Contribution Pricing

Posted in Marketing and Strategy Terms, Total Reads: 1482
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Definition: Contribution Pricing

Contribution Pricing is a pricing strategy which maximizes the profit coming from a product. In Contribution Pricing, the price of the product is kept on the basis of its contribution to cover the fixed costs it incurs even if to a minimal level. Here the assumption lies in the difference between the product’s price and the number of items sold and the variable costs involved. 

Formulae:

Price - Variable Costs/Unit = Contribution Margin/Unit

Contribution Margin/Unit x Units Sold = Product’s Contribution to Profit

Contributions to Profit From All Products – Firm’s Fixed Costs = Total Firm Profit

Relative Contribution = Product’s Contribution to profit / Production Factor


EXAMPLE

If a product is produced in let us say

Variable Costs : 10$ per piece

Fixed Costs (Total): 100000$

Demand (assumed): 10000 pieces

Now SP should contribute to fixed cost recovery too.

So it has to be above 10$ for sure as variable cost is that much


Now if we keep price at 20$.

It recovers 10$ of variable costs and contributes 10$ back to fixed costs.

for 10000 pieces it would be 10000*10$=100000$ which covers the fixed cost exactly.

Now any price above 20$ will help company maximize profits.



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