Cost-plus Pricing - Reasons For Wide Use

Reasons For Wide Use

Firms vary greatly in size, product range, product characteristics etc. Firms also face different degrees of competition in markets for their products. So, a clear explanation cannot be given for the widespread use of cost-plus pricing. However the following points explain as to why this approach is widely used:

• Even if a firm handles many products, this approach provides the means by which fair prices can be found easily
• This approach involves calculation of full cost. Prices based on full cost look factual and precise and may be more defensible on moral grounds than prices established by other means
• This approach reduces the cost of decision-making. Firms which prefer stability use cost-plus pricing as a guide to price products in an uncertain market where knowledge is incomplete
• Firms are never too sure about the shape of their demand curve neither are they very sure about the probable response to any price change. So, it becomes risky for a firm to move away from cost-plus pricing
• Unknown reaction of rivals to the set price is a major uncertainty. When products and production processes are similar competitive stability is achieved by usage of cost-plus pricing. This competitive stability is achieved by setting a price that is likely to yield acceptable returns to other members of the industry
• Management tends to know more about product costs than any other factors which can be used to price a product
• Insures seller against unpredictable, or unexpected later costs
• Ethical advantages (see just price)
• Simplicity
• Ready availability
• Price increases can be justified in terms of cost increases