COST BASED PRICING STRATEGIES
Full Cost Plus Pricing: It is a long term pricing strategies. It aims to ensure that
price cover all variable and fixed costs.
Advantages:
1) If the budgeted sales is achieved profit will be made
2) It is appropriate where fixed costs are significant
3) It is useful for justifying prices
4) Simple and cheap to operate
5) The full Cost system should be readily available if the system of standard
costing is in operation.
Selling price per unit= Budgeted production cost + Budgeted non
production cost + Mark up / Budgeted sales units
Disadvantages:
1) Ignores external factors
2) Size of markup is arbitrary
3) May not maximize profits
4) If the actual sales are below budgeted sales losses may occur
5) The method of accounting for overheads will have a large impact on the
cost calculated for different products.
MARGINAL COST PLUS PRICING:
Selling price per unit= Budgeted variable production cost + Budgeted variable
non production cost + Mark up / Budgeted sales unit
Advantages:
1) Mark up represents contribution which is useful in short term pricing
decision
2) Treats fixed cost by their nature not using an arbitrary allocation
Disadvantages:
1) May lead to failure to recover fixed costs
2) Not appropriate for long term pricing, particularly where fixed costs are
significant, because in the long term fixed costs may vary as well, and
not be sufficiently covered by Mark up
ROI Pricing
Price which is set to achieve a target percentage on the capital invested. It is a
long term pricing method.
Selling price per unit = Budgeted full cost + (Target ROI percentage * Capital
employed) / Budgeted sales units
Advantages:
1) Links pricing to short term costs and long term capital employed
2) Consistent with ROI as a performance measure
3) Target ROI can be set to take account of risk
Disadvantages:
1) Ignores external factors
2) Problems in calculating capital employed
3) Subjective split of shared investment between products
Opportunity cost pricing: It is a short term strategy used to price:
1) One off projects
2) Special orders
3) Tenders for contracts
Price = Relevant costs + Mark up
Life cycle cost pricing:
Life cycle cost pricing will not only consider current fixed and variable costs,
but all the costs over the product life. Over the product life time, its total
revenue should at least cover design, manufacture and close down costs as
well as costs of production.
Limitations of Cost Based Approaches
1) They ignore external factors such as demand and competition
2) They are unlikely to maximize profit, revenue or market share as mark
ups are subjective
3) They may result in prices completely different from those charged by
competitor
4) Using a cost basis may underestimate the features in the product that
are attractive to customer and could justify a higher price
