation, and opportunity
cost (i.e., the pretax return forgone by investing capital in inventory rather than the
best alternative). Carrying costs also may include a charge for spoilage of perishable
items or for obsolescence.
f. Inventory policies should consider the types of costs and any limitations the firm may
have, such as storage space.
1) Constraints may be imposed by suppliers.
2) The record-keeping cost of inventory should be considered.
g. The cost of holding safety stock and the cost of stockouts should be minimized.
1) Safety stock is the amount of extra stock that is kept to guard against
stockouts. It is the inventory level at the time of reordering minus the expected
usage during the lead time (time from order placement to its receipt).
a) EXAMPLE (adapted from CMA 1293 4-9): A company sells 60,000 units
per year. The average purchase lead time is 20 working days. Maximum
lead time is 27 working days. The company operates 240 days per year.
Thus, safety stock should be 1,750 units. Daily usage is 250 units
(60,000 per year 240 days), and a safety stock for 7 days (27 20)
should be maintained. Hence, safety stock is 1,750 units (250 units 7).
2) Stockout costs are lost sales, production, customer goodwill, etc.
2 SU 2: Managing Resources and Pricing
3) The problem may be diagrammed as follows:
a) The economic order quantity (EOQ) determines order size.
b) The reorder point is the intersection of the reorder level and the
downward-sloping total inventory line that allows sufficient lead time for
an order to be placed and received.
4) EXAMPLE (adapted from CMA 1288 5-22): Annual demand is 50,000 units, and
the optimal lot size is 6,250 units. Per-unit carrying costs and stockout costs
are $13 and $3, respectively. The following data relate to the appropriate
safety stock level:
Units Short During Number of Shortages in
the Lead Time Last 40 Reorder Cycles
200 6
300 12
400 6
The annual cost of establishing a 200-unit safety stock is expected to be $5,200.
The annual cost is the carrying cost of safety stock (200 units $13 = $2,600),
plus the stockout costs incurred. Excess demand has been 100 units (300
200) greater than the safety stock 30% of the time (12 40). The cost per
stockout was $300 (100 $3). Demand has exceeded the safety stock by
200 units (400 200) 15% of the time (6 40). The cost per stockout was $600
(200 $3). Thus, the expected stockout cost is $180 per reorder cycle [($300
30%) + ($600 15%)]. Given 8 cycles (50,000 units 6,250 EOQ), the annual
cost is therefore $4,040 [$2,600 + (8 $180)].
SU 2: Managing Resources and Pricing 3
2. Purchasing is the inventory management function that concerns the acquisition process. It
encompasses choice of suppliers, contract negotiation, the decision whether to purchase
centrally or locally, and value analysis.
a. The process is initiated by purchase requisitions issued by the production control
function. Purchase requisitions ultimately result from make-or-buy decisions made
when production processes were designed. For a retailer, the purchase decision is
the same as the decision about what to sell.
b. The choice of suppliers depends on price, quality, delivery performance, shipping
costs, credit terms, and service.
1) Purchasers with a competitive orientation and considerable economic power
may be able to extract very favorable terms from suppliers.
2) Purchasers with a cooperative orientation adopt a longer-term approach that
involves strategic teaming with suppliers. The purchaser and the supplier are
viewed as committed to a partnership involving joint efforts to improve
quality. This orientation includes the purchasers willingness to help develop
the suppliers managerial, technical, and productive capacities. Thus, it tends
to result in minimizing the number of suppliers.
c. Ordering may be a complicated task when a one-time, expensive purchase is made.
It also may be as simple as an email. Indeed, organizations increasingly are linked
with vendors by electronic data interchange (EDI). EDI permits the transmission
via computer of purchase orders, invoices, and payments. The result is reduced
inventories, document-handling costs, and reorder times.
d. Tracking purchases involves following up to anticipate any deviations from delivery
times, quantities, and quality. Tracking may prevent production interruptions.
e. The receiving function verifies the time of delivery, the quality and quantity received,
and the price. It also notifies purchasing, the subunit that requested the delivery,
inventory control, and accounting.
f. Negotiation of contracts depends on the nature of the item to be purchased. For a
customized item, the organization may use competitive bidding, with the contract
awarded to the lowest and best bidder; it may negotiate with a sole-source supplier
to reduce purchasing lead time; or it may order through a supplier catalog.
1) When purchased items are standardized and in high demand, the organization
may also preselect a sole-source supplier to which orders will be sent as
needed. Given great enough demand, the purchaser and supplier may even
agree to a long-term contract with some terms left open. A blanket contract
covers numerous items, and an open-ended contract permits terms to be
added or the period of the agreement to be extended.
g. Large organizations must decide whether to buy centrally or locally. Buying centrally
increases the organizations bargaining power and allows it to exploit the expertise of
corporate-level specialists. This expertise is important given the trend toward
purchasing items abroad. Centralized buying is facilitated by developments in
information technology.
1) Buying locally is indicated when items are unique to decentralized subunits,
when a JIT system is in place, and when short lead times are desired.
h. Purchasing shares responsibility for value analysis with the production and
engineering functions. Value analysis determines (1) the purpose of an item,
(2) whether that purpose is necessary, (3) whether a less costly standard item can be
found that serves the same purpose, and (4) whether the item can be simplified or its
specifications changed to reduce the cost. Thus, value analysis is done by teams of
specialists to evaluate how the performance of an item that is either produced or
purchased can be improved or its cost decreased.
3. Economic Order Quantity (EOQ)
a. Inventory models are quantitative models designed to control inventory costs by
determining the optimal time to place an order (or begin production) and the optimal
order quantity (production run).
1) The timing of an order can be periodic (placing an order every X days) or
perpetual (placing an order whenever the inventory declines to X units).
a) Periodic order systems place minimal emphasis on record keeping.
However, a risk of substantial overstock or understock may arise unless
inventories are checked for assurance that the model is still appropriate.
b) Perpetual systems detect an inventory decline to the reorder point by
entering every withdrawal on a perpetual record that shows the balance.
i) An alternative is to use the two-bin method for physical storage. In
this system, the reorder level amount is stored separately from the
balance of the items. When the stock clerk removes the last item
from the balance bin, an order should be placed. The reorder level
bin is then used until the order is received.
c) Physical inventories should be taken to reconcile records and verify
models in either a periodic or a perpetual system.
b. The basic EOQ model minimizes the sum of ordering (setup) costs and carrying
costs.
1) The following are the characteristics of this model:
a) Demand is known and uniform throughout the period.
b) The fixed costs of ordering are excluded.
c) Cost per order (setup) and unit carrying cost are constant.
i) Thus, the model is based on variable costs.
d) Full replenishment occurs instantly when the last item is used, stockout
costs are zero, and no safety stock is held. Thus, average inventory is
50% of the EOQ.
i) For example, if the EOQ is 500, the basic model predicts that the
average inventory level will be 250. The company will have 500
units immediately after a purchase and zero immediately before the
receipt of the next purchase (replenishment is assumed to be
instantaneous).
ii) However, safety stock increases the average inventory level by the
amount of the safety stock. The modified EOQ model assumes
that safety stock will never be used. Thus, if a safety stock of 100 is
carried by the company in the example, the average inventory level
will increase to 350. Inventory will be 600 units immediately upon
receipt of a purchase and 100 units immediately before the receipt
of the next purchase.
e) The model is relatively insensitive to error. A given percentage error in a
value results in a lower percentage change in the EOQ.
i) An EOQ sensitivity analysis involves varying the holding costs per
unit or the order costs to determine how much the changes affect
the optimal EOQ.
2) The EOQ results from using differential calculus to determine the minimum
point on the total cost curve. It also corresponds to the intersection of the
variable carrying cost and variable ordering (setup) cost curves. The basic
EOQ model is based on variable costs. The reason is that fixed costs are
eliminated when the total cost equation is differentiated with regard to
order/production quantity. (This calculation is not given.) The following is the
basic formula:
X
2aD
k
If: X = EOQ
a = variable cost per order (setup)
D = periodic demand in units
k = unit periodic carrying cost
3) EXAMPLE: If periodic demand is uniform at 1,000 units, the cost to place an
order is $4, and the cost to carry one unit in inventory for a period is $2, the
EOQ is 63.25 units.
EOQ
2($4)(1,000)
$2
63.25 units
4) The average level of inventory for this model will be one-half of the EOQ. The
formula shows that the EOQ varies directly with demand and order (setup)
costs, but inversely with carrying costs. Thus, if demand quadruples, the EOQ
will only double.
5) The EOQ is a periodic model. The number of orders (production runs) per
period is given by the periodic demand divided by the EOQ.
c. Variations of the EOQ model are numerous.
1) The effects of quantity discounts can be considered by using trial and error. If
the EOQ is below the discount level, the total cost equals the sum of the
purchase cost plus annual carrying and order costs. Next, the minimum order
quantity needed to obtain the discount is considered, and total cost is found for
this level. This process is repeated for multiple levels of discount. The optimal
order quantity is the one giving the lowest periodic total cost.
2) Lead time is accounted for by simply placing orders in advance. If back
ordering is acceptable to customers, it can be incorporated into the model.
