Cost Method

Pricing Methods

• • Penetration Pricing

  • Price Skimming

  • Competitive Pricing

  • High-Low Pricing

  • Freemium Pricing

  • Value-Based Pricing

• Cost-Based Pricing

  • Simple Mark-Up

  • Contribution Margin

  • Simple Prime Costs

Cost-Based Pricing

• • Desired cost-percentage

  • Multiplier

  • Base-selling price/Price Floor

  • Price Ceiling

  • Manufacturers Suggested Retail Price

  • Breakeven Point

Cost-Based Pricing

Cost based pricing is one of the pricing methods of determining the selling price of a product by the company, wherein the price of a product is determined by adding a profit element (percentage) in addition to the cost of making the product.

It uses manufacturing costs of the product as its basis for coming to the final selling price of the product. In Cost Based Pricing, either a fixed amount or a percentage of the total product manufacturing cost is added as profit to the cost of the product to arrive at its selling price.

Above, is a prime example of Nike, their associated costs of manufacturing, supply chain management (shipping, fees, and taxes), and marketing expenses (e.g. paying superstar athletes money to wear and promote their brand). The crazy part about this picture is that Nike only makes approximately $5 profit for every $100 shoe sold (e.g. while some shoes retail for far greater prices, the research and development of that shoe can keep the minimize the profits).

• • NIKE gross profit for the quarter ending May 31, 2019 was $4.633B, a 5.82% increase year-over-year.

  • NIKE gross profit for the twelve months ending May 31, 2019 was $17.474B, a 9.51% increase year-over-year.

  • NIKE annual gross profit for 2019 was $17.474B, a 9.51% increase from 2018.

  • NIKE annual gross profit for 2018 was $15.956B, a 4.21% increase from 2017.

  • NIKE annual gross profit for 2017 was $15.312B, a 2.28% increase from 2016.

  • NIKE revenue for 2018 was $36.4B, while $22.27B in footwear, and $10.73B in apparel, $1.4B in equipment sales.

Granted, this represents monies made through all of their product lines and not just shoes. In fact, their retail line makes most of their revenue annually, despite shoes being what they are most known for.

So how did they decide on their margin per shoe? There are a number of factors that go into their calculations, but one major factor that they are able to use is the amount of volume they sell in shoes (total number of shoes sold).

In the next sections, we will discuss how different industries have varying margins. Some of the margins are based a desired margin, profit or salary, or based on a number of other pricing strategies we have and will discuss. We will primarily focus on product costs,desired cost-percentage, base-selling price, breakeven point, and manufacturer's suggested retail price (MSRP).

Equations to Calculate Price

• • Total Cost of Product + Desired Profit Margin = Base Selling Price

  • Total Cost of Product = total fixed cost + total variable cost

• Cost + Mark-up = Base-Selling Price

  • Base-Selling Price + additional mark-up = Retail Selling Price (MSRP)

  • (Total Cost/Revenue) = Break Even Point

How to Calculate the Total Manufacturing Cost and Price Per Unit

Add the cost of direct materials, direct labor and manufacturing overhead within a given time period, such as one month, to determine the total manufacturing costs for a product line. Determine how many items were produced within the same time period. Divide the total manufacturing costs by the number of items produced to arrive at the production cost per unit.

The total fixed costs for a product are the materials, wages, shipping, taxes, and other items that are required to make a product. Without these costs, the item could not be made or sold. Some businesses often add in the required/desired profit, while others may add this in to the mark-up stage.

The total variable costs for a product may include items like marketing, special services like additional labor or outsourcing a product, or any other costs that do not always appear in the normal nature of creating your product..

Example:

• • Direct materials: Silk: $2500, thread: $100 = $2,600.

  • Direct labor: Hourly wages ($8 per hour x 8 hours x 22 days): $1408.

  • Manufacturing overhead: $2230.

  • Units produced: 360.

Total manufacturing price per unit = (Direct materials + direct labor + manufacturing overhead)/number of units manufactured:

• • ($2,600+$1408+$2230)/360.

  • $6,238/360=$17.33 Total manufacturing price per unit

Remember, this is just the Total Manufacturing Cost Per Unit and does not include profit or additional costs like marketing, supply chain management (shipping), storage, taxes, or damaged goods. Once we have added our desired profit margin that will give us our Base-Selling Price (which we will determine in the next section by understanding our Desired Cost Percentage).

Desired Cost Percentage

For many businesses, they often have a desired profit margin per product that they want to achieve. This is developed over time by businesses and can vary from business to business. Sometimes we think that businesses are making a large sum of money because we do not think about additional costs. But, I bet you thought Nike made more than $5 profit for every $100 shoe.

The numbers below are based upon statistics and personal encounters with individuals who are in charge of maintaining the margins of their business.

Example (with calculation): 25% Mark-up

Total cost of product = total variable cost + total variable cost

= $ 200 + $ 50 = $ 250

Profit margin (Markup) = 25%

Selling price = Total cost of product + profit margin

= 250 + 250 (25/100)

= $ 312.50

This $ 312.50 will be price floor or Base-Selling Price (the minimum price we would want to set for our product). The price ceiling will depend on the competitive status, company’s situation and perceived value of the product. This is how Cost based pricing works in a typical business.

We will add more information through the year to cover different mark-up methods and typical markup percentages from various types of businesses.

Advantages of Cost Based Pricing:

• • A straight-forward and simple strategy

  • Ensures that all production and overhead costs are covered before profits are calculated

  • Ensures a steady and consistent rate of profit generation

  • To find the maximum possible cost of product manufacturing allowable if the final selling price is fixed

  • To find the price of the customized product which has been produced as per the specifications of a single buyer

  • In cases where the customers have enough knowledge about product costs and thus have an upper hand

Disadvantages of Cost Based Pricing:

• • May lead to under priced products

  • May sometimes ignore consumer's role in the overall market

  • May ignore the opportunity cost of the investment

Think About It: Cost-Based Pricing

• • Beyond labor, what other costs are involved in a product (list)?

  • Why might a company sell a product below the base selling price or price floor?

  • Why do you think cost based pricing can be difficult to calculate a price in a service business (intangible)?

  • How can we set our prices above a price ceiling; despite competition charging less?

• • https://www.mbaskool.com/business-concepts/marketing-and-strategy-terms/6742-cost-based-pricing.html