Cost based pricing with an example

Cost-based pricing is a pricing method that is based on the cost of production, manufacturing, and distribution of a product. Essentially, the price of a product is determined by adding a percentage of the manufacturing costs to the selling price to make a profit. There are two types of cost-based pricing: cost-plus pricing and break-even pricing. Cost-based pricing is one of a handful of pricing strategies, such as value-based, going-rate, or competition-based pricing.

Cost-based pricing is the practice of setting prices based on the cost of the goods or services being sold. A profit percentage or fixed profit figure is added to the cost of an item, which results in the price at which it will be sold. For example, an attorney calculates that the total cost of running his office each year is 400,000 and he expects to achieve 2,000 billable hours in the coming year. This means that his cost per hour is 200. He wants to generate a 100,000 profit for the year, so he adds 50 to each billable hour, resulting in a billing rate of 250 per hour.

The pricing strategy can be expressed in two particular forms, namely full-cost pricing and direct-cost pricing. In such a case, full-cost pricing depends on several variables - fixed costs and percentage markup. In addition, direct-cost pricing contains variable costs and percentage markup. One of the key indications of cost plus pricing’s success is when marginal revenues equal marginal costs. As a pricing strategy, cost based pricing is easier to use than value based pricing. It is considered to be the simplest method of the pricing available.

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