Freight Absorption Pricing
The price of a commodity depends on various elements. Before a manufacturer assigns a price tag to a product, they must consider all the parameters that matter. A common method used to set the price of commodities is absorption pricing. Here, the price includes all variables of cost and fixed costs. This approach is an imitation of full cost plus pricing, where the full cost of a product is charged without including the profit.
Absorption pricing is used to determine the price of a product that will be applicable over a long period. This price is needed for the manufacture to pay for expenses incurred. It therefore allows a business to maintain profit within a long period. A variation of absorption pricing is freight absorption pricing, which includes freight costs to the buyer. In other word, freight absorption pricing factors in freight charges from the manufacturing site to the buyer.
Most companies prefer absorption pricing because it is generally simple. It is the easiest method that one can use to derive the price of a commodity. This simplicity is because it uses a simple formula, whose application does not require professional training. Additionally, this method creates opportunity profits. When using this method, a company adds a profit margin, meaning that the firm will earn returns once the products are sold.
The disadvantage of using absorption pricing is that it ignores competition in the market. A company maybe frustrated by using this formula especially in cases where it later realizes that other players in the market are charging different prices that are either too low too high. This occurs since the method does not consider the prices of competitors in the market.
Absorption pricing also does not consider price elasticity. When a company uses this formula, it is possible to offer prices that do not reflect what buyers in the market are able and willing to part with. It therefore attracts lower revenues because of high prices that are not affordable or throws away profits because of too low price per unit of production.
There are methods used to determine the price of a commodity. The first one is F.O.B. Origin method. Here, the buyer foots the shipping charges. In other words, shipment charges are transferred to the buyer as soon as the product is cleared from the warehouse. While this may sound ideal, it is important to listen to your customers, as some may not accept to bear this responsibility. Another method used to determine freight absorption pricing is uniform delivery pricing. Here, buyer pays standard shipping charges, regardless of where the manufacturer will ship the product. In cases where potential clients are in far flanked areas, the manufacturer may incur a lot. However, it can be effective where most buyers are within the same region.
In freight absorption pricing, the seller is responsible for the transport costs incurred while moving the products from the warehouse to the to the buyers’ location. This method is common where a company is interested in winning more customers as the formula is more appealing. If it works for you, freight absorption pricing can give you a competitive edge in the market. Most sellers use this as an incentive to encourage more buyers.
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