What is variable cost-plus pricing? Variable
cost-plus pricing can be defined as a type of pricing method where the selling price
is determined by adding the difference between the lowest current price offered amongst the
broker-dealer and the price charged to the customers for the investment as markup to
total variable cost. The sole purpose behind variable cost-plus pricing is to generate
some revenue even after covering all the operating expenses and overheads. Frequently
Asked Questions (FAQ) How to analyse variable cost-plus pricing? Variable cost refers
to the operating expenses subject to change with the increase or decrease in production.
For example, the cost of raw materials, labour charge, packing cost, etc., come under variable
cost. Therefore, the companies who have a high chance of incurring variable costs must
employ a variable cost-plus pricing method while setting the prices of their products. These
steps must follow to employ the variable cost-plus pricing: Step 1- Obtain the total cost
of production for a particular service or product. Then, find out the sum of fixed
cost and variable cost to obtain the total cost. Step 2- Obtain the unit cost of
the product or service by dividing the total cost by the number of manufactured products. Step
3- Set the selling price by multiplying the unit cost that has been obtained earlier
with the markup percentage. Image source: © Rummess | Megapixl.com How does variable
cost-plus pricing work? Many companies incur a high variable cost, including the labor charge,
cost of raw materials, etc., that vary with the production quantity. Therefore, such companies
must employ the variable cost-plus pricing method to determine the prices of their services
and products. To implement the variable cost-plus pricing method, the company must calculate
its variable cost precisely beforehand to determine the expected profit from the number
of units produced. For example, let us assume that the operating expense of a
particular product is AU$5. Now the company calculates that the fixed cost for manufacturing
the product is AU$3. Therefore, to compensate for the fixed cost, the profit set by the
company is AU$2. Thus the selling price of the product is set to be AU$ (5+3+2) = AU$
10. Image source: © Olandah23 | Megapixl.com What are the practical applications of variable
cost-plus pricing? The variable cost-plus pricing method is ideal for companies with
a high portion of the total cost as a variable cost. By employing this method, these companies
can ensure that it will compensate both fixed and variable costs incurred while manufacturing
the products. However, suppose the variable cost ratio to the fixed cost is low. In
that case, it indicates that the company experiences fixed cost more than variable cost and applying
the variable cost-plus pricing method in such case could result in inaccuracy in prices
and unsustainability to earning revenue in the long run. The application of the
variable cost-plus pricing method is also widely found in companies with excess capacity.
In such companies, fixed costs would not go up with the increase in the production quantity
(for example, no extra money would be spent upon warehouse rent). Therefore, the variable
cost in such cases would directly be proportional to the production quantity. Hence, the markup
percentage could be added to the unit variable cost to set the selling price to offer a decent
profit to the company.