Cost Based Pricing
Cost-based pricing is a pricing strategy where the selling price of a product is determined by adding a markup to the cost of production. It involves calculating the total cost of producing a product, including both variable and fixed costs, and then adding a desired profit margin to set the selling price. This approach is commonly used by businesses to ensure they cover their costs and generate a profit.
7 Key excerpts on "Cost Based Pricing"
eBook - ePubMedia Economics
Applying Economics to New and Traditional Media
- Colin Hoskins, Stuart M. McFadyen, Adam Finn(Authors)
- 2004(Publication Date)
- SAGE Publications, Inc(Publisher)
...New product pricing considers the price strategy for introducing a new product. This is a particularly important subject for media industries, where new products are being developed continuously: Every movie, television program, and music recording can be viewed as a new product. Another set of pricing issues arises as a result of short-run capacity constraints. Congestion costs and peak-load pricing are discussed in this context. Throughout, examples and applications, including answers to the questions posed in the first paragraph, will be drawn from media industries. 10.1 The Role of Costs in Pricing Survey research was used in the 1950s and 1960s to identify the pricing practices companies actually use. Full-cost pricing (also known as cost-plus pricing) was found to be most prevalent. This method calculates price on the basis of the following formula: Full-cost price = Direct costs (per unit) + Indirect cost (per unit) + Fair profit margin Direct costs are expenditures on factors of production, such as raw materials and labor, that are made in the period in which the factors are employed. We referred to these costs as explicit costs in chapter 6. Indirect costs are an allocation of overhead (what economists refer to as fixed costs). The basis for allocating might be the number of hours of labor needed to produce a unit of the product or the number of machine-hours necessary. The “fair” profit margin, expressed as a percentage of total costs, is usually the historical norm for the industry. Superficially, the full-cost pricing method looks attractive. Summing all costs and adding a mark-up would seem to guarantee a profit. This is not the case, however. The greatest drawback with the full-cost method is that it completely ignores demand. Note first that the full-cost price can only be calculated if an output is initially assumed. The indirect costs per unit will, obviously, vary inversely with the number of units over which the fixed overhead is to be allocated...
eBook - ePub- Elearn(Author)
- 2010(Publication Date)
- Routledge(Publisher)
...Pricing for profitability You may think that deciding the selling price for products is a function of the marketing department, and indeed the prime responsibility does lie with them. However, the marketing department does not make the decision in isolation. The pricing decision is … a complex mixture of strategic thought, operational planning, marketing and economic decision making by the supplier of the goods or service. Broadbent and Cullen (2003) One of the basic questions to be asked about any product is, ‘Are we making a profit on this product line?’ Whilst companies have loss-leaders to attract custom, this can only ever be in exceptional circumstances if the business is to survive. To maintain its profitability, an organisation needs to understand and take account of its costs when it makes pricing decisions. In this theme, you look at two techniques for allocating costs to products: full costing and marginal costing. In this theme you will: ♦ Learn how to make informed pricing decisions through using the full costing technique ♦ Practise preparing an estimate of costs using the full costing method and calculating a price ♦ Find out about marginal costing and identify situations where this is a useful technique. Pricing products To know whether we are making a profit on an existing product or service we must know both: ♦ the price of the product – this should be readily available ♦ the cost of making that product or providing that service. Providing information on cost is the central contribution financial managers make to decisions on product pricing. One-product businesses Determining the costs for a one-product business is relatively straightforward. Adam Kerr makes a famous cheese from the company's base in Dorset. The company produces 40,000 kilos a year and its annual costs are as follows: Milk £10,000 Other materials £5,000 Wages £60,000 Overheads £30,000 The total costs of the business for the year are therefore £105,000 (10 + 5 + 60 + 30)...
