Case Study:

Al Ennabi, Inc. is a newly established company in Doha since 2019. It produces premium ice cream in a variety of flavours. Over the past months, and due to the company’s endeavours to initially lower its prices to attract more customers, yet without compromising the quality of its products, the company has experienced rapid and continuous growth as reflected from the sustained demand of its products, which may allow management to reasonably consider the change of its selling prices, without ignoring the impact of competition of course. In addition, and in an effort to increase sales during the World Cup event in Qatar, Al Ennabi is planning to increase manufacturing capacity by opening production facilities in new geographic areas including the Pearl, Lusail, Al Wakra, Al Khor, across the majority of the shopping malls, in addition to the 6 main stadiums that are hosting the matches. These initiatives have put pressure on management to better understand both their potential markets and associated costs. Management identified three aspects of their current operation that could affect the new market expansion decision: (1) a highly competitive ice cream market, (2) the company’s current marketing strategy, and (3) the company’s current cost structure.

Since the company began operations in 2019, it has used the cost-plus approach for establishing prices for one box of ice cream. The product prices include the cost of materials and labour, a markup for profit and overhead cost together, and a market adjustment. As per Al Ennabi’s policy, an amount of QR 74 is set for each product to represent the mark up that shall cover both, the profit and overhead cost. The market adjustment is used to appropriately position a variety of products in the market. The goal is to price the products in the middle of comparable ice creams offered by competitors while maintaining high quality and high differentiation. Sales volume and prices as well as direct costs for the current year are presented below by product covering the period from January 1st , 2022 up-to-date.

The company’s manufacturing overhead costs were QR 2 371 120 (75% variable & 25% fixed).

Al Ennabi is considering replacing cost-plus pricing with target costing and has prepared the table below to better compare the methods. Al Ennabi tries to appeal to the top 30% of the retail sales customers, including restaurants and cafes. In positioning Al Ennabi’s products, three dimensions are considered: price, quality, and product differentiation. Accordingly, there are three main competitors in the market as follows:

 Competitor A – Low cost, low quality, high standardization

 Competitor B – Average cost, moderate quality, average differentiation

 Competitor C – High cost, high quality, high differentiation

Al Ennabi has also been reviewing its purchasing, manufacturing, and distribution processes. Assuming that sales volume will not be affected by the new target prices, and before considering the increase of the manufacturing capacity by opening new branches, the company believes that the improvements in these processes will result into the following:

 QR 5 decrease in the materials & labour unit cost for both the vanilla and choco flavours.

 QR 5 increase in the materials & labour unit cost for both the caramel and lemon flavours.

 QR 292 670 reduction in the variable manufacturing overhead cost.

Required: 

1. In regards to the supply and demand of Al Ennabi’s products, discuss the three major factors affecting the pricing decisions, and how would Al Ennabi set its short and longrun pricing decisions. You are also required to outline and differentiate between the two alternative approaches for setting Al Ennabi’s prices. In your answer, show the formula that represents each method. Furthermore, and given Al Ennabi’s business environment, which approach is relevant for setting its prices compared to other levels of competition in other market sectors.

2. Outline and discuss the necessary five main steps that Al Ennabi would go through to properly implement target costing. Give much attention to explaining the term value engineering by defining all relevant terms related to such process. You are also required to state how Al Ennabi could benefit from the application of such process.

3. Assuming that the planned increase in the manufacturing capacity is not yet in place, and that the sales volumes will not be affected by the new product pricing based on target costing and that the processes improvements will be implemented, prepare a comparative income statement to calculate the company’s operating income under both approaches; cost plus and target costing. Show detailed computations for the 4 flavours Al Ennabi is offering. You are required to display all your calculations and formulas using excel sheets.

4. Based on your computations above, compute Al Ennabi’s margin of operating income under the two pricing approaches and recommend which pricing method Al Ennabi should use in the future and explain why. You are required to display all your calculations and formulas using excel sheets.

5. Based on your computation in requirement 3 above, and referring to the results of the cost-plus approach, assume that Al Ennabi is using a flexible budgeting approach in monitoring and controlling its operations. Below are extracted items for the actual results based on the cost-plus approach and the budgeted amounts at the beginning of this current year for the total sales volume, sales amounts, and the associated manufacturing costs of four products (vanilla, choco, caramel & lemon).

Based on the above, you are required to run a level 1 and level 2 variance analysis indicating possible reasons for all deviations. You are required to display all your calculations using excel sheets.

6. Given that Al Ennabi would be much interested in sustaining its operations far beyond the World Cup event, and for multiple years coming ahead, you are required to discuss this interest in the context of the terminology life-cycle costing.