Cost-based pricing

1. Full cost plus pricing: It ensures the selling price covers the all variable and fixed costs.

2. Variable cot plus pricing: It may fail to cover fixed costs.

Limitation of cost-based pricing

It ignores external factors, such as demand

It may lead to the price completely different from those charged by competitors.

Target costing

It involves setting a target cost by subtracting a desired profit margin from a competitive market price, many companies use target costing as a response to control and reduce costs over the product life cycle.

Steps for target costing

-Determine product specification of which an adequate sales volume is estimated

-Set selling price that the company could be able to achieve a desired market share, this selling price is market-based price

-Estimate required profit based on return on sales or return on investment

-Calculate the target cost=Estimated selling price-Target profit

-Compile estimated cost for the product based on anticipated design specification and current cost levels

-Calculate target cost gap=Estimated cost-Target cost

-Make efforts to close the gap through set benchmarks for improvement towards the target cost by improving the technologies and processes, for example, training staff in more efficient techniques, cutting non-value added activities, etc.

-Negotiate with the customer before making the decision

Life cycle costing

It tracks and accumulates costs and revenues attributable to each product over the entire product life cycle, the total profitability of given product can be determined, whereas, in traditional accounting, do not accumulate cost over a product’s entire life cycle. Traditional cost accounting usually total all non-production costs and record them as period cost.

Product life cycle stages:

-Design stage

-Development stage

-Market launch

-Production and sales

-Withdrawal from the market

-Development

-Introduction

-Growth

-Maturity

-Decline