Introduction§
Variable cost-plus pricing often sounds like a dance move popular among accountants and producers. This pricing strategy adds a markup to variable costs, aiming to cover both fixed and extra cha-chings (profits) on the side. Though it might sound straightforward, it’s not the go-to groove for every situation, especially where fixed costs are shouting for attention.
How It Works§
Imagine you’re selling lemonade. The lemons and sugar are your variable costs because they change depending on how many glasses you want to sell. Suppose it costs $1 to make one glass, and you decide to add another $1 as markup to cover your time (fixed costs) and pocket money (profit). Now, each glass would be priced at $2. Simple, right? Well, this doesn’t take into account whether your competitor is selling it at $1.50 or if people even think your lemonade is worth $2.
When to Use Variable Cost-Plus Pricing§
This method shines in scenarios where businesses have more control over their variable costs than their fixed ones, making it a star performer for companies with minor fixed costs or very predictable fixed costs. It’s particularly useful in contract-related industries or businesses that deal mostly with variable costs and can predict these expenses accurately.
Advantages and Disadvantages§
Pros:§
- Simple and straightforward: Like putting on socks before shoes; it’s easy to figure out.
- Risk mitigation: Reduces the risk as it assures covering costs and making a profit.
- Adjustable: Like a good belt, it can be tightened or loosened based on the cost changes.
Cons:§
- Ignores the market opera: It doesn’t care if the audience is cheering for lower prices or your competitors are singing different tunes.
- Potential inefficiencies: If those variable costs are quite low, you might end up looking like you’re charging a diamond price for a soap bar.
- Not for the fixed-cost heavy hearts: If fixed costs are the main act, this pricing strategy might leave you in financial discord.
Related Terms§
- Fixed Cost: These are your constants, like rent; they don’t cha-cha-cha with your production volume.
- Markup: This is the extra bit you charge to make sure you’re winning, not just participating.
- Profit Margin: Essentially, how much you earn after covering the band and the stage setup costs.
Suggested Books§
Want to master the rhythm of pricing? Here are a few books to lead the dance:
- “Pricing Strategy” by Tim J. Smith - A deep dive into how to set the right price for your product.
- “Confessions of the Pricing Man” by Hermann Simon - A straightforward look into the art and science of pricing.
Variable cost-plus pricing might not always be the star of the show, but under the right spotlight, it can truly shine. Know your costs, understand the market, and maybe throw in a little extra groove to make it work for your business tune.