Tuesday, June 16, 2009


Marginal cost-plus pricing

Marginal cost-plus pricing/ mark- up pricing is a method of determining the sales price by adding a profit margin on to either marginal cost of production or marginal cost of sales.
Whereas a full cost- plus approach to pricing draws attention to net profit and the net profit margin, a variable cost-plus approach to pricing draws attention to gross profit and the gross profit margin, or contribution.

The advantages of a marginal cost-plus approach to pricing are as follows.

  • It is a simple and easy method to use.
  • The mark-up percentage can be varied, and so mark- up pricing can be adjusted to reflect demand conditions.
  • It draws management attention to contribution, and the effects of higher or lower sales volumes on profit. In this way, it helps to create better awareness of the concepts and implications of marginal costing and cost –volume-profit analysis. For example, if a product costs Rs 10 per unit and a mark –up of 150 % is added to reach a price of Rs.25 per unit, management should be clearly aware that every additional Rs.1 of sales revenue would add 60 pence to contribution and profit.
  • In practice, mark-up pricing is used in businesses where there is a readily identifiable basic variable cost. Retail industries are the most obvious example, and it is quite common for the prices of goods in shops to be fixed by adding a mark- up (20% or 33.3%,say ) to the purchase cost.
There are, of course, drawbacks to marginal cost- plus pricing ,
  • Although the size of the mark-up can be varied in accordance with demand conditions, it does not ensure that sufficient attention is paid to demand conditions, competitors’ prices and profit maximization.
  • It ignores fixed overheads in the pricing decision, but the sales price must be sufficiently high to ensure that a profit is made after covering fixed costs.
Approach to pricing might be taken when a business is working at full capacity, and is restricted by a shortage of resources from expanding its output further. By deciding what target profit it would like to earn, it could establish a mark-up per unit of limiting factor.

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