Tactical Decision Making

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Tactical Decision Making

• Short-run decision making approach that focuses
  on the costs and benefits of alternative courses
  of action.

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Steps to Making Tactical Decisions

• Define the problem.
• Identify alternatives.
• Predict costs and benefits of each alternative.
• Compare alternatives.
• Select best alternative.

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Types of Decisions

• Make or Buy
• Keep or Drop
• Special Order
• Sell or Process Further
• Product Mix

Important Short-term Perspective
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Relevant Costs Must

• 1) Differ across alternatives
• 2) Be a future cost
• Whether a cost is relevant depends on the
  decision being made and the time-horizon.

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Other Considerations

• Opportunity Costs
• Sunk Costs
• Full Cost Fallacy

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Cost Behavior in Traditional vs. ABC Systems

• Traditional Classification
• 1) Variable Costs
• 2) Fixed Costs

• ABC Classification
• 1) Unit-level costs
• 2) Batch-level costs
• 3) Product-level costs
• 4) Facility-level costs

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Categories of the Activity Resouce Usage Model

• 1) Resouces acquired as used and needed
• 2) Resouces acquired in advance of usage (single
  period or short term)
• 3) Resouces acquired in advance (multiperiod
  service capability)

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Activity Resource Usage Model and Cost Relevancy
1 Resources Acquired as Needed
Demand Constant
Demand Changes
Not Relevant
Relevant
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Activity Resource Usage Model and Cost Relevancy
2 Resources Acquired in Advance (Short Term)
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Activity Resource Usage Model and Cost Relevancy
3 Resources Acquired in Advance (Multiperiod)
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Make or Buy Decisions

• All else equal, the alternative with the lowest
  cost is preferred
• Identify the relevant costs of making
• variable production costs
• any fixed costs which can be eliminated or used
  in some other way
• Other strategic and qualitative factors are
  important

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Make-or-Buy Decisions
Assume the following cost data relate to the
decision to produce 12,000 units of a product or
buy from external source
Total Costs
Unit Cost Rental of equipment 15,000
1.25 Equip. depreciation
3,000 .25 Direct
materials 12,000
1.00 Direct labor
24,000 2.00 Variable
overhead 9,000
.75 Fixed overhead 36,000
3.00 Total
99,000 8.25
Purchase price from an outside vendor is 5.50
per unit
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Make-or-Buy Decision (Continued)
Alternatives Differential
Make Buy Cost to Make
Rental of equip. 15,000 ----
15,000 Direct materials 12,000
---- 12,000 Direct
labor 24,000 ----
24,000 Variable overhead 9,000
---- 9,000 Purchase
cost 66,000
(66,000) Relevant costs 60,000
66,000 ( 6,000)
Decision Manufacture parts in-house
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Keep or Drop Decisions

• Key Questions
• 1) Which costs can be eliminated along with the
  segment and which costs will still be there? Are
  there alternative uses for those resources?
• 2) Will it adversely affect other product lines
  or segments?
• 3) Need to consider the contribution of the
  segment (not just its bottom line profit).

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Keep-or-Drop Decision
Assume the following
Regular Deluxe
Total Sales Units
400 200 600
Sales revenue 200,000
150,000 350,000 Less variable
expenses Variable cost of sales
96,000 60,000 156,000
Variable selling admin. 10,000
7,500 17,500 Contribution Margin
94,000 82,500 176,500
Less direct fixed expenses Direct fixed
costs 30,000 85,000
115,000 Product Margin
64,000 (2,500) 61,500 Less
common fixed costs
30,000 Net income

31,500

Should the Deluxe product line be eliminated?
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Keep-or-Drop (Continued)

Differential
Keep
Drop Amount to Keep Sales
150,000 ----
150,000 Variable exp. (67,500)
---- (67,500)
Contr. margin 82,500
---- 82,500 Direct
fixed costs (85,000) ----
(85,000) Relevant benefit/loss

(2,500)
Decision Drop the Deluxe product line but
investigate alternative use of facilities. This
analysis provides a benchmark for
future decisions.
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Special-Order Decision
Assume the following price quotation sheet for
the XYZ Company who has received an offer buy at
38 per unit. Direct materials
12 Direct labor
14 Variable overhead
4 Variable
selling and administrative 2 Fixed
manufacturing 20
Total
52 Markup--50
26 Target selling price
78
Important XYZ Company has idle capacity and can
produce the special order without affecting its
current production.
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Special-Order Decisions
Decision Rule The floor for establishing a
price for a special order is incremental cost
(variable cost in this case).
Incremental Costs Direct materials
12 Sales price
38 Direct labor 14
Incremental cost 32 Variable overhead
4 Additional income
6/unit Variable S A 2
Total 32
Question What impact is this decision likely to
have on existing customers?
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Sell or Process Further

• The split-off point is where the products become
  separable
• Common processing costs are sunk
• Compare increased processing costs to increased
  sales revenue

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A Decision to Sell or Process Further
Separate Processing
Product A
Joint Costs
Joint Input
Should the company process further?
Separate Processing
Product B
Split-off point
Joint products
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A Decision to Sell or Process Further
Sell or process further decision
Products
A B
Sales value at split-off
240,000 300,000 Sales value
after additional processing 320,000
480,000 Allocated joint product costs
160,000 200,000 Cost of
further processing
100,000 120,000
Incremental revenue from processing 80,000
180,000 Cost of additional processing
100,000 120,000
Profit (loss) from further processi ng
(20,000) 60,000 Decision
Sell at
split-off Process further
Joint costs are irrelevant
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A Product Mix Decision
Cost and characteristics of two product lines are
given below
Product lines
A B
Sales price per uni 50
60 Variable cost 20
36 Contribution margin 30
24 C/M ratio 60
40 Production time 2 hours
1 hour
Contribution/hour 15
24 Available hours 2,000
2,000 Total Contribution 30,000
48,000