The Role of Global Small and Medium sized Enterprises

Introduction

Global Small and Medium-sized Enterprises (SMEs) have been playing a crucial role in the growth of economies specially in the developing nations. In developing economies, SMEs are accounted for increasing development across all the economic indicators and are also considered as strong contributors in both creating jobs and economic development as well. According to the recent assessment of the World Bank, SMEs tend to represent almost 90% of businesses worldwide with more than 50% of employment globally. In emerging or developing economies, SMEs are witnessed to contribute nearly 40% of annual income (GDP) (World Bank Group, 2019). For students who are seeking Economics dissertation help, understanding the impact of SMEs on economic growth and development is said to be the most significant area of study. In the UK, Smith Brothers (Contracting) Ltd is one of the leading SMEs in renewable energy along with an array of the energy sector for a wide range of projects. The company was founded in 1999 by Richard and John Smith. The continuous expansion of the business units across different parts in the UK, such as Ireland, has provided a widespread opportunity for Smith Brothers in the UK’s energy sector. The company entered in Ireland during 2016-2017 and projected more than 50% uplift in its revenue and made a turnover of £40 million in the financial year 2017-2018 (Smith Brothers (Contracting) Ltd, 2019).

The report aims to conduct a critical assessment of the advantages and disadvantages of marginal cost and absorption pricing strategy and evaluates their appropriateness for the SME Smith Brothers. Following the assessment of both the pricing strategies, the report suggests the most appropriate pricing strategy for Smith Brother that can help the SME to sustain its continuous growth in the UK.

Advantages

Marginal Cost is one of the most effective and widely used pricing techniques for SMEs. It is generally a process of setting the price of goods somewhat above the variable cost that required to produce the product. The marginal cost pricing typically relevant to the short-term pricing situations when SMEs have a small or minimum amount of unused manufacturing capability and the enterprises that unable to sell products at a high price (Han et al., 2010). The key advantages of marginal cost pricing include:

Increases profit through gathering a large volume of target customers irrespective of their distinct price sensitivity levels

Helps enterprises to easily enter in any market and perform business activities for term-term financial growth

After-sales services may increase company revenue as the marginal cost pricing includes the additional price for different accessories or spare parts. In short-run, it can be beneficial for the Smith Brothers.

Disadvantages

The pricing technique is robustly designed for companies intended to earn a short-term profit. Hence, it can negatively impact Smith Brothers in the long-run which can impact the long-term sustainability of the firm (Johansson et al., 2002).

Marginal cost pricing sets the price of goods with absolute minimum and tends to ignore the existing price of similar products available in the market (Yang, H. & Huang, 1998). Hence, it can negatively impact on values and long-term growth for Smith Brothers

Absorption Pricing

In absorption pricing, the price of products is set by including all the variable costs associated with it, along with the proportion of all fixed costs. In general, term absorption pricing can be termed as a pricing technique in which the price of products entails all the costs associated with the final product (Guilding et al., 2005).

Advantages

It helps SMEs to include both fixed and variable costs of production, and it is helpful for firms to evaluate profitability as well as to determine the final price of the products

It helps firms to track the profitability margin critically and helps firms to keep track of the products that are not sold when they were produced within the same financial period.

The pricing technique is compliant to GAAP standards, which further facilitates firms to represent its revenue and profitability while reporting financial performance easily.

The absorption pricing strategy does not involve increasing the operational efficiency of the firm. It often fails to provide a clear and good evaluation of costs and volume.

Absorption pricing also ignores in terms of comparing the potential profitability of different product lines, and it may lead the firm to face difficulties while making a competitive decision in production

Hence, if we compare both marginal cost and absorption pricing strategy, it can be suggested that absorption pricing can be the most appropriate method for Smith Brothers to build long-term sustainability in the UK’s energy distribution market. In this context, absorption pricing takes account of direct and other variable costs, which critically represents higher profitability for the firm. Nevertheless, it also provides an accurate profitability ratio than the marginal cost pricing method which is another key factor of the absorption pricing strategy. While we talk about its key benefits in reporting, absorption pricing can help Smith Brothers to efficiently calculate the company’s profit and net profit separately when presenting the income statement. Hence, it can also help the SME to gain a large number of potential stakeholders in the long run.

