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
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