Monday, June 15, 2009



In practice cost is the most important influence on price. Many firms base price on simple cost-plus rules (costs are estimated and than 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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