There are several ways of determining cost, and the profit can be added as either a percentage markup or an absolute amount. One example is:
P = (AVC + FC%) * (1 + MK%)
where:
P = (30 + 10) * (1 + .50)
An alternative way of doing the same calculation is:
To make things simpler, some firms, particularly retailers, ignore fixed costs and just use the purchase price paid to their suppliers as the cost term. They indirectly incorporate the fixed cost allocation into the markup percentage. To simplify things even further, sometimes a fixed amount is applied rather than a percentage. This fixed amount is usually determined by head-office to make it easy for franchisees and store managers. This is sometimes referred to as turnkey pricing.
Another variant of cost plus pricing is activity based pricing. This involves being more careful in determining costs. Instead of using arbitrary expense categories when allocating overhead, every activity is linked to the resources it uses.
Cost will need to be recalculated and the percentage markup will likely need to be adjusted as the product goes through its life cycle. This is sometimes referred to as product life cycle pricing, although it is seldom done deliberately or in a planned and organized manner. Price skimming and penetration pricing are also types of product life cycle pricing but they are demand based pricing methods rather cost based.
Calculating Price using the Cost-Plus Method
For example:
If variable costs are 30 yen, the allocation to cover fixed costs is 10 yen, and you feel you need a 50% markup then you would charge a price of 60 yen:
P = 40 * 1.5
P = 60
P = (AVC + FC%) / (1 - MK%)Advantages of Cost Plus Pricing
Disadvantages of Cost Plus Pricing
See Also:
Finding related topics