3) The limitations of the EOQ model are its restrictive assumptions, especially
that of constant demand. But it can be combined with probability concepts to
form an effective perpetual system.
d. Probabilistic models have been developed for the situation in which demand is
random yet has a known distribution.
1) In a perpetual system, the possibility of running out of stock exists only during
the reorder period, the time between placing and receiving the order. The
reorder point is found by using the probability distribution for demand during the
period.
a) The order quantity is found by using the basic EOQ model and average
demand.
b) If stockout costs are known, an optimal reorder point can be found.
i) If these costs are unknown, management can select a service level
or probability of being in stock that can be used to find the reorder
point.
e. Among the limitations of inventory models for control are that they are restricted to
one item at a time and consider each item to be of equal importance.
1) If a firm has 10,000 line items, 10,000 calculations must be made. Computer
programs are available to perform the computations, but they still need periodic
review.
2) The importance of items can vary from essential to immaterial. The priority of an
item needs to be considered in establishing controls.
3) A third limitation is that demand is often more variable than expected. Seasonal
variations, as well as unexpected changes, can be provided for by including a
forecasting model to estimate the demand to be used in the inventory model.
4. The ABC system is a simple inventory management technique.
a. This method controls inventories by dividing items into three groups.
1) Group A consists of high-dollar-value items, which account for a small portion
(perhaps 10%) of the total inventory usage.
2) Group B consists of medium-dollar-value items, which may account for about
20% of the total inventory items.
3) Group C consists of low-dollar-value items, which account for the remaining
70% of sales or usage.
b. The ABC system permits the proper degree of managerial control to be exercised
over each group. The level of control reflects cost-benefit concerns.
1) Group A items are reviewed on a regular basis.
2) Group B items may not need review as often as group A items, but they may
need review more often than group C items.
3) For group C, extensive use of models and records is not cost effective. It is
cheaper to order large quantities infrequently.
5. Materials requirements planning (MRP) is an integrated computer-based information
system designed to plan and control raw materials used in a production setting. MRP is
characterized as a push-through system because production is activated by forecasts of
demand, not actual customer needs.
a. MRP is also a dependent-demand system. It assumes that the forecasted demand
for materials is typically dependent upon some other factor, which can be
programmed into the computer, e.g., the demand for the completed product.
b. The timing of deliveries is vital to avoid production delays.
c. EXAMPLE: An auto manufacturer need only tell a computer how many autos of each
type are to be manufactured. The MRP system determines how many of every
component part will be needed. The computer will generate a complete list of every
part and component needed (a bill of materials).
d. MRP, in effect, creates schedules of when items of inventory will be needed in the
production departments. If parts are not in stock, the computer will automatically
generate a purchase order on the proper date (considering lead times) so that
deliveries will arrive on time.
6. Modern inventory control favors the just-in-time (JIT) model. Companies have traditionally
built parts and components for subsequent operations on a preset schedule. Such a
schedule provides a cushion of inventory so that the next operation will always have parts
to work with -- a just-in-case method.
a. In contrast, JIT limits output to the demand of the next operation. Reductions in
inventory levels result in less money invested in idle assets; reduction of storage
space requirements; and lower inventory taxes, pilferage, and obsolescence risks.
1) High inventory levels often mask production problems because defective parts
can be overlooked when plenty of good parts are available. If only enough
parts are made for the subsequent operation, however, any defects will
immediately halt production.
2) The focus of quality control under JIT shifts from the discovery of defective
parts to the prevention of quality problems, so zero machine breakdowns
(achieved through preventive maintenance) and zero defects are ultimate
goals. Higher quality and lower inventory go together.
b. JIT is a reaction to the trends of global competition and rapid technological progress
that have resulted in shorter product life cycles and greater consumer demand for
product diversity.
1) The objectives of JIT methods are (a) higher productivity, (b) reduced order
costs as well as carrying costs, (c) faster and cheaper setups, (d) shorter
manufacturing cycle times, (e) better due date performance, (f) improved
quality, and (g) more flexible processes. The ultimate objectives are increased
competitiveness and higher profits.
c. JIT systems are based on a manufacturing philosophy that combines purchasing,
production, and inventory control. It also treats many inventory-related activities as
nonvalue-added. Indeed, carrying inventory is regarded as a symptom of
correctable problems, such as poor quality, long cycle times, and lack of coordination
with suppliers.
1) Thus, a JIT system reduces carrying costs by eliminating inventories and
increasing the deliveries made by suppliers. Ideally, shipments are received
just in time to be incorporated into the manufacturing process. This system
increases the risk of stockout costs because the inventory buffer is reduced or
eliminated.
d. However, JIT also encompasses changes in the production process itself. JIT is a
pull system. Items are pulled through production by current demand, not pushed
through by anticipated demand. Thus, one operation produces only what is needed
by the next operation, and components and raw materials arrive just in time to be
used. To implement this approach and to eliminate waste of materials, labor, factory
space, and machine usage, the factory is reorganized to permit what is often called
lean production.
1) Plant layout is not arranged by functional department or process but by
manufacturing cells. Cells are sets of machines, often grouped in semicircles,
that produce a given product or product type.
a) Each worker in a cell must be able to operate all machines and, possibly,
to perform support tasks. Examples are setup activities, preventive
maintenance, movement of work-in-process within the cell, and quality
inspection.
b) In a pull system, workers might often be idle if they were not multiskilled.
Hence, (1) central support departments are reduced or eliminated,
(2) space is saved, (3) fewer and smaller factories may be required, and
(4) materials and tools are brought close to the point of use.
Manufacturing cycle time and setup time are also reduced. As a
result, on-time delivery performance and response to changes in markets
are enhanced, and production of customized goods in small lots
becomes feasible.
c) A cellular organization requires workers to operate as effective teams, so
employee empowerment is crucial in a JIT-lean production system.
Greater participation by employees is needed to achieve continuous
improvement and zero defects goals. They may have the power to stop
production to correct a problem, be consulted about changes in
processes, or become involved in hiring co-workers. Thus, managers in
such a system usually play more of a facilitating than a support role.
e. The Japanese term kanban and JIT have often been confused. JIT is the total system
of purchasing, production, and inventory control. Kanban is one of the many
elements in the JIT system as it is used in Japan. Kanban means ticket. Tickets
(also described as cards or markers) control the flow of production or parts so that
they are produced or obtained in the needed amounts at the needed times.
1) A basic kanban system includes a withdrawal kanban that states the quantity
that a later process should withdraw from its predecessor. It also includes a
production kanban that states the output of the preceding process. A vendor
kanban tells a vendor what, how much, where, and when to deliver.
2) Many companies have not been comfortable with controlling production using
tickets on the production floor. Computerized information systems have
been used for many years, and these companies have been reluctant to give up
their computers in favor of the essentially manual kanban system. Instead, they
have integrated their existing systems, which are complex computerized
planning systems, with the JIT system.
f. Another feature of the lower inventory levels in a JIT system is elimination of the need
for several traditional internal controls. Frequent receipt of deliveries from suppliers
often means less need for a sophisticated inventory control system and for control
personnel.
1) JIT also may eliminate central receiving areas, hard copy receiving reports, and
storage areas. A central warehouse is not needed because deliveries are
made by suppliers directly to the area of production.
2) The quality of parts provided by suppliers is verified by use of statistical
controls rather than inspection of incoming goods. Storage, counting, and
inspecting are eliminated in an effort to perform only value-adding work.
g. In a JIT system, the dependability of suppliers is crucial. Organizations that adopt JIT
systems therefore have strategic teaming agreements with a few carefully chosen
suppliers who are extensively involved in the buyers processes.
1) Long-term contracts are typically negotiated to reduce order costs. Indeed,
some major retailers have agreed to continuous replenishment
arrangements. A supplier with superior demand forecasting ability essentially
tells the buyer when and how much to reorder.
2) Buyer-supplier relationships are further facilitated by electronic data
interchange (EDI), a technology that allows the supplier access to the buyers
online inventory management system. Thus, electronic messages replace
paper documents (purchase orders and sales invoices), and the production
schedules and deliveries of the parties can be more readily coordinated.
h. A concept closely related to JIT is continuous replenishment of products (CRP). In
a CRP system, such as Wal-Marts, inventory management is the suppliers
responsibility. When customers pay for goods at checkout, point-of-sale (POS)
devices note bar codes and send automatic purchase orders to a central computer.
The orders from all stores are then collected and retransmitted to the supplier. Thus,
purchases are adjusted to demand with great speed and labor costs are reduced.
7. Modern manufacturing environments impose control and improve quality through
automation, whether involving one piece of equipment, a cell, or an integrated plant.
a. An example of the use of automation and advanced technologies is a flexible
manufacturing system (FMS), which consists of computer-controlled machinery that
performs many different programmed functions. By eliminating machine setup time,
strengthening control, and automating handling processes, an FMS permits the
efficient production of small numbers of different products by the same machines. A
company can therefore more accurately match output with consumer tastes and
avoid long production runs of identical goods.
1) An FMS consists of two or more computer-controlled machines linked by
automated handling devices, such as robots and transport systems.
