Definition of Financial Terms

Essay sample on Variable Cost Plus Pricing Strategy

Variable Cost Plus Pricing Strategy

Variable Cost Plus pricing strategy is a method of pricing whereby the selling is established through the addition of a markup to the total variable costs. It is expected that the markup will contribute to footing in whole or partly, the fixed costs and generate some profit. This pricing strategy is particularly useful in scenarios where competition is prevalent like contract bidding. However, it is not suitable in situations where fixed costs account for the largest share of total costs.

An example of variable cost plus pricing can be presented like; assume that that the total variable costs of manufacturing a single unit of a product are $10 and a markup of 50% is added. The selling price as projected by this variable cost-plus pricing method would be $15. In case contribution to fixed costs per unit is estimated at $4, then the profit per unit would be $1. Through the application of this pricing strategy, a business can significantly maximize its returns. This can be done through increasing the company’s production to the extent that their marginal revenue matches their marginal cost, then charging a price that is determined by the demand curve.

In practice, a variety of firms prefer using either value-based pricing or cost plus pricing which is also referred to as mark-up pricing. The selling price can be simply calculated by adding cost to the markup. One thing that should be noted about the variable cost pricing strategy is that it is a simple tool that can be applied by small, medium-sized and large businesses.

The reason why it is said that variable cost plus pricing is simpler compared to other pricing methods is because its calculation only needs the unit cost and the profit margin that is desired by the firm or business that is implementing it. The unit cost comprises of all fixed and variable costs that are associated with the manufacture of a product and distributing it into the market. Such costs include raw materials utilities, labor, transportation, overhead, marketing and packaging. Profit margin on the other hand refers to the markup on every unit sold. This can vary for wholesale and retail sales.

Variable cost plus pricing strategy is an effective tool because it ensures that all costs are met before the calculation of profits is done. Besides, this pricing strategy has another merit of generating steady profit at an established rate with sheer consistency. However, it should be noted that shifting market factors, consumer activity and competitor behavior need to be closely monitored so that the profit margin that is applied in variable cost-plus pricing is able to maximize the net gains and prevents the making of arbitrary decisions. Retaining consumers is much easier through scaling prices on a downward trend.

Constant monitoring of variables that are associated with cost plus pricing system is crucial since the method determines prices depending on overhead and costs of production. The savings incurred in these areas will be passed down to the consumers, instead of being retained as additional profits.

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