### ZIMSEC O Level Business Studies Notes: Marketing: Cost Based Pricing

• Refers to a variety of pricing strategies which involve the addition of a profit element on top of the costs of production
• The aim is to make sure that costs incurred in production of each unit are covered by the selling price of that unit
• Popular cost based pricing models include:
• Cost Plus Pricing
• Target Pricing and
• Marginal Pricing

#### Cost Plus Pricing

• pricing method in which a fixed sum or a percentage of the total cost is added (as income or profit) to the cost of the product to arrive at its selling price
• First the business determines the total costs of production
• This includes determining both the fixed and variable costs of production
• These total costs are then allocated to each unit of production to get the total cost per unit
• A mark up is then added to these cost per unit to arrive at the selling price per unit
• In a business that does not produce the items it sells e.g retailers the cost of goods sold is used instead of the total costs.
• The cost of goods sold includes the purchase price and other expenses incurred in bringing the products into a salable condition e.g. carriage inwards, import duty, freight charges etc
• The selling price is given using the formula
• $\text{Selling Price}= ( 1+\text{ mark up percentage } )*\text{Total Cost Per Unit}$

#### Target Pricing

• This is also known as break even pricing
• Here the business first determines a planned level of output/sales volume
• It also determines an acceptable level of profit
• Fixed costs in that particular period are also determined
• A break even price is then calculated i.e. a price level at which the business will make neither loss nor profit
• The total overheads are then calculated and the selling price determined using the formula:
• $\text{Profit}= \dfrac{\text{Total Costs}}{\text{Planned Level of Production}}$
• $\text{Selling Price}= \text{Profit+ Break Even Price}$
• The emphasis here is on a total amount of profit in a given period rather than on profit per unit as in cost plus pricing

#### Marginal Pricing

• Marginal cost is the cost of producing one extra unit of production
• In principle it refers to all the variable costs incurred in producing each extra unit of production
• Marginal cost pricing ignores fixed costs when setting the price
• The marginal cost per each unit is first determined an a satisfactory mark up is added to this marginal cost to get the selling price
• This mark up acts as contribution which contributes towards covering fixed costs and eventually profit
• The formula for finding the selling price when using marginal costing is:
• $\text{Selling Price}= ( 1+\text{ mark up percentage } )*\text{Variable Cost Per Unit}$