Question

Explain the essential differences between full cost pricing and marginal cost pricing strategies.

Answer 1

Marginal-Cost Pricing Strategy

Marginal pricing is designed to move inventory quickly. The pricing strategy places the price right at the margin. In some cases, pricing just ahead of the margin is also considered a marginal-cost pricing strategy. When the price and margin are the same, there is no profit left over for the business. This strategy is unsustainable and is designed primarily to move old inventory off the shelves. It recovers the initial overhead cost incurred against that inventory so the store can acquire new product to price with a profitable strategy.

Most margin-cost pricing occurs during year-end sales and other sales or when an updated product is released. For example, when a new phone model is released, retailers may price the older model phones on a marginal cost to move them out and make room for the new models. This pricing strategy is not used frequently, and it exists solely to push inventory out the door when turnover is needed in the business.

Full-Cost Pricing Strategy

Full-cost pricing strategies are designed to return a maximum yield profit. In many pricing strategies, the product margins are set against the overhead for each individual unit. For example, if a unit costs $5 to acquire, the price is set against this cost.

Full-cost pricing, however, incorporates the entire business overhead into the pricing strategy. The same $5 unit is priced based on the acquisition plus the necessary business overhead costs such as retail space and electricity. The price is based on the entire or full cost of the efforts that are used to sell the unit.

The full cost is distributed across all the inventory throughout the entire year or individual sales event. If a business is selling crafts at a fair, it distributes the price of booth space and transportation across the inventory being sold through the booth. The costs are absorbed by the customer using this method.