All businesses are concerned about revenues and costs.
Whether their products are automobiles, fast food, or the latest designer fashions, managers must understand how revenues and costs behave or risk losing control. Managers use cost accounting information to make decisions related to strategy formulation, research and development, budgeting, production planning, and pricing, among others. Sometimes these decisions involve tradeoffs. The following article shows how companies like Apple make those tradeoffs to increase their profits.
iTunes Variable Pricing: Downloads Are Down, but Profits Are Up1
Can selling less of something be more profitable than selling more of it? In 2009, Apple changed the pricing structure for songs sold through iTunes from a flat fee of $0.99 to a three-tier price point system of $0.69, $0.99, and $1.29. The top 200 songs in any given week make up more than one-sixth of digital music sales. Apple now charges the higher price of $1.29 for these hit songs by artists like Taylor Swift and the Black Eyed Peas.
After the first six months of the new pricing model in the iTunes store, downloads of the top 200 tracks were down by about 6%.While the number of downloads dropped, the higher prices generated more revenue than before the new pricing structure was in place. Since Apple’s iTunes costs—wholesale song costs, network and transaction fees, and other operating costs—do not vary based on the price of each download, the profits from the 30% increase in price more than made up for the losses from the 6% decrease in volume.
To increase profits beyond those created by higher prices, Apple also began to manage iTunes’ costs. Transaction costs (what Apple pays credit-card processors like Visa and MasterCard) have decreased, and Apple has also reduced the number of people working in the iTunes store
The study of modern cost accounting yields insights into how managers and accountants can contribute to successfully running their businesses. It also prepares them for leadership roles. Many large companies, such as Constellation Energy, Jones Soda, Nike, and the Pittsburgh Steelers, have senior executives with accounting backgrounds.
Financial Accounting, Management Accounting, and Cost Accounting
As many of you have already seen in your financial accounting class, accounting systems take economic events and transactions, such as sales and materials purchases, and process the data into information helpful to managers, sales representatives, production supervisors, and others. Processing any economic transaction means collecting, categorizing, summarizing, and analyzing. For example, costs are collected by category, such as materials, labor, and shipping. These costs are then summarized to determine total costs by month, quarter, or year. The results are analyzed to evaluate, say, how costs have changed relative to revenues from one period to the next.
Accounting systems provide the information found in the income statement, the balance sheet, the statement of cash flow, and in performance reports, such as the cost of serving customers or running an advertising campaign. Managers use accounting information to administer the activities, businesses, or functional areas they oversee and to coordinate those activities, businesses, or functions within the framework of the organization. Understanding this information is essential for managers to do their jobs. Individual managers often require the information in an accounting system to be presented or reported differently. Consider, for example, sales order information. A sales manager may be interested in the total dollar amount of sales to determine the commissions to be paid. A distribution manager may be interested in the sales order quantities by geographic region and by customer-requested delivery dates to ensure timely deliveries.
A manufacturing manager may be interested in the quantities of various products and their desired delivery dates, so that he or she can develop an effective production schedule. To simultaneously serve the needs of all three managers, companies create a database—sometimes called a data warehouse or infobarn—consisting of small, detailed bits of information that can be used for multiple purposes. For instance, the sales order database will contain detailed information about product, quantity ordered, selling price, and delivery details (place and date) for each sales order. The database stores information in a way that allows different managers to access the information they need.
Many companies are building their own Enterprise Resource Planning (ERP) systems, single databases that collect data and feed it into applications that support the company’s business activities, such as purchasing, production, distribution, and sales.
Financial accounting and management accounting have different goals. As many of you know, financial accounting focuses on reporting to external parties such as investors, government agencies, banks, and suppliers. It measures and records business transactions and provides financial statements that are based on generally accepted accounting principles (GAAP). The most important way that financial accountinginformation affects managers’ decisions and actions is through compensation, which is often, in part, based on numbers in financial statements.