8. Computer-aided design and manufacturing (CAD-CAM) models and predicts the
outcomes of alternative product decisions.
a. CAD-CAM is essentially a system that combines (1) storage and retrieval of drawings
and parts attributes, (2) computer graphics for drawing and display, (3) data
acquisition and control, and (4) mathematical modeling and control.
b. The database created in the design phase (CAD) can be used to produce a bill of
materials for the manufacturing phase (CAM). CAM can use CAD drawings and
information to give specific instructions to individual machines.
c. CAD-CAM helps engineers examine more options, conduct sophisticated simulations
and tests, and make themselves more effective.
1) Product value and quality are improved.
2) The need for physical prototypes is reduced.
d. CAD-CAM systems are usually expensive, high-risk, high-payback investments.
9. A computer-integrated manufacturing (CIM) system involves (a) designing products using
computer-aided design (CAD), (b) testing the design using computer-aided engineering
(CAE), (c) manufacturing products using computer-aided manufacturing (CAM), and
(d) integrating all components with a computerized information system.
a. CIM entails a holistic approach to manufacturing in which design is translated into
product by centralized processing and robotics. The concept also includes
materials handling. The advantages of CIM include flexibility, integration, and
synergism.
1) Flexibility is a key advantage. A traditional manufacturing system might
become disrupted from an emergency change, but CIM will reschedule
everything in the plant when a priority requirement is inserted into the system.
The areas of flexibility include the following:
a) Varying production volumes during a period
b) Handling new parts added to a product
c) Changing the proportion of parts being produced
d) Adjusting to engineering changes of a product
e) Adapting the sequence in which parts come to the machinery
f) Adapting to changes in materials
g) Rerouting parts as needed because of machine breakdowns or other
production delays
h) Allowing for defects in materials
2) CIM integrates all production machinery using one computer system.
3) Benefits of CIM include (a) improved product quality (less rework), (b) better
customer service, (c) faster response to market changes, (d) greater product
variety, (e) lower production costs, and (f) shorter product development times.
4) JIT is sometimes adopted prior to CIM because JIT simplifies production
processes and provides a better understanding of actual production flow, which
are essential factors for CIM success.
5) The flexibility offered by CIM is almost a necessity for JIT suppliers. For
example, a company that provides JIT deliveries to automobile plants cannot
adapt to changing customer production schedules with a manual system unless
a high inventory level is maintained.
6) The emphasis is on materials control rather than the direct labor control that is
dominant in most cost systems.
7) CIM is an addition to, not a substitute for, other types of manufacturing concepts
such as JIT. In other words, JIT should already be in place for CIM to work
most effectively.
10. Manufacturing resource planning (MRP-II) is a closed-loop computerized manufacturing
system that integrates all facets of a manufacturing business, including production, sales,
inventories, schedules, and cash flows.
a. The same system is used for both financial reporting and management of operations
(both use the same transactions and numbers).
b. MRP-II uses a master production schedule (MPS), which is a statement of the
anticipated manufacturing schedule for selected items for selected periods.
1) MRP also uses the MPS. Thus, MRP is a component of an MRP-II system.
11. Enterprise resource planning (ERP) is the latest phase in the development of
computerized systems for managing organizational resources. ERP is intended to
integrate enterprise-wide information systems. ERP connects all organizational operations
(personnel, the financial accounting system, production, marketing, distribution, etc.) and
also connects the organization with its suppliers and customers. See Study Unit 10 for a
full outline.
2.2 SUPPLY CHAIN MANAGEMENT
1. The relationship of an organization with its suppliers has already been described in the
sections on purchasing and JIT. This subunit concentrates on the distribution element of
the supply chain.
2. The supply chain consists of flows from sources of (a) raw materials, (b) components,
(c) finished goods, (d) services, or (e) information through intermediaries to ultimate
consumers.
a. These flows and the related activities may occur across the functions in an
organizations value chain (R&D, design, production, marketing, distribution, and
customer service). These flows and the related activities also may occur across
separate organizations.
b. The activities in the supply chain, wherever they occur, should be integrated and
coordinated for optimal cost management.
1) For example, an organization may help its suppliers to improve their processes,
with mutual cost, efficiency, time, and quality improvements.
c. Sharing of information and coordination among the organizations in the supply chain
can avoid the bullwhip, or whiplash, effect on inventories. This phenomenon
begins when retailers face uncertain demand from consumers caused by
randomness in buying habits. However, the variability of retailers orders to
manufacturers is affected by factors in addition to consumer demand. In turn,
manufacturers orders to suppliers may reflect a still greater variability because those
orders depend on factors in addition to retailer demand.
1) Causes. The bullwhip effect, that is, a cascade of demand variability throughout
the supply chain, may be caused by
a) Difficulties of predicting demand and derived demand at each link in the
supply chain
b) The need to purchase or manufacture goods in cost-efficient batches
c) Changes in price that may encourage purchases in anticipation of future
increases
d) Shortages that may lead to rationing by suppliers or manufacturers and
hoarding by manufacturers or retailers
d. Sharing of information about sales, inventory, pricing, advertising campaigns, and
sales forecasts by all functions and organizations in the supply chain moderates
demand uncertainty for all parties. The desired results are
1) Minimization of inventories held by suppliers, manufacturers, and retailers
2) Avoidance of stockouts
3) Fewer rush orders
4) Production as needed by retailers
e. Supply-chain inventory management faces certain difficulties, for example,
1) Incompatibility of the information systems of the parties
2) Refusal of some parties to share information, possibly because of security
concerns
3) Devoting insufficient resources to the task
4) Fear that others will not meet their obligations
3. Distribution is the transfer of goods (and, in other contexts, services and information) from
producers to customers or from distribution centers to merchandisers. Thus, distribution
manages outflows, and purchasing manages inflows. Among the interrelated issues
involved in distribution are selection of (a) distribution channels, (b) inventory placement,
(c) means of transportation, (d) shipment schedules, (e) routes, and (f) carriers.
4. A distribution channel is a series of interdependent marketing institutions that facilitate the
transfer of a product from producer to ultimate consumer or industrial user. A distribution
channel creates place, time, and possession utility by bringing sellers and buyers
together.
a. The following are intermediaries between sellers and buyers:
1) Merchant middlemen buy the goods outright and necessarily take title to them.
They include merchant wholesalers and most retailers.
2) An agent represents a principal in negotiating purchases, sales, or both, but
does not take title to the goods.
3) A broker serves as a go-between. Unlike an agent, a broker ordinarily does not
maintain a relationship with a particular buyer or seller. A broker also does not
assume title risks.
4) A consignee merely sells the consignors goods for a fee. Title remains with the
consignor until the goods are sold and title passes to the buyer.
5) Facilitating intermediaries are persons or firms outside the channel that
perform some services (inventory control, financial services, risk management,
information services, promotions) more effectively and efficiently than the
channel members.
b. Channel structure. Conventional distribution systems consist of one or more
independent producers, wholesalers, and retailers, each of which is a separate profit-
maximizing business. The profit objective of each independent channel member may
result in actions that are not profit maximizing for the system as a whole, and the
system offers no means for defining roles and controlling channel conflict.
1) In vertical distribution systems, producers, wholesalers, and retailers act as a
unified system. Channel conflict is managed through common ownership,
contractual relationships, or administration by one or a few dominant channel
members.
2) Horizontal distribution systems consist of two or more companies at one level
of the channel working together to exploit new opportunities, such as the
introduction of ATMs in supermarkets. The joint nature of horizontal distribution
efforts is the tool for managing channel conflict.
3) In a multichannel system, a single firm sets up two or more channels to reach
one or more customer segments. Because such a system is managed by a
single firm, channel conflicts can be evaluated and managed internally.
5. Inventory placement concerns the location of finished goods.
a. Forward placement puts inventory close to final customers at a distribution center
(warehouse), wholesaler, or retailer. This option minimizes transportation costs and
delivery times.
1) Forward placement is typical for convenience goods. These are consumer
goods and services that are usually low-priced and widely available.
Consumers buy them often and with a minimum of comparison and effort.
Examples are soap and newspapers. Producers of convenience goods
ordinarily use intensive distribution to sell their products through a large number
of retail or wholesale units.
b. Backward placement involves keeping inventory at a factory or maintaining no
inventory at all. This option is indicated when products are customized or when
regional demand fluctuates unpredictably. Centralizing the inventory helps to smooth
the effects of changes in regional demand.
6. Types of Transportation
a. Transportation by aircraft is the fastest but most expensive. Moreover, facilities are
limited, and considerable rehandling is needed.
b. Rail is a cheap method of transporting large amounts of freight, but delivery times are
slow and may vary substantially. Rehandling is also necessary.
c. Transporting freight by highway is a flexible method because virtually all destinations
in the U.S. can be reached via truck. Furthermore, shipment is relatively fast, no
rehandling is required, and rates are lower than rail for small amounts and short
distances.
d. Pipelines are available only for gases, liquids, and solids in the form of slurry.
Operating costs are low and no packaging is needed, but not all geographic areas
are served.
e. Water-based carriers serve only limited areas, but capacity is high and unit cost low.
7. Scheduling movements of freight balances purchasing, production, customer response
times, shipping costs, and selection of routes and carriers.
