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Full cost pricing adds overhead costs and a fixed markup to the cost of production. This creates standardized pricing, which can make it easier to handle price recommendations. There are some drawbacks, including difficulty when it comes to adjusting prices to compensate for changes in market conditions. Firms that use this approach may not be able to respond to increasing demand, when it might be possible to sell units at a higher cost to increase profits.
Three factors go into full cost pricing. The first is the cost of actually making a unit. Pricing considerations can include discussions of factory capacity, as companies may not always operate at full capacity. Fixed costs per unit can include some adjustment to account for this issue, ensuring that products are priced reasonably whether the facility is at full or only partial capacity.
Second are overhead costs, which can include debt service, facility maintenance, utilities, payroll, and related costs. These are tracked carefully in order to assess them fairly in full cost pricing. Companies want to be sure that the sales price of the unit will adequately cover overhead, as otherwise the production will be unsustainable. This can be a particularly big problem in the utility industry, where there are pressures to keep costs low that may interfere with pricing schemes.
Finally, the company assigns a fixed markup margin, based on a percentage of the price. The company might decide on a margin of 40%, for example, which means that if the cost of production and overhead for each unit is $10 United States Dollars (USD), the full cost pricing would be $14 USD. Appropriate markups can depend on the product and the industry. In retail, a 50% markup is common, while other industries may have higher and lower margins by convention. Companies need to consider this when establishing a formula for full cost pricing to make sure the markup is in line with the rest of the industry, or their prices may be too high.
One advantage to this approach is standardization. Pricing decisions can be made by anyone in a company with access to the information needed to complete the pricing formula. In addition, when every company in an industry uses full cost pricing, prices tend to remain similar, which keeps them competitive. The big disadvantage is the inability to adjust prices in response to changing market conditions. For example, dropping the price on a product might entice consumers to buy it along with accessories, which would boost overall sales even if the company barely breaks even or takes a loss.