A-Z guide for your economic assignment on Cost-plus pricing

Imagine you invest in a brand new mobile that your friends have raved about. Now, how much did you spend on that mobile phone?

Let us look at the Apple iPhone X. It costs Apple 370.25 dollars to produce it-but the final selling price is 999 dollars. The price of the device is marked up by 170 %, and this is how Apple makes a profit.  

In most cases, the selling price is determined by using the cost plus pricing strategy. It is determined by adding a percentage to the production cost for a product.

Students of managerial economics have to write an assignment on cost -plus pricing technique. This blog will provide you with a complete guide on cost plus pricing technique. If you are asking “What is cost-plus pricing technique?”, then go through this blog to discover the definitions and intriguing cost-plus pricing methods. 

What is the Cost Plus Pricing Technique?

Cost plus pricing is also known as the markup pricing. Cost-plus pricing is a simple cost-based pricing strategy for setting the prices of goods and services. 

With the cost-plus pricing methods, a company first adds the direct labour cost, direct material cost, and overhead to determine what it costs them to offer the product or the service. A markup (ratio between the cost of a good or service and its selling price) percentage is added to the total cost to determine the selling price of the product. This markup percentage is called profit. 

Differences between cost-based pricing and cost-plus pricing

An organisation has numerous options for selecting a pricing method. Prices are based on three dimensions- cost, demand and competition.

The organisation can use any of the dimensions or combination of dimensions given above to set the price of a product.

To look at the difference of the cost-based pricing and cost -plus pricing, have a look at the table given below:

COST BASED PRICING	COST PLUS PRICING
Cost-based pricing is the bigger picture of the pricing literature.	Cost-plus pricing is a part of the cost based pricing technique. It is a narrower picture in the pricing literature.
Cost-based pricing is a method where a fixed sum or percentage of the total cost is added as the income or profit to the manufacturing cost of the product to arrive at the selling price.	Cost-plus pricing methods involve adding a markup to the cost of services and goods to arrive at the selling price.
The formula to calculate cost-based pricing is: Total cost of a product= (fixed cost+ variable cost). Divide the total cost by a number of units of the product to determine the unit cost. Then, Unit cost* Markup % = Selling cost and profit margin of the product.	The formula for calculating the cost-plus pricing is : Cost-plus Price = Cost +Mark-up
This technique is fair and logical for most companies.	Cost-plus pricing is not fair for all the companies.
The cost-based pricing is criticised as it removes the motive to become more efficient.	The full-cost pricing theory is criticised due to its adherence to a rigid price.

Pros and Cons of Cost-plus Pricing Strategy:

Cost-plus pricing is one of the simplest methods to determine the price. Numerous businesses use cost-plus pricing as their primary strategy when releasing a new product in the market. Let’s have a look at some of the pros and cons of cost price pricing technique: 

PROS:

• It consumes fewer resources:

A cost-plus pricing approach major advantage is that it doesn’t require additional market research. Most companies are aware of the cost of production. They can simply calculate it by summing up multiple invoices, labour costs, etc. Companies can then take the costs and place a margin on top of them that they believe the market can bear. 

• It provides full coverage of cost and a consistent rate of return:

As long as the company is adding everything up accurately, cost-plus pricing ensures that the full cost of creating the product or fulfilling the service is covered. It also ensures a positive rate of return. 

• It helps to know the exact expense

One of the cost-plus pricing major advantages is that this technique enables a company to know exactly the expenditure it has incurred to make a product. Hence, the company can add profit margin accordingly, which helps in achieving the desired revenue of the firm. 

CONS: 

• Ignores future demand:

By implementing this technique, a company fails to take into consideration the future demand for a product. The future aspect should serve as one of the bases before even determining the price of the product. Therefore, this acts as a severe limitation for a company implementing this method. 

• Ignores competition:

By implementing this technique, a company fails to take into account the action of its competitors and the effect of competitor’s action on pricing of a product. Hence, in the modern competitive world when a company solely depends on the technique of cost-plus pricing, it faces the miserable failure of its products in the market. 

• Ignores consumers:

Possibly the biggest downfall of cost-plus pricing is that this technique completely disregards the willingness of customers to pay. If a company intends to make money through its products, it should involve its customers in the system. They are the most crucial part of selling anything, so any pricing technique that does not value its customers is sucking all its profit out of business. 

How is cost-plus pricing used for maximising the rates of returns of firms?

Cost Plus pricing strategy is perhaps the most rudimentary of all pricing strategies that are out there in the market.

Let’s have a look at the instance given below to understand how a firm can use cost-plus pricing for maximising the return rates: 

Suppose, you have been hired in the sales and marketing Department in say, ABC industry.

Imagine that ABC has recently been the beneficiary of a 10-year contract for a government, for the supply of electricity to the key government infrastructure. In addition, it has become vulnerable because of power outages.

To accomplish its goals, the ABC industry will require setting up a small power plant that it will operate and maintain in the duration of ten years of the contract.

ABC industry is contractually entitled to monthly reimbursements for what it incurs each unit of electricity and provides for the consumption. It also adds a 20% profit on the cost of supply of the electricity to the government. Therefore, it implements the cost-plus pricing approach.

Accordingly, ABC Industry incurs labour cost of $20,000 per month, $20,000 for the cost of diesel consumed in a month, $15,000 from the plant depreciation per month, and a management fee of $10,000.

Using the cost-plus pricing technique, ABC industry will take the sum total of costs that is $65,000 and add 20% of the total cost. It will be the profit of the company.

For the first month, the invoiced amount will, therefore be, $78,000.

Keeping certain limitations in mind like a false sense of financial security, the inability to solve the over and under-pricing problems of a product, ignoring competitors, etc., ABC industry or any industry can use the cost-plus pricing technique to maximise the return rate of the firm. 

Summing it up,

While assignments on Cost-plus pricing technique can give students of managerial economics a difficult time, this blog can be the answer to it all. With this comprehensive guide to all things about cost plus pricing technique, you can nail this assignment like never before. Save this to your bookmark list on your laptop so that you can find relevant information on cost-plus pricing methods while you are drafting that complicated economic assignment. Take the help of this guide and sail through your assignment like a champion. 

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