Special Order Pricing
Special order pricing is the price which the company can offer to their customers due to the large quantity or good relationship. The company may reduce the price due to bulk purchase or they want to build relationship with customers in order to make profit in next orders. Due to these reasons, the company will try to offer a special price which is usually below the standard price.
The company may willing to accept the lower margin with a large quantity, which means they can make a good profit in one order.
Example
Company A is a manufacturer of the shoe. The detail standard costing can be found below:
| Item | Amount | |
|---|---|---|
| Selling Price | 200 | |
| Direct Material | 40 | |
| Direct Labor | 60 | |
| Variable Overhead | 20 | |
| Fixed Overhead | 30 | |
| Total Cost per unit | 150 | |
The company usually makes a profit of $ 50 per unit. The fixed cost will remain the same ( $ 6,000,000) if the production below 200,000 units per month. If the production unit is higher than that, the fixed cost needs to increase by 50%.
During December 202X, the company produced 100,000 units of the shoe as its plan. However, we receive a special order from the customer to produce 80,000 units at $ 130 per unit. Should we accept this order?
Solution
Calculate incremental cost
| Item | Per unit | 80,000 units |
| Direct Material | 40 | 3,200,000 |
| Direct Labor | 60 | 4,800,000 |
| Variable Overhead | 20 | 1,600,000 |
| Total | 120 | 9,600,000 |
As the fixed cost still the same, we only incur the variable cost which is $ 9,600,000 for the new order which will generate $ 10,400,000 (80,000 units @ $ 130). The company still makes a profit of $800,000 from this special order, so we should accept it.
Impact of Special Order on Profit – Comparison of Profit
| Before accepting order | After accepting new order | |
| Sale | $ 20 M | $ 30.4 M |
| Direct Material | ($ 4 M) | ($ 7.2 M) |
| Direct Labor | ($ 6 M) | ($ 10.8 M) |
| Variable Overhead | ($ 2 M) | ($ 3.6 M) |
| Fixed Overhead | ($ 6 M) | ($ 6 M) |
| Net Income | $ 2 M | $ 2.8 M |
Point to Consider
Before accepting special order, company need to consider two factors which is the spare capacity and profit.
| Any capacity remaining | The company will consider accepting the special order when spare capacity is available. If our capacity is full, it will hurt our profit as we have given up the opportunity to produce for the standard price, but accept the special order at a lower price. Even we are able to make the production, but we will have less profit due to the opportunity cost. |
| Does the order profitable | The special order must be profitable, at least we can make a positive contribution. With this contribution margin, the company will be able to pay for fixed costs such as rental, depreciation and so on. In the end, we will make more profit. |