Costs
Costs set the floor for the cost that the company may charge for its product. The company desires to charge a price that both covers all its costs for manufacturing, distributing, and selling the product and delivers a fair rate of return for its risk and effort. A company's costs can be significant element in its pricing strategy. Companies with lower costs may set lower prices that result in higher profits and sales.
A company's costs take two forms, variable and fixed. Fixed costs (also known overhead) are costs that do not differ with production or sales level. For instance, a company has to pay each month's bills for heat, rent, interest, and executive salaries, whatever the company's output. Variable costs vary directly along the level of production. Each personal computer produced involves a price of computer chips, plastic, wires packaging, and other inputs. These costs tend to be the similar for each unit produced. They are called variable because their entire varies with the number of units produced. Whole costs are the sum of the fixed and variable costs for any given level of production. Management desires to charge a price that will at least cover the entire production costs at a given level of production. The company has to watch its costs carefully. If it costs the company more than competitors to manufacture and sell its product, the company will have to charge a higher price or make less revenue, putting it at a competitive disadvantage.
- Costs at Different Levels of Production
To price cleverly, management needs to know how its costs differ with different levels of production. It is because fixed costs are spread over more units, with each one bearing a smaller share of the fixed cost.