8. The management of distribution can be facilitated by distribution resource planning
(DRP), a methodology with procedures similar to those of MRP-II. Instead of expected
demand, DRP begins with gross requirements forecasted at the retail level. It also needs
to determine inventory levels, lead times, and a distribution structure.
a. The usual DRP system responds to the pull of orders by retailers for replenishment of
their stock.
b. An alternative is a push system. The supplying location considers orders from all
ordering locations and inventory availability. Thus, it improves inventory allocation by
considering the total systems needs.
2.3 PRICING
1. Pricing Objectives
a. Profit maximization. Classical economic theory assumes all firms always select the
price that results in the highest profit.
b. Target margin maximization. This is stated as a percentage ratio of profits to sales.
c. Volume-oriented objectives set prices to meet target sales volumes or market
shares.
d. Image-oriented objectives set prices to enhance the consumers perception of the
firms merchandise mix.
e. Stabilization objectives set prices to maintain a stable relationship between the firms
prices and the industry leaders prices.
2. Price-Setting Factors
a. Supply of and demand for products and services are determined by customers
impact on demand, the actions of competitors, and costs.
b. Internal Factors
1) Marketing objectives may include survival, current profit maximization, market-
share leadership, or product-quality leadership.
2) Marketing-mix strategy.
3) All relevant costs (variable, fixed, and total costs) in the value chain from R&D
to customer service affect the amount of a product that the company is willing to
supply. Thus, the lower costs are in relation to a given price, the greater the
amount supplied.
4) Organizational location of pricing decisions.
5) Capacity.
a) For example, under peak-load pricing, prices vary directly with capacity
usage. Thus, when idle capacity is available, that is, when demand falls,
the price of a product or service tends to be higher given a peak-load
pricing approach.
c. External Factors
1) The type of market (pure competition, monopolistic competition, oligopolistic
competition, or pure monopoly) affects the price. For example, a monopolist is
usually able to charge a higher price because it has no competitors. However,
a company selling a relatively undifferentiated product in a highly competitive
market may have no control over price.
2) Customer perceptions of price and value.
3) The price-demand relationship.
a) The demand curve for normal goods is ordinarily downward sloping to
the right. Thus, quantity demanded usually increases as the price
decreases.
b) However, over some intermediate range of prices, the reaction to a price
increase for prestige goods is an increase in the quantity demanded.
Within this range, the demand curve is upward sloping. Consumers
interpret the higher price to indicate a better or more desirable product.
Above some price, the relation between price and quantity demanded will
again be negatively sloped.
c) Price elasticity of demand. If demand is price elastic (inelastic), the ratio
of the percentage change in quantity demanded to the percentage
change in price is greater (less) than 1.0. For example, if customer
demand is price elastic, a price increase will result in the reduction of the
sellers total revenue.
4) Competitors products, costs, prices, and amounts supplied.
d. The time dimension for price setting is important. Whether the decision is for the
short term (generally, less than 1 year) or the long term determines which costs are
relevant and whether prices are set to achieve tactical goals or to earn a targeted
return on investment. For example, short-term fixed costs may be variable in the long
term, and short-term prices may be raised (lowered) when customer demand is
strong (weak).
1) From the long-term perspective, maintaining price stability may be preferable to
responding to short-term fluctuations in demand. A policy of predictable prices
is desirable when the company desires to cultivate long-term customer
relationships. This policy is only feasible, however, when the company can
predict its long-term costs.
3. Pricing Approaches
a. Cost-based pricing involves setting a price that will recover the value chain costs and
provide the desired return on investment.
b. Market-based pricing involves basing prices on the products perceived value and
competitors actions rather than on the sellers cost. Nonprice variables in the
marketing mix augment the perceived value. For example, a cup of coffee may have
a higher price at an expensive restaurant than at a fast-food outlet. Market-based
pricing is typical when there are many competitors and the product is undifferentiated,
as in many commodities markets, e.g., agricultural products or natural gas.
c. Competition-Based Pricing
1) Going-rate pricing bases price largely on competitors prices.
2) Sealed-bid pricing bases price on a companys perception of its competitors
prices.
d. New Product Pricing
1) Price skimming is the practice of setting an introductory price relatively high to
attract buyers who are not concerned about price and to recover R&D costs.
2) Penetration pricing is the practice of setting an introductory price relatively low
to gain deep market penetration quickly.
e. Pricing by Intermediaries
1) Markups are tied closely to the price paid for a product
2) Markdowns are reductions in the original price
f. Price Adjustments
1) Geographical Pricing
a) FOB-origin pricing charges each customer its actual freight costs.
b) A seller that uses uniform delivered pricing charges the same price,
inclusive of shipping, to all customers regardless of their location.
i) Nearby and distant customers are charged the same amount. This
policy is easy to administer, permits the company to advertise one
price nationwide, and facilitates marketing to faraway customers.
c) Zone pricing sets differential freight charges for customers on the basis of
their location. Customers are not charged actual average freight costs.
d) Basing-point pricing charges each customer the freight costs incurred
from a specified city to the destination regardless of the actual point of
origin of the shipment.
e) A seller that uses freight-absorption pricing absorbs all or part of the
actual freight charges. Customers are not charged actual delivery costs.
2) Discounts and Allowances
a) Cash discounts encourage prompt payment, improve cash flows, and
avoid bad debts.
b) Quantity discounts encourage large-volume purchases.
c) Trade (functional) discounts are offered to other members of the
marketing channel for performing certain services, such as selling.
d) Seasonal discounts are offered for sales out of season. They help
smooth production.
e) Allowances (e.g., trade-in and promotional allowances) reduce list prices.
3) Discriminatory pricing adjusts for differences among customers, the forms of a
product, or locations.
4) Pricing may be based on consumer psychology. For example, consumers
who cannot judge quality may assume higher prices mean higher quality.
5) Promotional pricing temporarily reduces prices below list or even cost to
stimulate sales.
6) Value pricing involves redesigning products to improve quality without raising
prices or offering the same quality at lower prices.
g. Product-Mix Pricing
1) Product-line pricing sets price steps among the products in the line based on
costs, consumer perceptions, and competitors prices.
2) Optional-product pricing requires the firm to choose which products to offer as
accessories and which as standard features of a main product.
3) Captive-product pricing involves products that must be used with a main
product, such as razor blades with a razor. Often the main product is relatively
cheap, but the captive products have high markups.
4) By-product pricing usually sets prices at any amount in excess of storing and
delivering by-products. Such prices allow the seller to reduce the costs and
therefore the prices of the main products.
5) Product-bundle pricing involves selling combinations of products at a price
lower than the combined prices of the individual items. This strategy promotes
sales of items consumers might not otherwise buy if the price is low enough.
An example is season tickets for sports events.
h. Illegal pricing. For example, pricing products below cost to destroy competitors
(predatory pricing) may be illegal.
1) Price discrimination among customers also may be illegal.
2) Collusive pricing results when companies conspire to restrict output and set
artificially high prices.
a) A cartel is an organization of sellers (e.g., the oil cartel OPEC) who
undertake joint action to maximize profits by controlling the supply, and
therefore the price, of their product. In many nations, such collusive
conduct is illegal. The reason is that, as a result of the monopolistic and
anticompetitive practices of cartels, (1) supply is lower, (2) prices are
higher, (3) competition is restrained, and (4) the relevant industry is less
efficient.
3) Dumping is a trade practice that violates international agreements. It occurs
when a firm charges a price (a) lower than that in its home market or (b) less
than the cost of product. Dumping is done to penetrate a market or as a result
of export subsidies.
4. Cost-based pricing begins with a cost determination followed by setting a price that will
recover the value chain costs and provide the desired return on investment. When an
industry is characterized by significant product differentiation, e.g., automobiles, cost-based
and market-based pricing approaches are combined.
a. A cost-plus price equals the cost plus a markup. Cost may be defined in many
ways. Most companies use either absorption manufacturing cost or total cost when
calculating the price. Variable costs may be used as the basis for cost, but then fixed
costs must be covered by the markup.
1) Following are four commonly used cost-plus pricing formulas:
a)
Price Total cost (Total cost Markup percentage )
b)
Price
Absorption
manufacturing
cost

Absorption
manufacturing
cost
Markup percentage
c)
Price
Variable
manufacturing
cost

Variable
manufacturing
cost
Markup percentage
d)
Price
Total
variable
cost

Total
variable
cost
Markup percentage
2) The costs of unused capacity in production facilities, distribution channels,
marketing organizations, etc., are ordinarily not assignable to products or
services on a cause-and-effect basis, so their inclusion in overhead rates may
distort pricing decisions. Including the fixed costs of unused capacity in a
cost-based price results in higher prices and in what is known as the
downward (black hole) demand spiral.
a) As higher prices depress demand, unused capacity costs increase, the
fixed costs included in prices increase, and demand will continue to
spiral downward. One way to avoid this problem is not to assign unused
capacity costs to products or services. The result should be better
operating decisions and better evaluation of managerial performance.
5. A target price is the expected market price for a product or service, given the companys
knowledge of its consumers perceptions of value and competitors responses.
a. The companys contacts with its customers and its market research studies provide
information about consumers perceptions of value.
b. The company also must gain information about competitors potential responses by
learning about their technological expertise, products, costs, and financial positions.