eBook - ePub- Mick Broadbent, John Cullen(Authors)
- 2012(Publication Date)
- Routledge(Publisher)
...The economic literature considers the price of a good or service from the viewpoint of the type of market the firm is operating within, using terminology which includes perfect market, oligopoly, and monopoly. The literature considers that different market conditions will impact on the ability of a firm to affect price. The marketing literature sees price as one decision variable within the marketing mix, or total product offering, of that particular product or service. The emphasis is on the requirement of the customer and the proactive ability of the firm to influence the market. The strategic literature sees price as a variable within the ‘value chain’ and the establishment of a generic strategy for the firm to generate and maintain competitive advantage. The establishment of long-term competitive advantage may be through relative cost advantage, hence the inclusion of target costing within this chapter. The accountant’s contribution and the cost approach to pricing views price as a residual figure established from the cost data within the organization. While this view may provide basic data for a range of viable selling prices, the actual price set must be seen as a complex, interactive decision resulting from the inputs of many variables. To place the accountant’s pricing approach in context it would be useful to view Figure 9.1, which has been used in other chapters. This chapter explores the ideas of cost classification, introduced in Chapter 4, by applying the different cost models to arrive at selling prices. The data collection system holds information about costs which may be classified in various ways, direct and indirect, fixed and variable, controllable and uncontrollable, to mention only three. The process of accounting may assist in reaching decisions about selling prices based upon these different cost classifications...
eBook - ePubMarketing and the Customer Value Chain
Integrating Marketing and Supply Chain Management
- Thomas Fotiadis, Dimitris Folinas, Konstantinos Vasileiou, Aggeliki Konstantoglou(Authors)
- 2022(Publication Date)
- Routledge(Publisher)
...Another choice is to maintain the price at the same levels and simultaneously invest more in marketing communication activities to improve the placement of the product as one of higher quality against its substitutes. This choice will take precedence if they expected profit losses from the reduction of prices is greater than the extra marketing communication expenses. Moreover, the company may utilize the initiative of the competitor to reduce prices in order to increase the quality of its product, even proceeding to price increase. This choice becomes attractive when there emerges an opportunity for significant differentiation in the company's offer, covering a new gap which was created by the movements of competitors’ products in the perceptual map of the buyers. Some business successfully faced the challenge of competitors’ price reductions by introducing a similar product into the market with a lower cost (fighter brand), maintaining or even increasing the price of the original existing product. In this way, the business aims at two different market sectors: the dedicated customers who believe in the value-quality of the original product, and those who are sensitive to price, thereby increasing the total market share. 2.9 Pricing of logistics services Pricing is a branch of the science of accounting. Cost is the disposal of or investment in purchasing power for the acquisition of tangible or intangible goods and services, for the purpose of using them to generate sales revenues or meet community needs. The main features of cost are that it is an investment of money in the form of tangible goods or services (e.g. purchase of fixed or raw materials, payment of premiums, interest), and the purpose of cost is to generate revenue. Pricing is the process followed to determine the cost of a good or an operation. The purpose of knowledge of cost is to set selling prices, and control sales and financial activities...
eBook - ePubReturn on Investment Manual
Tools and Applications for Managing Financial Results
- Robert Rachlin(Author)
- 2019(Publication Date)
- Routledge(Publisher)
...Because it applies the same amount of fixed costs regardless of volume levels, it treats fixed costs as a variable expense. In addition, since profits are considered variable in relation to volume, it does not allow the opportunity to cost a product based on volume. The calculation is made as follows: Step 1. Determine the cost of acquiring the product for sale. It may be the cost of manufacturing the product or of purchasing the finished or subassembled parts. Step 2. To the results of Step 1, add the costs associated with obtaining the volume, such as selling, advertising, promotion, sales salaries, commissions and overrides, and travel and entertainment costs. Step 3. Determine the desired profit as a dollar amount or as a percentage of total costs in Steps 1 and 2. This desired profit is added to the total costs to determine the selling price. Table 12-1 illustrates the overall markup technique and how the selling price is determined. If a company sold 10,000 units, the hypothetical statement of income shown in Table 12-2 would result. As you have just observed, the markup pricing method establishes the lowest basic price given a desired level of profit. This method requires determining and identifying different types of costs and adding a desired markup in order to arrive at a selling price. It is sometimes referred to as the total cost method, or full costing, and can be expressed in terms of a formula, as can other markup methods. The formula for this technique can be expressed as: and can be illustrated by using the following per unit data: SP = TC + MU(TC) Total Cost Method This method also recoups all costs of the product and adds a desired profit margin (markup) to arrive at a selling price. It is one of the easiest methods to use but can be misleading because of the way overhead costs are allocated...
