Cost based Pricing

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Definition: Cost based Pricing

Cost based pricing is one of the pricing methods of determining the selling price of a product by the company, wherein the price of a product is determined by adding a profit element (percentage) in addition to the cost of making the product. It uses manufacturing costs of the product as its basis for coming to the final selling price of the product. In Cost Based Pricing, either a fixed amount or a percentage of the total product manufacturing cost is added as profit to the cost of the product to arrive at its selling price.

Cost Based Pricing Methodology:

The floor and the ceiling prices are determined as shown above. These are the minimum and maximum prices that a seller will demand from the buyer for a specific product or service. They serve as the available price range. Depending on the company and market situation, the price is then determined.

Example (with calculation):

Total cost of product = total variable cost + total variable cost

= $ 200 + $ 50 = $ 250

Profit margin (Markup) = 25%

Selling price = Total cost of product + profit margin

= 250 + 250 (25/100)

= $ 312.5

This $ 312.5 will be price floor. The price ceiling will depend on the competitive status, company’s situation and perceived value of the product. This is how Cost based pricing works in a typical business.

Advantages of Cost Based Pricing:

• A straight-forward and simple strategy

• Ensures that all production and overhead costs are covered before profits are calculated

• Ensures a steady and consistent rate of profit generation

• To find the maximum possible cost of product manufacturing allowabale if the final selling price is fixed

• To find the price of the customized product which has been produced as per the specifications of a single buyer

• In cases where the customers have enough knowledge about product costs and thus have an upper hand

Disadvantages of Cost Based Pricing:

• May lead to under priced products

• May sometimes ignore consumer's role in the overall market

• May ignore the opportunity cost of the investment

Hence, this concludes the definition of Cost based Pricing along with its overview.

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