This information may be obtained from competitors customers, suppliers, employees,
and financial reports. Reverse engineering of their products is also possible.
c. Subtracting the unit target operating income determines the long-term unit target
cost. Relevant costs are all future value-chain costs, whether variable or fixed.
1) Because it may be lower than the full cost of the product, the target cost may not
be achievable unless the company adopts comprehensive cost-reduction
measures.
2) The Japanese concept of Kaizen is relevant to target costing. A policy of
seeking continuous improvement in all phases of company activities facilitates
cost reduction, often through numerous minor changes.
3) Value engineering is a means of reaching targeted cost levels. It is a
systematic approach to assessing all aspects of the value chain cost buildup
for a product: (a) R&D, (b) design of products, (c) design of processes,
(d) production, (e) marketing, (f) distribution, and (g) customer service. The
purpose is to minimize costs without sacrificing customer satisfaction.
a) Value engineering requires identifying value-added and nonvalue-added
costs. Value-added costs are costs of activities that cannot be
eliminated without reducing the quality, responsiveness, or quantity of the
output required by a customer or the organization.
b) Value engineering also requires distinguishing between cost incurrence
and locked-in costs. Cost incurrence is the actual use of resources, and
locked-in (designed-in) costs will result in use of resources in the future
as a result of past decisions. Traditional cost accounting focuses on
budget comparisons, but value engineering emphasizes controlling costs
at the design stage before they are locked in.
6. The product life cycle begins with precommercialization (product development),
proceeds through the introduction and growth stages, continues into the products
maturity stage, and finally ends with the harvest or decline stage and the final provision of
customer support.
a. Life-cycle costing is sometimes used as a basis for cost planning and product
pricing. Life-cycle costing estimates a products revenues and expenses over its
expected life cycle. The result is to highlight upstream and downstream costs in
the cost planning process that often receive insufficient attention. Emphasis is on the
need to price products to cover all costs, not just production costs.
1) A concept related to life-cycle cost that is relevant to pricing is whole-life cost,
which equals life-cycle costs plus after-purchase costs (operating, support,
repair, and disposal) incurred by customers. Reduction of whole-life costs is a
strong competitive weapon. Customers may pay a premium for a product with
low after-purchase costs.
b. Pricing Policies
1) During precommercialization, the strategy is to innovate by conducting R&D,
marketing research, and production tests. The firm has no sales and therefore
no pricing policy, but it has high investment costs.
2) The introduction stage is characterized by slow sales growth and lack of profits
because of the high expenses of promotion. Competitors are few, basic
versions of the product are produced, and higher-income customers are usually
targeted. Cost-plus prices are charged. They may initially be high to permit
cost recovery when unit sales are low.
3) In the growth stage, sales and profits increase rapidly, cost per customer
decreases, customers are early adopters, new competitors enter an expanding
market, new product models and features are introduced, and promotion
spending declines or remains stable. Prices are set to penetrate the market.
4) Some writers identify a separate stage between growth and maturity. During the
shakeout period, the overall growth rate falls, price cutting occurs, industry
profits decrease, and weaker firms leave the market. The growth phase tends
to result in too many competitive entrants, brands, and models; greater intensity
of competition; and too much capacity.
a) The firm eliminates weak products and product lines, strengthens R&D and
engineering efforts, reduces prices through effective promotions, and
improves relationships with other firms in the distribution channel (e.g., by
reducing inventory carrying costs).
b) The firm also must ensure that it has a sustainable competitive advantage.
For example, an early quality advantage may disappear as competing
products improve and customers focus more on price and service.
5) In the maturity stage, sales peak but growth declines, competitors are most
numerous but may begin to decline in number, and per-customer cost is low.
Profits are high for large market-share firms. For others, profits may fall
because of competitive price-cutting and increased R&D spending to develop
improved versions of the product.
6) During the decline stage, sales and profits drop as prices are cut, and some
firms leave the market. Customers include late adopters, and per-customer
cost is low. Weak products and unprofitable distribution media are eliminated,
and advertising budgets are pared to the level needed to retain the most loyal
customers.
7. Pricing and Generic Competitive Strategies
a. Michael E. Porters generic strategies model is based on the concept that each of a
firms competitive advantages ultimately may be categorized as either a cost or a
differentiation advantage.
1) The firms advantages should be used within the firms competitive (target)
scope to achieve its objectives. This scope may be broad (e.g., industry wide)
or narrow (e.g., a market segment).
b. Using the variables of competitive advantage (cost and differentiation) and
competitive scope (broad and narrow), Porter described four generic strategies to
be applied by business units.
1) Cost leadership is the generic strategy favored by a firm that seeks competitive
advantage through lower costs. This strategy has a broad competitive
scope. Such a firm can earn higher profits than its competitors at the industry
average price or charge a lower price to increase market share.
2) Differentiation is the generic strategy that seeks competitive advantage through
providing a unique product or service. This strategy has a broad
competitive scope. Such a firm may earn higher profits because consumers
are willing to pay a higher price than that charged by competitors. However,
that price difference must exceed the additional cost of the differentiated
product or service.
a) A successful differentiation strategy creates a buyer perception that few, if
any, substitutes are available. Thus, the firm may have the additional
advantage of being able to increase price by passing supplier cost
increases to buyers.
3) Cost focus is the generic strategy favored by a firm that seeks competitive
advantage through lower costs but with a narrow competitive scope (e.g., a
regional market or a specialized product line). The rationale for a cost-focus
strategy is that the narrower market can be better served because the firm
knows it well.
4) Focused differentiation is the generic strategy favored by a firm that seeks
competitive advantage through providing a unique product or service but with
a narrow competitive scope, e.g., a regional market or a specialized product
line.
8. Pricing and Market-Based Competitive Strategies
a. The dominant firm in a market pursues a market-leader strategy. The leader should
attempt to increase total demand in the market because it will gain the most.
Demand will increase if the firm uses pricing to attract new users by employing a
1) Market-penetration strategy to focus on customers who might use the product
or service.
2) New-market segment strategy to pursue customers who have never used the
product or service.
3) Geographical expansion strategy to target users in previously unserved
localities
b. The market leader must defend market share through offensive and defensive
actions. Kotler and Singh have identified six defense strategies.
1) A position defense strengthens the firms brand power. Greater brand power
permits higher prices.
2) A flank defense creates outposts that protect the leaders position. For
example, a firm might respond to a competitors price attack on one of its major
products by introducing new brands. One of these might be sold at the same
price as the attackers brand and a second at a lower price.
3) A preemptive defense anticipates an attack, such as by (a) targeting particular
competitors for price cuts before they can launch assaults, (b) flooding the
market with products for every segment and niche, or (c) sending market
signals indicating ways in which the leader intends to anticipate attacks.
4) A counteroffensive defense is a counterattack. For example, the leader may
meet an attackers price cuts in one market by slashing prices in another
market that is more important to the attacker.
5) A mobile defense may involve market broadening, a reorientation from a
specific product to the underlying need. An example is the repositioning of oil
companies as energy companies. An alternative is market diversification, an
effect of conglomerate mergers of firms.
6) A contraction defense is planned contraction or strategic withdrawal. This
defense involves concentrating resources in the areas of greatest strength
rather than defending all of the firms positions.
c. The leader may attempt to obtain a greater market share. In general, a firm that
increases its market share in its served (target) market, as opposed to the total
market, will increase profits if it adopts an appropriate strategy.
1) The economic cost of the strategy must be acceptable. Beyond a certain
optimal market share, profits may decline, for example, because prices may
need to be lowered and costs (e.g., legal and lobbying costs) may increase.
2) The leader must adopt the right marketing mix (the marketing methods used).
For example, market share should be earned, not bought by lower profit
margins.
d. Trailing (runner-up) firms may choose a market challenger strategy.
1) The challenger may attack the leader, for example, by across-the-board
innovation or by better serving the market. The attack may be directed at firms
of similar size that are not serving the market, e.g., those that are failing to
introduce new products or are overpricing.
2) Kotler suggests five general attack strategies by a challenger.
a) A frontal attack directly pits the firms products, prices, promotions, and
methods of distribution against the targets. An example of a modified
frontal attack is price cutting, a strategy that may succeed if there is no
retaliation and the perception is that the products quality equals that of
the target.
b) A flank attack may be directed at a geographic or segmental weakness of
the target (an underserved market) or an unmet need (such as the desire
for more healthful fast food).
c) An encirclement attack is used by a challenger with an advantage in
resources. It is an assault on multiple marketing fronts.
d) The bypass attack directs the assault against markets where the
competitive target is not strong. It may involve diversification of products
or geographic markets. It also may involve developing next-generation
technology so as to move the competition to an arena where the
challenger is strong.
e) Guerilla warfare consists of numerous small attacks designed to reduce
the strength of the target, e.g., by ad campaigns, carefully chosen price
decreases, and lawsuits. Such warfare ordinarily must be followed by a
different (and stronger) type of attack if the challenge is to succeed.
3) The market challenger must devise combinations of strategies that are more
specific than the general strategies. For example,
a) Price discounting succeeds if buyers are price sensitive, the product or
service is similar to the market leaders, and the discounts are not
matched.
b) Lower-priced goods of average quality may substantially outsell higher
quality goods if the price is much lower.
c) Prestige goods are high-quality items sold at a high price.
d) Product proliferation is a strategy based on better product variety.
e. Market-follower strategies are adopted by firms that do not wish to challenge the
leader.
