Limitations of Cost Plus Pricing
Despite its apparently widespread popularity, full-cost pricing has got so many limitations. First of all, does the use of standard mark-ups to set prices make logical sense? Generally, no. It ignores the vital economic considerations of demand and competition. Any pricing method that ignores the above said considerations is not likely to lead to the optimal price. It is prone to distortion by accounting misapplications such as undue reliance upon historical cost, an unjustifiable inclusion of manufacturing overhead based on predetermined rates, and an ignorance of the effect of volume on unit costs and profits.
Cost-based pricing cannot be considered as a rigid, deterministic formula. It is simply one way of determining the target price on the first trial in a trial and error approach. If target price is unacceptable to the buyers in the market, the firm will have no choice but to adjust the selling price or to change their product line.
The illustration discussed above includes only one product. Adopting cost-based pricing as the method of pricing becomes more complex in a multi-product firm, because the total cost per unit of a specific product is the total of the per unit variable cost plus some apportioned or allocated share of fixed costs.
Still mark-up pricing remains popular for varied reasons. First, the sellers have perfect knowledge about costs than about demand. By trying the price to cost, their pricing task is much simplified. They need not have to make frequent adjustments as demand changes. Second, when all the companies in the industry use the same pricing method, then prices tend to be similar thus minimizing price competition which would not be the case if the companies paid attention to demand variations when they priced. Third, cost-plus pricing is fairer to both buyers and sellers. Sellers do not take advantage of buyers when the latter's demand becomes acute. Yet, they earn a fair return on the investment.
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