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Unit 14: Pricing Decisions

Notes

Notes Cost-plus pricing method is widely used in India due to two special reasons.
1. The prevalence of sellers’ market in India till recently made it possible for the
manufacturers to pass on the increases in costs to the consumers.
2. Costs plus a reasonable margin of profit are taken into consideration for the purposes

of price fixation in the price-controlled business in India.

14.1.2 Target Return Pricing

An important problem that a firm might have to face is adjusting prices to changes in costs. The

popular policies that are often followed for deciding prices include revising prices to maintain

a constant percentage mark-up over costs; revising prices to maintain profits as a constant
percentage of total sales and revising prices to maintain a constant return on invested capital.
The use of the above policies is illustrated below.

Example: A firm sells 1,00,000 units per year at a factory price of ` 12 per unit. The

various costs are given below:
Variable Costs Materials ` 3,60,000
Labor ` 4,20,000
Fixed Costs Overhead ` 1,20,000
Selling and Administrative ` 1,80,000

Total investment cash, inventory and equipment ` 8,00,000
Suppose, the labor and materials cost increases by 10 per cent. So let us look at how we should
revise price according to the above-mentioned three policies.

The above data reveal that costs are ` 10,80,000, the sales are ` 12,00,000 and the profi t is ` 1,20,000.

The profit percentages according to the three policies are:
1. Percentage over costs 1,20,000/10,80,000 × 100 = 11.1
2. Percentage on sales 1,20,000/12,00,000 × 100 = 10

3. Percentage on capital employed 1,20,000/8,00,000 × 100 = 15
The revised costs are ` 11,58,000 (` 10,80,000 + 36,000 + 42,000).
According to the first formula, we have to earn a profit of 11.1 per cent on costs. Our revised

profits should be ` 1,28,667 and sales volume on this basis would be ` 12,86,67. The selling price

would, therefore, be ` 12.87 per unit.
Under the second formula, the profit should be 10 per cent on sales. If sales are S, the profi t would

S/10 and the cost would be 9S/10. We know the cost and we have to find out the sales.
If 9S/10 = ` 11,58,000, S = ` 12,86,667
Therefore, the price per unit is ` 12.87
Under the third formula, we assume that the capital investment is the same. Therefore, the
required profi t is ` 1,20,000 (15 per cent on ` 8,00,000). The sales value would then be ` 12,78,000
and the selling price per unit would be ` 12.78.

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