Full Cost Plus Pricing

in Price

In practice cost is the most important influence on price. Many firms base price on simple cost-plus rules (costs are estimated and then a profit margin is added in order to set the price) a study by Lancelot gave a number of reasons for the predominance of this method.

• Planning and use of scarce capital resources are easier.
• Assessment of divisional performance is easier
• It emulates the practice of successful large companies.
• Organizations fear government action against 'excessive' profits.
• There is a tradition of production rather than of marketing in many organizations.
• There is sometimes tacit collusion in industry to avoid competition.
• Adequate profits for shareholders are already made, giving no incentive to maximize profits.
• Cost-based pricing strategies based on internal data are easier to administer.
• Over time, cost-based pricing produces stability of pricing, production and employment.

Full cost -plus pricing is a method of determining the sales price by calculating the full cost of the product and adding a percentage mark- up for profit. The full cost' may be a fully absorbed production cost only, or it may include some absorbed administration, selling and distribution overhead.

A business might have an idea of the percentage profit margin it would like to earn. And so might decide on an average profit mark-up as a general guideline for pricing decisions

This would be particularly useful for businesses that carry out a large amount of contract work or jobbing work, for which individual job or contract prices must be quoted regularly to prospective customers. However, the percentage profit mark-up dose not have to be rigid and fixed, but can be varied to suit the circumstances. In particular, the percentage mark-up can be varied to suit demand conditions in the market.

Problems with and advantages of full cost-plus pricing.

There are several serious problems with relying on a full cost approach to pricing.

• It fails to recognize that since demand may be determining price, there will be a profit-maximizing combination of price and demand.
• There may be a need to adjust prices to market and demand conditions
• Budgeted output volume needs to be established. Output volume is a key factor in the overhead absorption rate.
• A suitable basis for overhead absorption must be selected, especially where a business produces more than one product.

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Randika Lalith Abeysinghe has 1 articles online

http://professional-edu.blogspot.com/2009/06/57-pricing-strategies-full-cost-plus.html

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Full Cost Plus Pricing

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This article was published on 2010/04/01