1) These firms believe that product imitation may be preferable to product
innovation. Because the innovator has already incurred the expenses of
bringing the new product to market, the imitator may be profitable selling at or
below the market price charged by the leader.
2) Some industries are characterized by conscious parallelism. These industries
(e.g., fertilizers and chemicals) tend to have high fixed costs and little product
and image differentiation. Market followers tend to imitate the leader, including
its pricing strategy, because competing for a greater market share provokes
painful retaliation.
3) A market follower requires a strategy to maintain its share of current and new
customers, fend off challengers, protect its advantages (e.g., service or
location), lower its costs, and improve the quality of its products and services.
a) A counterfeiter operates illegally by selling low-price copies on the black
market.
b) A cloner sells low-price variations of a product with sufficient differentiation
to avoid liability for counterfeiting.
c) An imitator sells a product that is significantly differentiated, e.g., with
respect to price, promotion, location, and packaging.
d) An adapter improves products and may operate in different markets or
evolve into a market challenger.
4) Market followers ordinarily have lower percentage returns than market leaders.
f. Market-nicher strategies are followed by small or mid-size firms that compete in
small (niche) markets that may be overlooked by large firms.
1) Successful niche marketers often have higher rates of return than firms in large
markets. They often (a) sell high-quality products at premium prices, (b) have
low costs, and (c) excel in need satisfaction because they know their markets
well.
2) Successful niche marketers have high profit margins. By contrast, mass
marketers sell at low prices in high volume.
3) Niche marketers must create, expand, and protect their niches. The risk is that a
niche may evaporate or be entered by a large firm.
4) The essence of niche marketing is specialization, but success often depends
on multiple niching. Creating new niches diversifies risk and increases the
firmss probability of survival.
9. International Pricing
a. The gray market poses difficulties for a firm that sells products at different prices in
different countries. In a gray market, products imported from one country to another
are sold in a third country, or even in the original exporters country. Sellers try to
make a profit from differences in retail prices.
b. The price escalation problem requires setting different prices in different countries. It
is caused by an accumulation of additional costs, e.g., (1) currency fluctuations;
(2) transportation expenses; (3) profits earned by importers, wholesalers, and
retailers; and (4) import duties. To address this issue, a firm may set a
1) Standard price globally. This strategy may result in prices being unprofitable in
some markets and too high in others.
2) Market-based price in each market. This strategy ignores cost differences. It
may create a gray market in certain regions.
3) Cost-based price in each market with a standard markup. In a region or
country where costs are high, this strategy may result in prices that are too high
to be competitive within the local market.
c. A transfer price is the price charged by one subunit of a firm to another. When the
subsidiary-buyer is in a foreign country, the higher the transfer price, the higher the
potential tariffs. However, the tax levied on a subsequent sale by the subsidiary will
be lower because of its higher acquisition cost.
2.4 MANAGING HUMAN RESOURCES
1. Managing human resources means acquiring, retaining, and developing employees.
These functions should be consistent with the strategy and structure of the organization.
The essential activities include
a. Developing a human resource strategy. Such a strategy at its broadest is a systems
approach that treats employees and future employees as human capital, that is, as
intangible assets whose fullest potential should be developed.
b. Recruitment and selection.
c. Evaluation of performance.
d. Training and development.
2. Research indicates that a people-centered human resource strategy improves employee
retention and profits. Jeffrey Pfeffer (see Kreitner, Management, 9th ed., page 357)
suggests the following practices:
a. A job security policy
b. Stringent hiring procedures
c. Employee empowerment (e.g., use of self-managed teams)
d. Basing compensation on performance
e. Comprehensive training
f. Reduction of status differences
g. Information sharing
3. Human resource planning consists of forecasting future employment requirements. It
includes the hiring, training, and monitoring of employees. Planning includes scanning the
external environment to understand the areas labor supply, workforce composition, and
work patterns. Companies often perform such analysis before building a new plant in a
new geographic area, but regular analyses at established locations is sometimes
overlooked. Companies must forecast future employee needs to ensure adequate
resources when needed. Labor resources are not always as mobile as raw materials.
4. Job analysis is the first step. It entails interviewing superior employees about the way they
accomplish their tasks, analyzing work flows, and studying the methods used to achieve
work-unit objectives.
a. Has the nature of the job changed? If so, the job description should be rewritten.
b. If the jobs nature remains the same, the job specifications should be written from the
job description and sent to personnel to be advertised.
c. A job description, based on job analysis, should list basic duties. For higher-level
positions, reporting relationships may also be included.
1) EXAMPLE: For an accounting clerk, the job description might include
a) Preparing payroll checks
b) Maintaining inventory ledgers
c) Preparing invoices
d. Job specifications, based on the job description, should list the abilities needed by a
person hired for that job.
1) EXAMPLE: The job specifications for an accounting clerk might list the
following:
a) 10-key facility
b) Typing ability at a specified number of correct words per minute
c) Experience in a similar position for a specified number of years
d) Bondable
e) Education to a specified level and, perhaps, in specified types of courses
2) For other jobs, other factors may be pertinent:
a) Physical characteristics, e.g., strength and stamina
b) Personal characteristics, e.g., personality and communication skills
3) Some sources include job specifications within the definition of job description.
5. Recruitment
a. Sources of Personnel
1) Advertising in media (e.g., newspapers and employer or other Internet sites)
2) Referrals (networking)
3) Walk-ins
4) Internal job posting and computerized staff inventories of existing employees
5) Targeted recruiting sources, e.g., colleges and universities
6) Temporary placement and part-time employees
7) Employment agencies and executive headhunters
b. Many countries have laws that prohibit employment discrimination with regard to any
employment action, for example, hiring, training, compensation, retention, or
promotion. Prohibited bases of discrimination may be race, color, religion, sex,
national origin, age, or disability.
1) The government may evaluate compliance with employment law by checking
a) Sources of employees recruited for each job category
b) Advertising
c) Estimates of employees needed for coming year
d) Statistics on number of applicants processed by sex, race, etc., for each
job category and level
2) The law may prohibit doing the following in recruiting interviews:
a) Making notation of sex
b) Asking marital status (may ask after hiring for insurance purposes)
c) Asking for number of children (may ask after hiring for insurance purposes)
d) Asking for height and weight
e) Asking for criminal record (only for security clearance)
f) Asking type of military discharge
g) Asking age
3) The modern trend, reinforced not only by legal requirements but by the need for
fresh viewpoints, is to recruit for diversity.
a) In this context, diversity may be defined to include not only legally
protected categories but also other differences such as background and
personality. Genuine diversity is an absence of any form of intolerance
and the creation of a heterogeneous culture.
b) Recruiting for diversity must be accompanied by an emphasis on
retention.
6. Using temporary or part-time workers gives management the flexibility to adjust quickly to
changing market conditions.
a. Such workers can often be paid lower salaries and given fewer benefits.
b. Disadvantages of temporary or part-time workers include the lack of long-term benefits
to the company from training and less employee loyalty.
c. These workers can improve the morale of permanent employees, however, by
relieving overtime pressures or by performing the less desirable tasks.
1) They may lower the morale of permanent employees who want more overtime
work or believe that their jobs are threatened.
d. Leasing employees has administrative benefits because the lessor prepares payrolls,
pays the employees, files tax returns, etc. (S)he also assumes liability for
unemployment claims.
1) However, the behavioral disadvantages of directly hiring temporary or part-time
workers also apply to employee leasing.
7. Employee selection. Requirements should come from job specifications developed from
each job description and include education, experience, physical characteristics, and
personal characteristics.
a. All requirements, including selection tests, must be based on their relationship to the
ability to perform successfully in a specific job category.
b. According to Del J. Still (see Kreitner, pp. 359-360), the selection process involves
1) Preparation by developing job descriptions and job specifications and writing
interview questions
2) Reviewing those questions for fairness and conformity with the law
3) Organizing by defining the roles and methods of interviewers
4) Collecting information from applicants
5) Evaluating
6) Meeting to discuss information about applicants
7) Deciding whether to offer employment
c. Interviewing is the most frequently used selection method. Because the unstructured
interview is subject to cultural and other forms of bias, the structured interview is
preferable. It consists of written questions related to the job that have standard
answers. The questions are created and scored by a committee so as to minimize
bias. Types of questions address
1) Job situations
2) Job-related knowledge
3) Simulation of job activity
4) Employee requirements
8. Applicant testing. Testing applicants for jobs with quantifiable output (e.g., jobs requiring
clerical skills or manual dexterity) is easier than testing for positions with a less tangible
work product (e.g., public relations director or human resource manager).
a. All tests must be validated in each organization and for minority and nonminority
groups before they can be predictive of successful performance.
b. Tests must be given to all applicants for the same job category.
c. It is not easy or inexpensive to validate a test.
d. Test validity is the capacity of a test to measure accurately what it was designed to
measure.
e. Test reliability is the ability of a test to obtain the same scores in repeated
administrations, regardless of validity.
f. Lie detector tests, drug tests, DNA screening, AIDS tests, and personality tests are
significant and controversial matters.
