Cost Allocations Can Distort Pricing Decisions
Kraft Foods Group Used

Essay

Cost Allocations Can Distort Pricing Decisions
Kraft Foods Group used to sponsor a car in the NASCAR races. Like other major corporations that sponsor sports events, Kraft believes that the public's awareness of its products is enhanced by sponsoring a NASCAR. For the right to have "Kraft" displayed prominently on the automobile, Kraft pays the racing team an annual fee.
Kraft is organized around a number of business units that are profit centers. Senior management at Kraft believes that since the various business units at Kraft receive the benefits of the NASCAR exposure through greater name recognition, and hence greater sales, the costs of the program should be allocated back to the business units and ultimately to all Kraft products. The cost of the NASCAR program is allocated back to the Kraft business units based on sales revenue. Suppose the allocation is 10 percent of revenues. That is, for every $1 of revenue, the business unit is allocated $0.10 of cost from the NASCAR car.
One of Kraft's business units sells Velveeta processed cheese in cartons containing 200 32 ounce packages. The following table summarizes possible pricing levels, cartons sold at that price, and costs for the various number of cartons. $$\begin{array} { | c | c | c | } \hline \text { Price } & \text { Number of Cartons Sold } & \text { Total Cost } \\\hline \$ 564 & 218 & \$ 71,800 \\\hline 562 & 219 & 71,900 \\\hline 560 & 220 & 72,000 \\\hline 558 & 221 & 72,100 \\\hline 556 & 222 & 72,200 \\\hline 554 & 223 & 72,300 \\\hline 552 & 224 & 72,400 \\\hline 550 & 225 & 72,500 \\\hline 548 & 226 & 72,600 \\\hline\end{array}$$ Required:
a. What price-quantity combination maximizes the profits of the Velvetta, ignoring the allocation of NASCAR?
b. If $0.10 of the NASCAR is allocated for every dollar of Velvetta revenue, what price-quantity combination of Velvetta maximizes profits after allocating NASCAR costs?
c. What price-quantity combination of Velvetta maximizes profits after allocating NASCAR costs using total costs (instead of revenues), where for every dollar of total costs, $0.20 of NASCAR costs are allocated?
d. Instead of allocating the NASCAR based on revenues, it is allocated based on profits before allocated costs. For every $1.00 of profits before allocated costs, $0.30 of NASCAR costs are allocated. Now what price-quantity combination maximizes Velvetta profits after allocating NASCAR costs?
e. Should NASCAR costs be allocated to the business units, and if so, what allocation scheme should be used (revenues, costs, or profits)?