Cost-based sales price formation
You need a cost estimate for each individual costing process. But not every company bases its pricing almost exclusively on its costs. This is much more often the case in the industry, since the developed products usually hardly differ from the competitors. Thus, costs are ultimately the decisive factor in customers’ purchasing decisions.
The activity of pricing includes the definition of mathematical and also strategically sustainable prices and the method of accounting for your products or services. In general, the questions of pricing are fixed costs, variable costs, definition of contribution margin and equilibrium point, competitive analysis and positioning.
How to calculate by cost
This type of pricing is more mathematical and focuses on understanding it deeply and separating it conceptually correctly in order to achieve the most reliable results possible. Before going deeper into important examples and concepts, we should remember that each pricing process involves 5 steps:
- cost increase
- equilibrium point analysis
- Definition of the business model
- competitive intelligence
- Positioning and strategy
By focusing on the costs, you will probably deepen your 1 point much and also use the 2 point. However, points 3, 4 and 5 should also be used to help with the final adjustment.
Fixed, variable, direct and indirect costs
We have a complete and thorough contribution to cost accounting, so we will only quickly illustrate each concept here.
Fixed costs: those which are important irrespective of their production and sale. Typically, including rent and salary. How you can calculate the fixed costs is here.
Variable costs: those which are calculated according to their production and sale. We usually have raw materials, taxes, commissions.
Direct costs: Those that concern only one production line.
Indirect costs: Costs that affect more than one production line and must be correctly accrued.
Problems with cost accounting
In the example above I have simplified some calculations and challenges to fit into the article and concentrate on the basic concept of costing. However, in the real life of a company, it has some problems that you are likely to face:
Calculation and inventory management: In real life, raw material costs are not stable and simple. You always buy and conditions change. To ensure the right costs, you must have good inventory management and use the right costing method for your business.
Complex production lines: The allocation of overhead costs is often very complicated. Sometimes many products use the same machine, you have to consider that the machine itself varies its cost over the months due to maintenance problems. This is the true art of the big industries.
Total process efficiency: This is another factor that affects costs, but in a simple mathematical formula it is invisible. Do your suppliers deliver on time? Does your storage generate losses? Do you have more stock than you need?
Cost is not value: it’s tempting to become too addicted to cost figures and forget that you have to create value to be competitive and innovative. From time to time you should forget and understand the numbers and get to know your customers to think about new products and businesses.
Price formation in the energy market
The main task of a market price is to strike a balance between supply and demand. This is particularly important in the electricity markets because of the inability to store electricity and the high costs associated with a power outage. The brainbi day-ahead market is an auction-based exchange for the physical supply of electricity.