Product Costing and Pricing under Long-Term Capacity Commitment

Rajiv D. Banker · Iny Hwang · Birendra K. Mishra

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Accounting and Organizational Management Supply Chain and Inventory Management Capital Investment and Risk Analysis

Abstract

We develop a model to analyze optimal product-costing and pricing decisions in a dynamic information environment under long-term-capacity commitment. The arrival of new information about demand and cost parameters each period makes the problem complex. The optimal prices and capacity choices in our model cannot be decoupled as in Banker and Hughes' (1994) single-period model. The optimal prices are based on product costs that are adjusted each period to reflect changes in expected variable costs as well as utilization of fixed activity resources. The charge for each fixed resource is monotonically increasing in the expected demand for that resource in each state given the optimal capacity choice. The average optimal prices across periods and states are similar to Banker and Hughes' (1994) benchmark prices. Finally, we investigate a two-period version of the model to explore the optimality of carrying idle capacity. The optimal product-cost charge for fixed capacity is strictly less in the first period than in the second period when the firm expects demand growth.

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1996Management Accounting 1987How Cost Accounting Systematically Distorts Product Costs 1988Relevant costs, congestion and stochasticity in production environments 1987Cost Allocation and Opportunity Costs 2021Management Accounting 2002The Adequacy of Full-Cost-Based Pricing Heuristics 2002Capacity Planning and Pricing under Uncertainty 2001Sequential Solutions to Capacity-Planning and Pricing Decisions

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2014Levelized Product Cost: Concept and Decision Relevance 2019Costing Systems 2011Cost Information and Pricing: Empirical Evidence*2017Pricing and capacity planning for product-line expansion and reduction 2012Capacity commitment and pricing for substitutable products under competition 2013Target Costing in the Presence of Product and Production Interdependencies

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