when to use variable cost plus pricing
this method of pricing can be suitable for a company when a high proportion of total costs are variable a company can be confident that its markup will cover fixed costs per unit if the ratio of variable costs to fixed costs is low meaning that there are considerable fixed costs that go up as more units are produced the pricing of a product may end up being inaccurate and unsustainable for the company to make a profit variable cost plus pricing may also be suitable for companies that have excess capacity in other words a company that would not incur additional fixed costs per unit by incrementally increasing production variable costs in this case would compose most of the total costs e g no additional factory space would need to be rented for extra production and adding a markup on the variable costs would provide a profit margin the major shortcoming of this pricing method is that it fails to take into account how the market views the product in terms of value or the prices of similar products sold by competitors advantages and disadvantages of variable cost plus pricingthe main advantage of variable cost plus pricing is its simplicity it allows sellers to easily set a price that covers their costs while allowing a reasonable margin for profit it also makes it easy to set contracts with suppliers who usually prefer to lock in a price that locks in set profits over a model that is less predictable it also makes it easier to justify price increases to consumers since a rise in prices can simply be attributed to rising production costs variable cost plus pricing is not suitable for a company that has significant fixed costs or fixed costs that increase if more units are produced any markup on the variable costs on top of the fixed costs per unit might result in an unsustainable price for the product on the other hand the variable cost plus pricing model does not factor in market conditions and may sometimes leave money on the table for example if a particular product line is in especially high demand among consumers the producers could earn greater profits by raising the prices on those products likewise the model does not account for competing products in some cases a company could increase its profit margins if its products are superior to the competitors conversely a company can sometimes increase revenues by lowering prices if doing so undercuts the prices of their competitors comparatively simple way to cover the cost of producing goodsallows suppliers to lock in prices that cover costsfacilitates contract negotiation with a comparatively simple means of calculating prices