9. Orientation is the introduction to the workplace and one of the most common types of
training. The employees receive their first formal information about
a. Overall organizational objectives
b. The organizational chart
c. Benefits such as retirement, health insurance, and vacation and sick leave.
d. Organizational procedures, such as grievance procedures and safety rules.
10. Training and Development
a. Training consists of organizational programs to prepare employees to perform
currently assigned tasks.
1) On-the-job or experiential training, for example, by job rotation,
apprenticeships, and mentoring arrangements, is usually less costly than
off-the-job training. However, it may disrupt the workplace and result in
increased errors. It is suited to acquisition of technical skills.
2) Off-the-job training is provided, for example, in classroom lectures, film study,
and simulations. It is well suited to development of problem solving and
interpersonal abilities and to teaching of complex skills.
3) Computer-based training is expected to become more common.
b. Development includes programs to prepare people to perform future tasks and
acquire new skills.
1) The focus is mostly on management and organizational development of human
relations skills. Management coaching and mentoring enhance the
development process.
c. Training also has been defined to encompass development. Kreitner (p. 373) defines
training broadly as using guided experience to change employee behavior or
attitude.
d. The evaluation and appraisal process helps identify individual strengths and
weaknesses as the basis for training and development opportunities. Also, jobs
and markets change, leading to a need for workers with different skills.
Organizations thrive when workers value lifelong learning.
1) Viewing performance evaluation as a training and developmental process can
foster a culture in which evaluation is sought out.
2) A training needs assessment should be conducted to (a) determine what
training is relevant to employees jobs, (b) determine what training will improve
performance, (c) determine whether training will make a difference,
(d) distinguish training needs from organizational problems, and (e) link
improved job performance with the organizations objectives and bottom line.
3) Self-assessment by employees is another means of identifying training and
development needs. However, it normally yields shorter-term training needs
and often has more to do with employees personal career goals than with
strategic business needs. Thus, many companies use self-assessment only as
a supplement to other approaches.
e. Training and development programs are successful when they achieve the greatest
retention (learning) of skills and knowledge that are transferred to the job. The
following is a model for the process of learning:
1) Establishing objectives
2) Modeling the skills or making a meaningful presentation of facts
3) Practicing the skills
4) Obtaining feedback
11. Evaluation
a. An important aspect of management is the evaluation of employees.
1) Evaluations are important to employees, the employer, and the organization.
2) Evaluations provide an opportunity for growth of the employee and, when done
properly, can prevent disputes.
a) Documentation must be complete, accurate, and consistent.
b) Employees should be notified of appraisals and given an opportunity to
discuss them.
c) Different techniques are necessary to accommodate different employee
performance levels.
b. Purposes of Evaluation
1) Performance criteria identify necessary job-related abilities.
2) Performance objectives help employees direct their energies toward achieving
the organizations objectives without constant supervision.
3) Performance outcomes promote employee satisfaction by acknowledging when
jobs are completed and done well.
4) Evaluation distinguishes effective from ineffective job performance.
5) The employer and the organization develop employee strengths and identify
weaknesses.
6) Evaluation sets compensation.
a) But separating performance evaluations from compensation decisions may
be beneficial. An advantage is that more emphasis is placed on long-
term objectives. It also emphasizes other rewards, such as feelings of
achievement and the recognition of superiors. Another advantage is that
the employees good performance can be separated from the overall
companys bad financial performance.
i) A disadvantage is that the employee may not be motivated
immediately by a good appraisal because of the delay in receipt of
any monetary reward. The evaluation also may not be taken as
seriously by the employee if compensation is not correlated with
performance.
7) Evaluation identifies promotable employees.
a) Internal promotions motivate employees and are less difficult and
expensive than external hiring.
i) But hiring an internal candidate can lead to social inbreeding. Many
firms look to external candidates for certain jobs because they bring
a fresh perspective to the organizations problems and may have
more up-to-date training or education.
c. Problems of Evaluation
1) Design of an appraisal system can be faulty if the
a) Criteria for evaluations are poor or inappropriate
b) Technique is cumbersome or not understood by users
c) Criteria focus on wrong attributes causing emphasis on wrong things
(e.g., personal appearance or beliefs rather than job accomplishments)
d) Senior management does not lend support
2) Evaluation-Based Problems
a) Halo effect. A managers judgment on one positive trait affects rating on
other traits. The converse is the horn effect, that is, allowing one
negative trait to influence the evaluation of other traits.
b) Central tendency. All personnel are rated within the same narrow range,
e.g., All my people are good. In a sense, all employees are rated
average. The forced normal distribution method essentially results in
central tendency because most employees must be rated average.
c) Recency effect. Most recent behavior overshadows overall performance.
d) Differing standards. Some managers have stricter standards than
others, making cross-departmental comparisons difficult.
e) Personal bias. Traits may not reflect actual job performance, so appraisal
can be biased by the degree to which the manager likes the subordinate.
f) Leniency error occurs when a manager fails to give a negative evaluation
because of fear of damaging a good working relationship with a worker.
g) Contrast error is the tendency to rate people relative to other people
rather than performance standards. If most employees are mediocre, a
person performing at an average level is rated as outstanding. That
same person might be rated as poor if most workers perform at an
above-average level. Although such comparisons may be appropriate at
times, the normal rating process should be based on job requirements.
h) Traits like dependability or industriousness may have little to do with the
job expected of an employee and are too subjective to be measured.
i) Trait scales tend to equate subjectively both pertinent and
nonperformance traits (e.g., quality of work and appearance may receive
equal points toward total appraisal score on many scales).
j) The once-a-year process tends to affect the usefulness and accuracy of
any job-related information.
k) According to attribution theory, people attempt to determine whether
observed behavior is internally or externally caused.
i) If behavior is unusual for an individual, causation is perceived to be
external. If it is not unusual, causation is ordinarily perceived to be
internal.
ii) If everyone in similar circumstances behaves in a certain way,
causation is believed to be external. Otherwise, causation is
believed to be internal.
iii) However, biases may distort attributions.
G Fundamental attribution error is a bias in judgments about
the behavior of others. It is a tendency to overestimate
internal factors and underestimate external factors.
G Self-serving bias is the tendency to attribute ones successes
to internal factors (e.g., diligence and talent) and failures to
external factors (e.g., bad luck).
d. Major Types of Appraisals
1) Rating scales for personal traits have many of the weaknesses discussed
previously.
2) Management by objectives (MBO) is a participative process in which
supervisors and subordinates mutually establish objectives. A rating is based
on achievement of the objectives.
3) Critical incidents are important aspects of the job that the evaluator uses to
rate employee performance. Critical incidents (superior and inferior
performance) should be documented by supervisors when they occur.
4) Behaviorally anchored rating scales (BARS) contain descriptions of good and
bad performance. They are developed through job analysis for a number of
specific job-related behaviors and then used for evaluation of employees.
5) Writing a narrative (essay) to describe employee performance is time
consuming and may challenge supervisors with poor writing skills.
6) A weighted checklist consists of randomly ordered items that describe specific
employee behaviors. The relative weights are unknown to the supervisor.
7) Rankings of coworkers may be made by supervisors based on specific
job-related behaviors. However, they tend to cause resentment and do not
quantify the differences among those compared.
e. Characteristics of Effective Evaluation Systems
1) Relevant. Criteria should be reliable and valid. They should relate to employee
functions, that is, to activities over which the employees exert control.
2) Unbiased. Systems should be based on performance, not on unrelated
personal characteristics.
3) Significant. The focus should be on the important part of the job, not what is
convenient to evaluate.
4) Practical. Systems should be as objective, easy to use, clearly understood, and
efficient as possible.
f. Criteria for Effective Appraisal
1) Employees must understand the appraisal.
2) They must believe that the appraisal is fair.
3) They must believe that it is important to them and their jobs.
g. Acceptance of appraisals is more likely if a manager spends some time with each
employee and offers praise as well as constructive criticism.
h. A 360performance appraisal is a multirater model for employee assessment. It
provides anonymous feedback by peers, customers, supervisors, and subordinates.
1) Appraisal is subjective and may be affected by popularity.
2) Evaluations do not include copies of job descriptions or performance goals.
i. Team ratings are necessary if teamwork is part of the work process. Team ratings
can be handled in the same way as individual appraisals, but many firms use a
different method. Thus, team ratings are often done by the teams themselves or
customers.
1) The first step is to define excellence as a basis for evaluation. This definition is
made available to team members in the form of a team agreement that
determines how the team operates.
2) Teams are jointly accountable for their work. Thus, if any member of the team
fails, the other members must ask how they could have helped.
3) A good team rating system should separate feedback sessions from salary
reviews. People may not be candid if they think that their responses will affect
the compensation of teammates.
4) Team evaluations should be made without managers present. Often a neutral
facilitator will lead the discussions.
12. Compensation and benefits are extrinsic rewards. They should (a) satisfy individual
needs, (b) encourage positive expectations, (c) be equitable, (d) be related to performance,
(e) serve to motivate employees (e.g., rewards should promptly follow good appraisals),
and (f) help the company retain valuable employees (e.g., by making benefits contingent on
employment). Compensation and benefits take many forms, each with its own advantages
and disadvantages. Cost and ease of administration also are considerations. Regardless
of the other factors, market competitiveness is a requirement for pay and benefit policies.
