Full cost pricing involves adding overhead costs and a fixed margin to the cost of production to create standardized prices. However, it can be difficult to adjust prices to compensate for changes in market conditions. The total cost price includes the cost of making a unit, overhead costs, and a fixed markup. Standardization allows anyone in a company to make pricing decisions, but the inability to adjust prices can be a drawback.
The full cost price adds overhead costs and a fixed margin to the cost of production. This creates standardized prices, which can make it easier to manage price recommendations. There are some drawbacks, including the difficulty in adjusting prices to compensate for changes in market conditions. Companies using this approach may not be able to keep up with increasing demand, when it is possible to sell units at a higher cost to increase profits.
Three factors go into the total cost price. The first is the cost of making a unit. Pricing considerations may include discussions of factory capacity, as companies cannot always operate at full capacity. Fixed costs per unit may include some adjustments to account for this issue, ensuring products are reasonably priced whether the facility is at full or partial capacity.
Second are overhead costs, which can include debt service, facility maintenance, utilities, payroll, and related costs. These are carefully tracked to fairly appraise them at full cost price. Companies want to ensure that the selling price of the unit will adequately cover overhead costs, otherwise production will be unsustainable. This can be a particularly big problem in the utility industry, where there are pressures to keep costs down that can interfere with pricing schemes.
Finally, the company assigns a fixed markup, based on a percentage of the price. The company might decide on a 40% margin, for example, which means that if the cost of production and overhead for each unit is $10 US Dollars (USD), the total price would be $14 USD. Appropriate margins may depend on the product and industry. In retail, a 50% markup is common, while other industries may have increasingly higher margins by convention. Companies need to take this into account when establishing a formula for full cost pricing to ensure that the margin is in line with the rest of the industry, or their prices may be too high.
One advantage of this approach is standardization. Anyone in a company can make pricing decisions with access to the information needed to complete the pricing formula. Also, when all firms in an industry use full cost pricing, prices tend to stay similar, keeping them competitive. The big drawback is the inability to adjust prices in response to changing market conditions. For example, lowering the price of a product could entice consumers to buy it along with accessories, increasing overall sales even if the company barely breaks even or suffers a loss.
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