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| Kolobok Inc. produces premium ice cream in a variety of flavors. Over the past several years, the company has experienced rapid and continuous growth and is planning to increase manufacturing capacity by opening production facilities in new geographic areas. These initiatives have put pressure on management to better understand both their potential markets and associated costs. Kolobok’s 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 1990, Kolobok has used the mark-up approach for establishing prices for six-gallon containers of ice cream. The product prices include the cost of materials and labor, a markup for profit and overhead cost (a standard $20), and a market adjustment. 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 for 2007 based on Kolobok’s mark-up pricing are presented below by product.  For the year 2007, Kolobok’s before-tax return on sales was 7%. The company’s overhead expenses were $500,000, selling expenses $250,000, administrative expenses $180,000, and interest expenses were $30,000. Kolobok’s marginal tax rate is 30%. Kolobok is considering replacing mark-up pricing with target costing and has prepared the table below to better compare the methods. Kolobok tries to appeal to the top 30% of the retail sales customers, including restaurants and cafes. In positioning Kolobok’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  Kolobok has also been reviewing its purchasing, manufacturing, and distribution processes. Assuming that sales volumes will not be affected by the new target prices, the company believes that improvements will yield a $125,000 decrease in labor expense and a 25% reduction in overhead expense. A. Describe target costing. B. Analyze and compare the two alternative pricing methods: mark-up pricing and target costing. C. Assuming that the sales volumes will not be affected by the new product pricing based on target costing and that the process improvements will be implemented, calculate Kolobok’s before-tax return on sales using the proposed target prices. D. Recommend which pricing method (mark-up or target) Kolobok should use in the future and explain why. |