Measuring Appropriateness of Marginal Cost and Absorption Pricing Strategies

Firms tend to apply a marginal cost pricing strategy when they sell goods at a price, which includes the entire manufacturing cost, excluding the production overheads. The key advantage of marginal cost pricing is that it helps firms to attain major attention of the buyers as the price of products meets the pricing sensitivity of the final customers. For SMEs like Smith Brothers, the company can apply the marginal cost pricing for a short-term period to gain a boost in its revenue (Cachon & Lariviere, 2005). However, in the long run, the marginal cost pricing may obstruct the possible growth and competitiveness of the firm. Despite its short-term limitations, marginal cost pricing also considered as an incompetent pricing technique in terms of appropriately separate fixed and variable costs. This is because all costs associated with the production of goods are variable for firms if it runs for the long run (Cachon & Lariviere, 2005). Hence, selecting marginal cost pricing for Smith Brothers may not be an appropriate decision for the enterprise.

Absorption Pricing Strategy

Absorption pricing strategy is probably the most effective pricing technique for firms, specially the SMEs. The implementation o absorption pricing involves an appropriate allocation of costs that are attributable to the products. In comparison to other pricing techniques, absorption pricing encompasses direct and variable costs associated with the production process and also helps in appropriately tracking the profitability ratio of the firm during the financial period (Singh, 2013).

Concerning its implementation on SMEs like Smith Brothers, the absorption pricing strategy would be more effective for the enterprise than other techniques. In absorption pricing, the technique aptly recognizes the efficiency of embracing different types of costs associated with the production process. The process not only facilitates firms to avoid possible losses, but it can also deliver the enterprise to determine and frame the most suitable pricing policy for its products. Hence, the implementation of the absorption pricing method would be a better choice for Smith Brothers. The process of encompassing all costs (fixed and variable) associated with all the manufacturing processes while setting the price of products can be an effective decision for Smith Brothers. This can help the enterprise to avert possible challenges associated with the costs and overheads associated with the production of its energy products. The application of the absorption pricing strategy can also deliver additional benefits to Smith Brothers to expand its business across different emerging markets. This is because the accounting and reporting process in the absorption pricing method include GAAP compliances and is also applicable for various other recognized bodies such as FASB in the United States of America and ASB in India, among others. The regulations underpinning the absorption pricing method can provide immense support to Smith Brothers in preparing its external report along with formulating its inventory valuation processes.

Conclusion

In the modern competitive business scenario, selecting an appropriate pricing strategy for products and services is critical as it is one of the most strongly visible entities for organizations to sustain their competitive position. Suitable pricing is crucial for organizations to maintain the growth and profitability of the business. In the context of SMEs, although the marginal cost method is widely practiced, it is frequently identified that the method tends to impose major impacts on firms to appropriately measure and evaluate profitability. In contrast, the absorption pricing technique if probably more effective for large and medium-sized organizations because it helps firms to encompass both fixed and variable costs when pricing products. Moreover, it also focuses on determining the pricing of products based on changing cost in variable entities during production and enables firms to determine the suitable price of products on a real-time basis. The implementation of the absorption pricing strategy can be a better choice for Smith Brothers to separately calculate the company’s profit and net profit by encompassing both fixed and variable costs. Also, the implementation of this pricing strategy can facilitate Smith Brothers to relate efficient or inefficient utilization of resources during production by accurately indicating factory overheads and inventory costs. Hence, to sustain long term in the highly competitive renewable energy industry, the implementation of an absorption pricing strategy would be more effective for Smith's brother than the marginal cost pricing method.

References

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