Full Cost Plus Pricing Methodology(Part2)
In the earlier article, we discussed pertaining to the factors which affect pricing and the pricing objectives in relation to the business objective.
This article deals with the various pricing methodology, a businessman/entrepreneur can refer to when pricing a product:
FULL COST PLUS PRICING METHODOLOGY:
Full Cost Plus Pricing:
- Traditional method of pricing a product;
- Most commonly used method;
- Prices are set by adding a percentage of profit ( either a mark up or a margin) to the total cost of the product;
- Consistent with the absorption costing technique;
- Commonly used by wholesalers, retailers, construction contractors, services, government contractors;
Full Cost Plus Pricing is useful in situation where:
- Products are made based on specification by the customers;
- Main objective is to make profit after considering fixed costs of the business;
- The costs are difficult to estimate in advance;
- Expected demand at different price levels is difficult to estimate.
The following are the advantages and disadvantages that we need to consider when using the Full Cost Plus Pricing methodology:
Advantages are:
- Easy and simple to understand;
- Pricing decisions become standardized;
- Adopts a conservative approach that in the long run to at least ensure the recovery of fixed cost of a business; and
- Difficult of estimating demands can be avoided.
Disadvantages are:
- Tendency to set prices on inaccurate estimates;
- Challenges of apportioning the fixed overheads properly into different products
- Unsuitable for short term decisions making particularly in situation like surplus production capacity, tendering for contracts price and others;
- Ignores competition and price elasticity of demand and
- Ignores opportunity costs and relevant costs
Simple Illustration:
Let’s look at Product A:
Production cost as follows:
Variable cost -material $1.50
Variable cost- labor     $1.50
Total variable cost      $3.00
Fixed cost                    $3.00
(excludes administrative and selling overheads)
Required 50% mark up on total production cost.
For Full-Cost Plus Pricing:
Total cost = $3.00+$3.00 =$6.00
50% on total/full cost = 50% x $6.00 =$3.00
Hence, Selling price = $6.00+$3.00 =$9.00 per unit.
By pricing at $9.00, the company wants Product A to at least cover its total production cost.
- Variable/Marginal Cost Plus Pricing(Part3)
- Break-Even Pricing And Minimum Pricing Methodologies(Part5)
- Rate Of Return Or Rate Of Investment Pricing Methodology(Part4)
- Short Term Decision Making: Other Relevant Cost Techniques(Part2)
- Factors Affecting Pricing(Part 1)
- Criteria Of A Good Intra Transfer Pricing System(Part2)
- Reasons For Implementing Intra Group Transfer Pricing(Part1)
December 11, 2007
Posted in: Pricing Decision
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