eBook - ePubThe Strategy and Tactics of Pricing
A Guide to Growing More Profitably
- Thomas T. Nagle, Georg Müller(Authors)
- 2017(Publication Date)
- Routledge(Publisher)
...Profit contribution, you will recall, is the income remaining after all incremental, avoidable costs have been covered. It is money available to cover non-incremental fixed and sunk costs with, ideally, a lot left over for profit. When managers consider only the incremental, avoidable costs in making pricing decisions, they are not saying that other costs are unimportant. They simply realize that the level of those costs is irrelevant to decisions about which price will generate the most money to cover them. Since non-incremental fixed and sunk costs do not change with a pricing decision, they do not affect the relative profitability of one price versus an alternative. Consequently, consideration of them simply clouds the issue of which price level will generate the most profit. All costs are important to profitability since they all, regardless of how they are classified, have to be covered before profits are earned. At some point, all costs must be considered. What distinguishes value-based pricing from cost-driven pricing is when they are considered. A major reason that this approach to pricing is more profitable than cost-driven pricing is that it encourages managers to think about costs when they can still do something about them. Every cost is incremental and avoidable at some time. For example, even the cost of product development and design, although it is fixed and sunk by the time the first unit is sold, is incremental and avoidable before the design process begins. The same is true for other costs. The key to profitable pricing is to recognize that customers in the marketplace, not costs, determine what a product can sell for. Consequently, before incurring any costs, managers need to estimate how much customers can be convinced to pay for an intended product, given their alternatives. Management must then decide, while all costs are still avoidable, what costs they can profitably incur given the expected revenue. Of course, no one has perfect foresight...
eBook - ePubThe ROI of Pricing
Measuring the Impact and Making the Business Case
- Stephan Liozu, Andreas Hinterhuber, Stephan Liozu, Andreas Hinterhuber(Authors)
- 2014(Publication Date)
- Routledge(Publisher)
...5 MAKING THE BUSINESS CASE FOR VALUE-BASED PRICING INVESTMENTS Stephan M. Liozu Introduction Of the three main approaches to pricing in industrial markets—cost-based, competition-based, and value-based—the last is considered superior by most marketing scholars (Anderson et al. 2010; Hinterhuber 2004; Ingenbleek et al. 2010) and pricing practitioners (Cressman Jr 2010; Forbis and Mehta 2000). Paradoxically, few firms have adopted it. A meta-analysis of pricing approach surveys between 1983 and 2006 reveals an average adoption rate of just 17 percent (Hinterhuber 2008b). Cost-based and competition-based approaches still play a dominant role in industrial pricing practice. There are many published reasons for the low adoption of value-based pricing. Scholars focus on the difficulty of defining value and the lack of market orientation (Anderson et al. 1993). Practitioners often mention issues with value assessment, internal communication breakdowns between marketing and sales teams, and the lack of incentive alignment (Cressman Jr. 2009; Hinterhuber 2008a). One of the least-mentioned barriers to the increased adoption of value-based pricing is the difficulty of measuring and selling the required investment and the ROI internally. While the role of champions at the top is a key to successful implementation (Liozu et al. 2011), it remains very difficult to justify the investment for value-based pricing and pricing in general to top management in the C-suite. What, then, are the roadblocks to justification? Difficulties in making the business case for value-based pricing Difficulty in scope definition The first possible difficulty lies in defining the scope of the value-based pricing concept. What are the relevant programs, activities, and costs? Our recent academic paper published in January 2012 in the Journal of Revenue and Pricing Management reveals the difficulty in conceptualizing value-based pricing (Liozu et al. 2012)...