13. Human Resource Planning
a. A human resource audit evaluates compliance with laws and regulations, determines
whether operations are efficient, and considers the companys recruitment and salary
and benefit programs.
b. It is a thorough analysis of the human capital of the organization that permits
1) Scheduling of training to develop experienced staff as needed
2) Appropriate retention and promotion decisions
3) Analysis of staffing needs
c. Information should be compiled about employees education, experience, work
histories, and compensation histories.
d. Human resource or human asset accounting attempts to measure the value, and
the changes in value, of the organizations investment in human capital.
1) Although this asset is enormously valuable (sometimes estimated at two or
three times the annual payroll), it is not shown in balance sheets or accounted
or in earnings statements.
a) One experimental measurement approach is a present value of human
resources.
b) Another is a cost approach, with financial investments (training, customer
goodwill, etc.) offset by reductions (e.g., retirement).
14. Downsizing results from organizational decline, changes in the business cycle, or business
combinations. The objectives are cost reduction, improved efficiency, and higher profits.
a. These purposes often are not achieved. Many companies follow cycles of hiring,
firing, and rehiring that do not yield benefits that offset the harm to fired employees,
the loss of morale of the survivors, and the damage to communities.
b. Downsizing also tends to have a disproportionate effect on women and members of
minorities, who tend to be the last hired and first fired.
c. The alternative view is that employees are not readily disposable commodities but
rather valuable resources who should be terminated only as a last resort. This view
seeks alternatives to involuntary termination.
1) Redeployment involves retraining or transferring employees.
2) Voluntary retirement programs offer accelerated retirement benefits, severance
allowances, or other compensation.
3) Employees may be shifted to lower-level positions.
4) All employees may be asked to accept reduced hours or pay.
5) Outplacement assists laid-off employees in finding new jobs.
6) The law may require companies to give notice of facilities closings or layoffs.
2.5 STUDY UNIT 2 SUMMARY
1. Although traditional inventory management minimizes inventory and the related holding
costs, many companies use inventory as a hedge against inflation as well as a guarantee
of future availability. Moreover, inventory carrying costs are sometimes transferred to
suppliers or customers.
2. Inventory policy considers, among other things, (a) the types of ordering and carrying costs,
(b) stockout costs, (c) safety stock, and (d) reorder points.
3. The purchasing process is initiated by purchase requisitions issued by the production control
function. Purchase requisitions ultimately result from make-or-buy decisions made when
production processes were designed. For a retailer, the purchase decision is the same as
the decision about what to sell. The choice of suppliers depends on price, quality, delivery
performance, shipping costs, credit terms, and service. Ordering is increasingly done by
EDI. Other purchasing issues are (a) value analysis, (b) whether to buy centrally,
(c) negotiation of contracts, (d) tracking, and (e) receiving.
4. Inventory models are quantitative models designed to control inventory costs by determining
the optimal time to place an order (or begin production) and the optimal order quantity
(production run). The timing of orders may be periodic or perpetual.
5. The basic EOQ model minimizes the sum of ordering (setup) costs and carrying costs. The
EOQ is the square root of twice the periodic demand times the order (setup cost), divided
by the periodic unit carrying cost.
6. In the ABC system of inventory management, the level of control of each group reflects
cost-benefit concerns.
7. Materials requirements planning (MRP) is an integrated computer-based information system
designed to plan and control raw materials used in a production setting. MRP is
characterized as a push-through system because production is activated by forecasts of
demand, not actual customer needs.
8. The just-in-time (JIT) model of inventory control limits output to the demand of the next
operation. Reductions in inventory result in less investment in idle assets; reduction of
storage space requirements; and lower inventory taxes, pilferage, and obsolescence risks.
JIT also encompasses changes in the production process. JIT is a pull system. Items are
pulled through production by current demand, not pushed through by anticipated demand.
Thus, one operation produces only what is needed by the next operation, and components
and raw materials arrive just in time to be used. To implement this approach and to
eliminate waste, the factory is reorganized to permit lean production.
9. In a JIT system, the buyer-supplier relationship is critical. It is often facilitated by EDI. Thus,
long-term contracts are typically negotiated to reduce order costs. Indeed, some major
retailers have agreed to continuous replenishment arrangements. A supplier with superior
demand forecasting ability essentially tells the buyer when and how much to reorder.
10. A concept closely related to JIT is continuous replenishment of products (CRP). In a CRP
system, such as Wal-Marts, inventory management is the suppliers responsibility.
11. An example of the use of automation and advanced technologies is a flexible manufacturing
system (FMS), which consists of computer-controlled machinery that performs many
different programmed functions. An FMS permits efficient production of small numbers of
products by the same machines.
12. Computer-aided design and manufacturing (CAD-CAM) models and predicts the outcomes
of alternative product decisions.
13. A computer-integrated manufacturing (CIM) system involves (a) designing products using
computer-aided design (CAD), (b) testing the design using computer-aided engineering
(CAE), (c) manufacturing products using computer-aided manufacturing (CAM), and
(d) integrating all components with a computerized information system.
14. Manufacturing resource planning (MRP-II) is a closed-loop, computerized manufacturing
system that integrates all facets of a manufacturing business, including production, sales,
inventories, schedules, and cash flows.
15. Enterprise resource planning (ERP) is the latest phase in the development of computerized
systems for managing organizational resources. ERP connects all organizational
operations (personnel, the financial accounting system, production, marketing, distribution,
etc.) and also connects the organization with its suppliers and customers.
16. The supply chain consists of flows from sources of (a) raw materials, (b) components,
(c) finished goods, (d) services, or (e) information through intermediaries to ultimate
consumers. These flows and the related activities may occur across the functions in an
organizations value chain (R&D, design, production, marketing, distribution, and customer
service). These flows and the related activities also may occur across separate
organizations. The activities in the supply chain should be integrated.
17. Distribution is the transfer of goods (and, in other contexts, services and information) from
producers to customers or from distribution centers to merchandisers. Thus, distribution
manages outflows, and purchasing manages inflows. Among the interrelated issues
involved in distribution are selection of (a) distribution channels, (b) inventory placement,
(c) means of transportation, (d) shipment schedules, (e) routes, and (f) carriers.
18. Price-setting factors include supply and demand. Supply of and demand for products and
services are determined by customers impact on demand, the actions of competitors, and
costs. Internal factors include (a) marketing objectives, (b) the marketing-mix strategy,
(c) all relevant costs in the value chain, (d) the organizational location of pricing decisions,
and (e) capacity. External factors include (a) the type of market; (b) customer perceptions
of price and value; (c) the price-demand relationship; and (d) competitors products, costs,
prices, and amounts supplied.
19. Prices may be cost-, market-, or competition-based.
20. Pricing may depend on the sellers place in the distribution channel and whether a product is
new. Price also reflects geographical factors, various discounts and allowances,
promotional considerations, and the product mix.
21. Predatory and collusive pricing are illegal in the U.S., and price discrimination among
customers may be. Moreover, international cartels engage in monopolistic and
anticompetitive practices.
22. A target price is the expected market price for a product or service, given the companys
knowledge of its consumers perceptions of value and competitors responses. Subtracting
the unit target operating income determines the long-term unit target cost. Relevant costs
are all future value-chain costs, whether variable or fixed.
23. Life-cycle costing is a basis for cost planning and product pricing. It estimates a products
revenues and expenses over its expected life cycle.
24. Pricing policies should be appropriate to the stage of the product life cycle: (a) introduction,
(b) growth, (c) shakeout, (d) maturity, and (e) decline.
25. Using the variables of competitive advantage (cost and differentiation) and competitive
scope (broad and narrow), Porter described four generic business strategies: (a) cost
leadership, (b) differentiation, (c) cost focus, and (d) focused differentiation.
26. The dominant firm in a market pursues a market-leader strategy. The leader should
attempt to increase total demand because it will gain the most. Demand will increase if
the firm uses pricing to attract new users by employing a market penetration, new-market-
segment, or geographical-expansion strategy. The leader takes offensive and defensive
actions to defend market share and also may try to obtain a larger market share.
27. Trailing (runnerup) firms may choose a market challenger strategy. General strategies
include (a) frontal attack, (b) flank attack, (c) encirclement attack, (d) bypass attack, or
(e) guerrilla warfare. Specific strategies include (a) discounting, (b) selling lower-priced
goods of average quality, (c) selling prestige goods, or (d) product proliferation.
28. Market followers do not challenge the leader. They may be counterfeiters, cloners, imitators,
or adapters.
29. Market nichers are small to mid-size firms that compete in small markets.
30. International pricing involves such issues as the gray market, price escalation, and transfer
pricing.
31. Managing human resources means acquiring, retaining, and developing employees. These
functions should be consistent with the strategy and structure of the organization. The
essential activities include (a) development of a human resource strategy that treats
employees as human capital, (b) recruitment and selection, (c) evaluation of performance,
and (d) training and development.

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STUDY UNIT TWO

MANAGING RESOURCES AND PRICING

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