Different Pricing methods are suggested and the most common are given as under:
•Full cost pricing
•Marginal cost pricing
•Multi Product pricing
This article discusses the ‘Full Cost Pricing’ strategy in detail, so that one can be easily made familiar with the Pricing strategies. The other pricing methods are only off shoots of the Full cost pricing method.
Price of a commodity is determined by demand for and supply of a commodity. The influence of demand and supply differs depending upon the nature and type of a commodity and also the form of market in which the commodity is sold. . A firm’s supply of a commodity is based on its production which is determined by the principle of MC = MR.MC is marginal cost and MR is marginal demand.
Based on the market form the demand for the goods sold by a firm differs. In a perfectly competitive market a firm has a perfectly elastic demand. Thus it is a price taker. In a monopoly market the firm is the price maker. To sell more quantity, however, it has to lower the price. In a monopolistic competition there are many firms and commodity is differentiated. Each firm may have some influence on the price, yet due to the existence of close substitutes a firm cannot charge much higher price than its competitors. In an oligopoly market, the price is rigid and very often non price competition takes place. In theory the price charged is equal to average cost, so that a firm can earn a normal profit depending on cost and the demand can be higher than the average cost enabling the firm to earn excess profit. In the short run, a firm may be required to charge a price less than the average cost in order to remain in the market.
In practice, however, price charged may not be as per the theoretical principle. Let us discuss some of the methods followed by the firms.
FULL COST PRICING:
It is logical that, pricing of a commodity should cover the cost of production of the good and also bring a fair amount of profit. Many business enterprises have the idea that the perfect sales price is the sum of all costs plus the profit which will yield the goal return on capital employed. Under the method which is also called “COST PLUS PRICING OR MARK-UP PRICING? the firms first estimate the average viable cost (AVC) and add the average overhead charges (usually estimated as a percentage of AVC) to obtain fully allocated average cost (AC). For AC the firm adds up a mark up (m) on costs for earning profits. The following formula explains mark up on costs.m = (P – C) / C
Where M= Mark up on cost P = Product Price C = fully allocated average cost
Here P-C is the profit margin.
From the above equation we can derive the price of a commodity from the cost plus pricing method. The price of the product will beP = C (I + M)
Let us explain this with an example
Full capacity output = 12,500
80% Output (normal output) 10,000
Total Variable cost Rs. 1, 00,000
Overhead cost Rs. 60,000
Mark – up 25 percent
From the above the AV = Rs. 10
Average overhead cost Rs.6
The allocated full cost is 10 + 6 = 16
P = 16 (1 + 0.25) = 20
Mark – up is (Rs. 20 – Rs.16) = 0.25 i.e. 25%