MARKETING DECISIONS 111
Despite its limitations, CVP analysis is a useful tool in making decisions about
pricing and volume, based on an understanding of the cost structure of the
business. How, then, do firms make decisions about what price to charge?
Alternative approaches to pricing
Accounting information can be used for pricing in various marketing strategies:
žCost-plus pricing.
žTarget rate of return pricing.
žOptimum selling price.
žSpecial pricing decisions.
žTransfer pricing.
Cost-plus pricing.......................................
Accounting information may be used in pricing decisions, particularly where the
firm is a market leader orprice-maker. In these cases, firms may adoptcost-plus
pricing, in which a margin is added to the total product/service cost in order
to determine the selling price. In many organizations, however, prices are set by
market leaders and competition requires that prices follow the market (i.e. the
firms areprice-takers). Nevertheless, even in those cases an understanding of cost
helps in making management decisions about what product/services to produce,
how many to make and whether the price that exists in the market warrants the
business risk involved in any decision to sell in that market. An understanding of
the firm’s marketing strategy is therefore essential in using cost information for
pricing decisions.
In the long term, the prices that a business charges must cover all of its
costs. If it is unable to do so, it will make losses and may not survive. For every
product/service the full cost must be calculated, to which the desired profit margin
is added.Full costincludes an allocation to each product/service of all the costs
of the business, including producing and delivering a good or service, and all its
marketing, selling, finance and administration costs. The calculation of full cost is
covered in Chapter 11, but it is taken as given for the purposes of this chapter.
Using the CVP example provided earlier in this chapter, the average cost was
£20 assuming a level of activity of 20,000 units. The cost-plus pricing formula may
be applied as amark-upon any element of cost. For example, a mark-up of 25%
would result in a selling price of £25.
cost+mark-up on cost=selling price
£20+(25% of £20)=£25The profit margin is the profit as a percentage of the selling price. Using the same
example, the profitmarginof £5 is 20% of the selling price of £25. Amark-upis the
percentage added to cost for profit, whereas themarginis the percentage of the
selling price that is represented by profit.