Business
Textbooks
Boundless Business
Product and Pricing Strategies
Pricing Methods
Business Textbooks Boundless Business Product and Pricing Strategies Pricing Methods
Business Textbooks Boundless Business Product and Pricing Strategies
Business Textbooks Boundless Business
Business Textbooks
Business
Concept Version 9
Created by Boundless

Cost-Based Pricing

Cost-based pricing involves calculating the cost of the product, and then adding a percentage mark-up to determine price.

Learning Objective

  • Analyze the use of cost-plus pricing as a pricing method


Key Points

    • Cost based pricing is the easiest way to calculate what a product should be priced at. This appears in two forms: full cost pricing and direct-cost pricing. Full cost pricing takes into consideration both variable, fixed costs and a % markup. Direct-cost pricing is variable costs plus a % markup.
    • Cost-plus pricing is a pricing method used by companies to maximize their profits. The firms accomplish their objective of profit maximization by increasing their production until marginal revenue equals marginal cost, and then charging a price which is determined by the demand curve.
    • Cost-plus pricing is used primarily because it is easy to calculate and requires little information.

Terms

  • rate of return

    Rate of return (ROR), also known as return on investment (ROI), rate of profit or sometimes just return, is the ratio of money gained or lost (whether realized or unrealized) on an investment relative to the amount of money invested.

  • markups

    Markup is the difference between the cost of a good or service and its selling price. A markup is added on to the total cost incurred by the producer of a good or service in order to create a profit.

  • variable cost

    the amount of resources used that changes with the change in volume of activity of an organization


Examples

    • Cost-plus pricing is the simplest pricing method used by companies. It is primarily used because it is easy to calculate, requires little information, and allows them to maximize their profits. They first calculate the cost of the product, and then add a percentage mark-up. This approach sets prices that cover the cost of production and provide enough profit-margin to the firm to earn its target rate of return. This method, although simple, has two flaws; it takes no account of demand and there is no way of determining if potential customers will purchase the product at the calculated price.
    • Information on demand and costs is not easily available, and managers have limited knowledge as far as demand and costs are concerned. This additional information is necessary to generate accurate estimates of marginal costs and revenues. However, the process of obtaining this additional information is expensive. Therefore, cost-plus pricing is often considered the most rational approach in maximizing profits because it relies on arbitrary costs and arbitrary markups.

Full Text

Cost-plus pricing is the simplest pricing method. A firm calculates the cost of producing the product and adds on a percentage (profit) to that price to give the selling price. This appears in two forms: the first, full cost pricing, takes into consideration both variable and fixed costs and adds a % markup. The other is direct cost pricing, which is variable costs plus a % markup. The latter is only used in periods of high competition as this method usually leads to a loss in the long run.This method, although simple, does not take demand into account, and there is no way of determining if potential customers will purchase the product at the calculated price.

Cost-plus pricing is a method used by companies to maximize their profits. There are several varieties, but the common thread is that one first calculates the cost of the product, then adds a proportion of it as markup. Basically, this approach sets prices that cover the cost of production and provide enough profit margin to the firm to earn its target rate of return. It is a way for companies to calculate how much profit they will make.

Cost-plus pricing is used primarily because it is easy to calculate and requires little information, therefore it is useful when information on demand and costs is not easily available. This additional information is necessary to generate accurate estimates of marginal costs and revenues. However, the process of obtaining this additional information is expensive. Therefore, cost-plus pricing is often considered the most rational approach in maximizing profits. This approach relies on arbitrary costs and arbitrary markups.

Cost-based Pricing

Cost-based pricing model

[ edit ]
Edit this content
Prev Concept
The Marketing Mix
Demand-Based Pricing
Next Concept
Subjects
  • Accounting
  • Algebra
  • Art History
  • Biology
  • Business
  • Calculus
  • Chemistry
  • Communications
  • Economics
  • Finance
  • Management
  • Marketing
  • Microbiology
  • Physics
  • Physiology
  • Political Science
  • Psychology
  • Sociology
  • Statistics
  • U.S. History
  • World History
  • Writing

Except where noted, content and user contributions on this site are licensed under CC BY-SA 4.0 with attribution required.