Should we consider capacity utilization in Pricing our products?

In order to frame a price policy, one of the element that should receive consideration is the determination of normal capacity. Normal capacity is the utilisation of plant that is necessary to meet the average commercial demand over a period of time, long enough to level out peaks which come with seasonal and cyclical variations. The following chart illustrates the major relationships involved.

Price determination should normally be based on the level of production and capacity utilisation likely to be achieved. Any assumption of low utilisation may result in over estimating the cost. Conversely, a high utilisation assumption may result in under estimating the cost. It is, therefore, desirable that the level of production and capacity utilisation which are likely to apply, say in the next three years should be arrived at with utmost care on realistic basis keeping in view not only the past performance but also the future demand. 

A uniform system of costing should also be devised and introduced in each industry for the fixation of price.
If a firm wants to survive and stay in business, it has to maintain its fixed capital intact so that its fixed assets may be replaced at the end of their useful working life out of the funds generated from profits retained in the business. In a period of relatively stable price levels, depreciation based on historical cost of fixed assets would perhaps be adequate for achieving this object. 

In periods when the price level is continuously changing, the firm may not be left with adequate funds generated out of accumulated depreciation at the end of the life of the plant to replace the plant at a higher price. Hence depreciation should be properly included as a part of cost so as to leave sufficient profits for asset replacement.
Share This
Previous Post
Next Post