I.I.F.T.

Subject: Cost Oriented Pricing Methods

Submitted to:
Prof. Alka Raghunath

Submitted by:
Abhishek Agarwal bba(FT) 6th sem

Synopsis
I) Introduction

II) Full Cost or Total Cost Method A) Direct Cost i) Variable Cost ii) Other Cost B) Fixed Cost C) Merits of Full Cost or Total Cost Method D) Disadvantages of Full Cost or Total Cost Method

III)

Marginal Cost Pricing A) Advantages of Marginal Cost Pricing B) Disadvantages of Marginal Cost Pricing C) Circumstances of Feasibility

Introduction
These are based on the cost incurred in the production of the articles. As total costs include fixed costs and variable costs, export pricing may be based on full cost or only on variable costs. A reasonable profit will be added to the base cost to arrive at the export pricing. The cost oriented pricing methods may be: 1) Full cost or Total cost method 2) Variable cost or marginal cost method

1. Full Cost or Total Cost Method

This method is also known as cost-plus method and it is the most common methods. Under this method for arriving at the export pricing, the total cost of production of the article is considered. In addition to the fixed and the variable cost incurred in the production of item, all direct and indirect expenses needed for the export of the product including cost on transportation, freight, custom duties, risk. To this, a reasonable profit allowance is added to the cost. From this amount, the value of total assistance received from any source is deducted. Given below are the various elements of the total cost:

A) Direct Cost: It includes variable and other costs directly related to exports. i) Variable cost: It includes expenditure on direct materials, direct labor, variable production overheads and variable administrative overheads.

ii)

Other Costs: These costs are directly related to exports. These include: a) Selling cost advertising support to importers in the foreign market b) Packing c) Labeling d) Commission to agent e) Export credit insurance f) Bank charges g) Inland freight h) Forward charges i) Inland insurance j) Port charges k) Duties on exports of the product l) Expenditure on Warehousing at Port m) Documentation and incidental n) Expenditure therein o) Interest on fund involved or cost of deferred credit p) Cost of after sale service, including free supply of spare parts q) Pre-shipment inspection r) Loss due to rejection of product

B) Fixed Cost It includes: i) Overheads on production and Administration ii) Publicity and Advertising, iii) Travel Abroad iv) After sale service.

Apart from the above, following amounts are deducted: i) Compensatory assistance ii) Duty drawback iii) Import replenishment benefits iv) Expenditure on freight and insurance

Merits of this Approach

a) Thorough this method, exporter becomes aware of the full cost in marketing the product in a market abroad. b) It is a very simple method

Disadvantages of this Approach

When smaller number of units is to be exported, it would be difficult for the exporter to supply the product all the same price because of its high cost of production per unit due to fixed cost. This method is justified only when the cost of information about demand and the administrative cost of applying a demand based pricing policy exceed the profit contribution arrived at by when this approach is applied.

2. Marginal Cost Pricing

In this method, the price is determined on the basis of variable cost or direct cost, while fixed cot element in total cost of production s totally ignored. The firm here is concerned only with the marginal incremental cost of producing the goods which are sold in foreign markets. Now, the fixed cost remains fixed up to a certain level of output irrespective of the volume of output. On the other hand, variable costs vary in proportion to the volume of production. Thus, the variable or the direct or marginal costs set the price after output at break-even point (BEP).

This method is based on the following assumptions: i) The export sales are bonus sales and any return on the variable cost contributes to the net profit. ii) The firm has been producing the goods for home consumption and fixed costs have already met or in other words, Break Even Point has been achieved. Thus if the manufacturer are able to realize the direct costs, including those which are involved in export operations specifically, they would not affect the profitability of their firms. However, the profitability of the firm should be assessed with the reference to marginal cost which should normally constitute the basis for export pricing. Direct cost and other elements in calculating price will remain the same.

Advantages of Marginal Cost Pricing

i) ii) No overhead costs Firms from Developing countries are benefitted as the lower prices based on variable costs may help them enter a market. Price may be used a s a technique for securing market acceptance for products newly introduced into the market. Large Market: since the buyer of the products from developing countries are usually in countries with low national income. It is advisable for the firm to serve a large segment of the market at low prices. Low prices may serve to widen and create markets. In such countries price is still the decisive factor and quality is comparatively less important.

iii)

Disadvantages of Marginal Cost Pricing

i) Attracts Anti-Dumping Process: developing countries might be charged for dumping their products in the foreign market because they would be selling their products below net prices and attract antidumping provisions which take away their competitive advantage. Cut-Throat Competition: the use of this approach may give rise to cut-throat competition among exporting firms from developing countries resulting in loss in valuable foreign exchange to the exporting countries. Marginal Cost Pricing is not advisable in the following cases: a) If the importers are regularly purchasing products at a low price, it will be difficult for exporters to increase the price of the commodities later on. It may lose their market. b) The policy is not useful or of limited use to industries which are mainly dependent upon export markets and where overheads or fixed costs are insignificant.

ii)

iii)

Circumstances of Feasibility

i)

ii) iii) iv)

Large domestic market: there must be a large domestic market of the products so that the overheads may be charged from products manufactured for domestic market. Mass production: mass production techniques must have been adopted so that the gap between the fixed and marginal cost may be reduced. Higher prices in the home market: the home market has a capacity to bear the high prices. No overheads costs: additional production for exports is possible without increasing overhead costs and within permissible production capacity.