Relevant Costs

What Are Relevant Costs?

Relevant costs are future, incremental cash flows that will change depending on the decision. For a cost to be relevant, it must:

• Be avoidable depending on the decision taken.

• Be differential between options.

• Be a cash flow, not sunk or apportioned cost.

🔍 Key Decision Areas for Halfpenny & Relevant Costs Analysis

1. Product Mix Decisions: Focus on High-Margin Lines

Scenario: Should Halfpenny continue producing lower-margin loaves like wholemeal, or shift towards high-margin products like rustic loaves and rolls?

Relevant Costs:

• Direct raw material costs (e.g., seeds/grains for multi-seed/rustic)

• Direct labour costs (K$25/hr × standard time per stage)

• Variable overheads

• Opportunity cost of using fixed production capacity for lower-margin items

Not Relevant:

• Fixed overheads (unless decision leads to capacity expansion/contraction)

• Past development costs for products

Strategic Insight:

• Wholemeal Loaves: Margin = 13.2%

• Rustic Rolls: Margin = 48.9%

• Shifting capacity toward rustic products is financially sound if demand is sustainable.

2. Make-or-Buy Decision: Outsourcing vs In-House Production

Scenario (Hypothetical): Should Halfpenny outsource a portion of bread roll production to a third-party due to capacity constraints?

Relevant Costs:

• In-house variable costs per batch

• Outsourcing cost per unit from supplier

• Cost of labour/electricity saved

• Impact on quality/brand reputation (intangible but critical)

Not Relevant:

• Allocated fixed overheads

• Depreciation on owned equipment

Suggestion:

If external supplier price < internal relevant cost per unit and quality is matched, outsourcing a portion may be viable during peak times.

3. Special Order Pricing

Scenario: A large overseas retailer requests a special order of multi-seed loaves at K$1.00 per unit (lower than usual price). Should Halfpenny accept?

Relevant Costs per loaf (batch-based):

• Variable costs = Raw materials + Direct labour + Variable overhead= K$1,473.75 + 57.50 + 171.94 = K$1,703.19 per batchPer loaf = K$1,703.19 / 2,500 = K$0.681

• Incremental delivery/packaging costs (if any)

Not Relevant:

• Regular selling price

• General fixed overheads

Decision Rule:

If offered price > relevant cost, and capacity exists, accept the order.

💡 Accepting at K$1.00 would provide approx. K$0.32 contribution/loaf, assuming capacity exists.

4. Discontinuing a Product Line

Scenario: Should Halfpenny stop producing wholemeal rolls?

Relevant Costs:

• Lost contribution margin from wholemeal rolls

• Savings in materials and labour

• Avoidable fixed costs (if any)

• Opportunity cost of using capacity for more profitable products

Decision Rule:

Drop the product only if contribution lost < contribution gained elsewhere using the freed-up capacity.

5. Investment in New Product Development

Scenario: Harry Chang proposes a new "low-carb protein roll." Should Halfpenny proceed?

Relevant Costs:

• Development costs (R&D, testing)

• Marketing launch spend

• Additional ingredient costs (e.g. plant-based proteins)

• Incremental distribution costs

Not Relevant:

• Sunk costs of previous failed product R&D

• Overheads unless directly impacted

Additional Factors:

• Consumer trend alignment (yes, per BreadTech Digest)

• Cannibalisation risk of existing products

Decision should include NPV or Payback analysis based on estimated future cash flows, all of which must be incremental and cash-based.

6. Pricing Strategy for Retailers

Scenario: Should Halfpenny adjust pricing strategy for large vs small retailers?

Relevant Considerations:

• Average sales price for large retailers is ~20% lower

• Longer credit terms (40–60 days) increase working capital burden

• Small retailers offer better margin but smaller volume

Relevant Costs:

• Cash cost of credit (e.g. interest lost from extended receivables)

• Customer acquisition and service costs

• Volume discount costs (if pricing is reduced)

Strategic Options:

• Consider offering discount for early payment

• Push sales more toward small retailers if cost-to-serve is lower

🧮 Summary Table: Relevant vs Irrelevant Costs

Cost Type	Relevant?	Explanation
Direct materials	✅	Varies by product
Direct labour	✅	Based on standard time per process
Variable overheads	✅	Avoidable if production doesn't occur
Fixed overheads (allocated)	❌	Not affected by short-term decisions
Depreciation	❌	Non-cash, sunk cost
Sunk development costs	❌	Already incurred
Future marketing spend (new line)	✅	Only if it changes due to decision
Credit cost (extended payment)	✅	Opportunity cost of delayed inflows
Lease payments (short term)	❌/✅	Only relevant if lease can be cancelled

🧭 Final Strategic Recommendations

1. Prioritise rustic and multi-seed products: relevant cost analysis confirms superior margins.

2. Review product lines for discontinuation: especially wholemeal, unless strategic reasons exist (e.g., brand positioning).

3. Consider launching new niche products only after rigorous analysis of incremental costs and projected contribution.

4. Assess special orders independently: they can be accepted at lower margins if they cover relevant costs.

5. Move toward more data-driven decision making, not based on incremental budgeting alone.