Activity-Based Costing and Predatory Pricing: The Case of the Petroleum Retail Industry
1. What are product-cost subsidizations?
When excessive costs are charged to high-volume products while insufficient costs are charged to low-volume products. One example of how this occurs is when product-costing is based on labor-hours. Products that are produced infrequently will typically require less annual man-hours when compared to major products. Calculating the costs of several products based on a traditional volume-based costing system ignores other costs that are not related to volume. These costs may be engineering, set-up time, material costs, or other variables.
2. What are possible consequences of product-cost subsidizations?
When prices are based on cost, product-cost subsidization can lead to increased demand for undercosted and underpriced low-volume products, which are probably being sold at unprofitable prices. Conversely, companies experience reduced customer demand for overcosted, overpriced high-volume products and services. State and federal laws have been enacted against predatory pricing, which is the selling of products below cost as a deliberate action to drive out the competition. Alternatively, products may appear to be priced below cost because of the use of unrealistic, unit-based traditional costing systems, which results in the appearance of predatory pricing where it does not exist.
3. List alternative approaches to assign costs in a gasoline service center.
Unit-based approach - focuses on the product itself and uses only one criterion or driver for allocating the costs to the products. In our case the activity driver is the gas sold and its average monthly cost (or facility-wide cost) is spread among the three types of gasoline (regular, plus, and premium) based on the percentage of gallons of gas sold per month, calculated and determined for each of the gas types.
Simple-average approach - assigning the...