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The decision to accept/reject a special order - 1

One issue likely to be appropriate to all managers at some time in their careers is whether to accept what we will refer to as a special order. By this we mean, ‘Are there circumstances in which it might make sense in financial terms to sell products or services at a lower price than normal, or alternatively, to provide a service internally at less than its full cost?’

In considering such decisions, it is most important to be quite clear about the meaning of the term full cost. In many organisations external and internal prices for products and services are generated with reference to the full or total cost of its provision plus a percentage margin, a practice known as cost-plus pricing. Within the full cost, there will usually be allocated and apportioned fixed overheads required to be covered, irrespective of whether a special order is accepted. Such non-relevant costs must be ignored since the criteria for accepting a special order must only consider whether the direct benefits which result, exceed those costs that could be avoided by not taking it.

Such evidence, as exists from surveys of pricing, reveals that some organisations do accept special orders using some form of the contribution analysis, although the bias towards its use is not as significant as many textbooks would imply.

You should be aware that the acceptance of a special order with reference to direct costs and benefits can be problematic if it generates a special order ‘culture’. If all orders are priced as special, how will fixed overheads ever be recovered!

There are also other considerations to be taken into account that may have financial consequences. For example, if it became widely known that special orders were negotiable then the subsequent marketing and selling of products, or services, may be far more difficult, and require a good deal more effort to be expended than currently.

As a general guideline then, in these types of decisions, a company must consider:

  1. Whether the acceptance of a special order will tie up capacity which could be used for profitable orders at some time in the future. If it does so then it should avoid the special contract.
  2. Whether the acceptance of a contract will affect the regular revenue of the product, and ultimately the future pricing structure of that product.

Generally speaking, a special contract should not be accepted if it will affect consumer behaviour adversely within the same marketplace. General knowledge of the availability of special orders may well lead to "consumer games" with the supplier. Special orders might relate to Government contracts or customers in a separate market segment; possibly in an overseas market.

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