Pricing C5: Advanced Cost-Based Pricing and Economic Profitability

Cost estimation

involves predicting the costs (fixed, variable, direct, indirect) of producing goods or services to inform pricing.

Cost estimation

the process of forecasting the cost and resources needed to complete a project within a defined scope and accounts for each element required for the project and estimates a total amount that determines a project’s budget.

Advanced cost-based pricing

involves strategies where businesses set prices based on costs while aligning with market dynamics, competition, and profit goals.

Marginal cost pricing

involves setting the price of a product equal to or slightly above the marginal cost—the additional cost of producing one more unit. This strategy is often used to maximize capacity utilization, penetrate markets, or compete in price-sensitive segments and assumes fixed costs are already covered, so the focus is on covering variable costs and contributing to profit.

Marginal cost pricing

Encourages sales volume; Ignores fixed costs in the short term; Common in industries with high fixed costs (e.g., utilities, airlines) or during economic downturns.

Markup pricing

involves adding a fixed percentage to the cost of producing or acquiring a product to determine its selling price. It ignores demand elasticity and competitor pricing, potentially leading to overpricing or lost sales in competitive markets.

Target cost pricing

starts with a desired selling price (based on market research or competition) and works backward to determine the allowable cost, and is a proactive, market-driven approach. It aligns pricing with customer expectations and forces cost efficiency/innovation and is prevalent in industries like automotive or consumer electronics, where competition is fierce.

Target return pricing

sets prices to achieve a specific return on investment (ROI) or profit goal, based on total costs and expected sales volume and is often used by firms with significant capital investments who need to justify expenditures. It ensures financial goals are met, useful for long-term planning and assumes accurate sales volume forecasts; if sales fall short, the target return isn’t achieved.

Marginal Cost Pricing

focuses on short-term gains and volume, often ignoring long-term sustainability.

Markup Pricing

straightforward but rigid, lacking adaptability to market shifts.

Target Costing

customer-centric and innovative but requires precision in cost management.

Target Return Pricing

prioritizes financial objectives, ideal for capital-heavy firms but sensitive to sales forecasts.

Strategic cost analysis

Examines how pricing affects profit through cost structure, volume, and market response. It is a process that helps businesses understand costs and how to reduce them. It involves analyzing the relationship between costs and the value delivered by a product or service, and helps businesses make informed decisions, understand their cost structure, and gain a competitive edge.

Value chain analysis

Analyzes each step in the production process to maximize value

Cost driver analysis

Helps understand the factors that drive costs

Benchmarking

Compares a company's processes and performance metrics to industry bests

Target costing

Determines costs based on the product price

Value engineering

Examines all activities of a project to eliminate or modify unnecessary costs