Cost Based Pricing

Refers to a variety of pricing strategies which involve the addition of a profit element on top of the costs of production
The aim is to make sure that costs incurred in production of each unit are covered by the selling price of that unit
Popular cost based pricing models include:
Cost Plus Pricing
Target Pricing and
Marginal Pricing

pricing method in which a fixed sum or a percentage of the total cost is added (as income or profit) to the cost of the product to arrive at its selling price
First the business determines the total costs of production
This includes determining both the fixed and variable costs of production
These total costs are then allocated to each unit of production to get the total cost per unit
A mark up is then added to these cost per unit to arrive at the selling price per unit
In a business that does not produce the items it sells e.g retailers the cost of goods sold is used instead of the total costs.
The cost of goods sold includes the purchase price and other expenses incurred in bringing the products into a salable condition e.g. carriage inwards, import duty, freight charges etc
The selling price is given using the formula
$\text{Selling Price}= ( 1+\text{ mark up percentage } )*\text{Total Cost Per Unit}$

This is also known as break even pricing
Here the business first determines a planned level of output/sales volume
It also determines an acceptable level of profit
Fixed costs in that particular period are also determined
A break even price is then calculated i.e. a price level at which the business will make neither loss nor profit
The total overheads are then calculated and the selling price determined using the formula:
$\text{Profit}= \dfrac{\text{Total Costs}}{\text{Planned Level of Production}}$
$\text{Selling Price}= \text{Profit+ Break Even Price}$
The emphasis here is on a total amount of profit in a given period rather than on profit per unit as in cost plus pricing

Marginal cost is the cost of producing one extra unit of production
In principle it refers to all the variable costs incurred in producing each extra unit of production
Marginal cost pricing ignores fixed costs when setting the price
The marginal cost per each unit is first determined an a satisfactory mark up is added to this marginal cost to get the selling price
This mark up acts as contribution which contributes towards covering fixed costs and eventually profit
The formula for finding the selling price when using marginal costing is:
$\text{Selling Price}= ( 1+\text{ mark up percentage } )*\text{Variable Cost Per Unit}$

NB To read about the advantages and disadvantages of cost based pricing click here

To access more topics go to the O Level Business Notes

Cost Based Pricing- Updated 2024