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Advantages and disadvantages of Cost Plus Pricing

Advantages :

1. Fair method:It is a fair method of price fixation. The business executives are convinced that the price fixed will cover the cost.
2. Assured Profit: If price is greater than cost, the risk is covered. This is true when normal expected capacity basis of cost estimation is used.
3. Reduced risks and uncertainties: A decision maker has to take decisions in the face of many uncertainties. He may accept a pricing formula that seems reasonable for reducing uncertainty.
4. Considers market factors: This sort of pricing does not mean that market forces areignored. The mark up added to the cost to make a price reflect the well established customs of trade, which guide the price fixer towards a competitive price.

Disadvantages :

1. Ignores demand: It ignores demand. It fails to take into account the buyers’ needs and willingness to pay which govern the sales volume obtainable at each series of prices.
2. Ignores competition: It fails to reflect competition adequately.
3. Arbitrary cost allocation: It takes for granted that the costs have been estimated with exact accuracy which is not often true particularly in multi-product firms because the common costs are allocated arbitrarily.
4. Ignores opportunity cost: For many decisions incremental costs rather than full costs play a vital role in pricing. This aspect is ignored.
5. Price-Volume relationships: Since the fixed overheads are apportioned on the basis of volume of production, the cost will be more if a sales volume is less and cost will be less if sales volume is more. The increase or decrease in sales volume again is dependent of price. Thus it is a vicious circle–cost plus mark up is price based on sales volume and sales volume is based on price.
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