Pricing policies and practices: cost-plus, marginal costing, multiple product, transfer, skimming and penetration pricing

1. Meaning of pricing and pricing policy

Price is the money value at which a product is exchanged. Pricing is the process of fixing it. A pricing policy is the set of guidelines a firm follows in fixing prices over time, consistent with its objectives; a pricing method is the technique used to reach a particular price. Theory (Unit IV, topics 1–2) says MR = MC; in practice firms rarely know their MR curve, so they use rules of thumb that approximate it.

2. Objectives of pricing policy

• Profit maximisation, in the short or long run.
• A target rate of return on investment (for example 15% on capital employed).
• Maintaining or increasing market share.
• Price stability, avoiding price wars.
• Meeting or preventing competition, including deterring entry.
• Survival in hard times, covering at least variable cost.
• Building a product image (premium pricing).
• Social and legal objectives: fair prices for essentials; compliance with price controls and with the ban on predatory pricing under Section 4 of the Competition Act, 2002.

Factors affecting price: cost of production, demand and its elasticity, competition, the firm’s objectives, stage of the product life cycle, government regulation and taxes, and the general economic situation.

3. Methods of pricing: overview

4. Cost-plus (full cost or mark-up) pricing

Price = average total cost + a percentage mark-up for profit. Hall and Hitch’s Oxford study (1939) found that British businessmen priced in this way rather than equating MR and MC.

Example. Average variable cost Rs. 60, average fixed cost Rs. 20, so full cost Rs. 80. Mark-up 25% on cost: price = 80 + 20 = Rs. 100. The same Rs. 20 is a 20% margin on price. State which base is meant.

Merits: simple; uses cost data the firm already has; looks fair to buyers and to regulators; gives price stability when rivals use similar mark-ups. Demerits: ignores demand and competition; full cost depends on the output assumed, which itself depends on price (circular); allocation of fixed costs among products is arbitrary.

5. Marginal cost pricing and marginal costing problems

Under marginal cost pricing the firm treats variable (marginal) cost as the floor and any price above it as making a contribution to fixed costs and profit. It is useful for special orders, export orders, off-season pricing, and pricing in a depression.

Problem 1. Selling price Rs. 50, variable cost Rs. 30 per unit, fixed cost Rs. 2,00,000. Sales 15,000 units.

• Contribution per unit = 50 − 30 = Rs. 20. P/V ratio = 20 ÷ 50 = 40%.
• BEP = 2,00,000 ÷ 20 = 10,000 units, or 2,00,000 ÷ 0.40 = Rs. 5,00,000.
• Sales = 15,000 × 50 = Rs. 7,50,000. Profit = 15,000 × 20 − 2,00,000 = Rs. 1,00,000.
• Margin of safety = 7,50,000 − 5,00,000 = Rs. 2,50,000 (check: 1,00,000 ÷ 0.40 = 2,50,000).
• Units needed for a profit of Rs. 1,60,000 = (2,00,000 + 1,60,000) ÷ 20 = 18,000.

Problem 2 (pricing a special order). The same firm has capacity for 20,000 units. An export buyer offers Rs. 36 a unit for 3,000 units. Full cost at 15,000 units is 30 + (2,00,000 ÷ 15,000) = Rs. 43.33, so the offer looks like a loss. But fixed cost does not change: the order adds contribution of 3,000 × (36 − 30) = Rs. 18,000 to profit. Accept, provided the home market is kept separate.

Limitations: if used for all sales, fixed costs are not recovered; regular customers may demand the low price; it can be attacked as dumping or, by a dominant firm, as predatory pricing.

6. Multiple product pricing

Most firms make several products sharing common plant and overheads. Approaches:

• Full-cost allocation: share common costs by some base (machine hours, sales value) and add a mark-up; simple but arbitrary.
• Contribution approach: price each product to cover its own variable cost and make the largest total contribution; give priority to products with the highest contribution per unit of the scarce factor.
• Product line pricing: price products in a line at steps reflecting quality (basic, standard, premium models).
• Complementary and loss-leader pricing: low price on one item (printer, razor) and profit on the other (cartridges, blades).
• By-product pricing: any price above the cost of handling a by-product adds to profit.

7. Transfer pricing

Transfer price is the price at which one division of a firm sells goods or services to another division of the same firm, or one company to an associated company. Methods: market-based (the outside market price, the best where one exists); cost-based (variable cost, full cost, or cost plus mark-up); negotiated between divisions; and dual pricing. Objectives: to measure each division’s performance fairly, to encourage goal congruence (divisions acting in the interest of the whole firm), and to keep divisional autonomy.

Between associated enterprises in different countries, transfer prices shift profit between tax jurisdictions. Indian income-tax law therefore requires international transactions between associated enterprises to be at an arm’s length price: the price that would be charged between unrelated parties. The transfer pricing rules of the Income-tax Act, 1961 are carried into the Income-tax Act, 2025, in force from 1 April 2026.

8. Skimming and penetration pricing

Skimming price. A high initial price for a new product to “skim the cream” from buyers who are willing to pay most, followed by price cuts in stages to reach wider markets. Suited where: demand is inelastic at first; the product is new and distinctive or protected by a patent; there are buyers who value novelty or status; the firm wants early recovery of research and launch costs; capacity is limited at first. Examples: new smartphones, new drugs, electronics. Merits: quick recovery of cost, high profit, an image of quality, and room to cut price later (cutting is easier than raising). Demerits: high profits attract competitors; it limits the market at first; buyers may resent later cuts.

Penetration price. A low initial price to capture a large share of the market quickly. Suited where: demand is elastic; large-scale production gives economies; competition is expected soon; the firm wants to deter entry and build loyalty. Examples: low launch tariffs in mobile data, consumer goods in small sachets, new FMCG brands. Merits: rapid market share, entry barred, economies of scale. Demerits: slow recovery of cost, low profit at first, difficulty of raising price later.

How this is examined

January 2026: “Mention the objectives of pricing policy and explain the skimming and penetration price policy” (10 marks). August 2024: “Define pricing. Explain the various methods of pricing” (10 marks) and “Skimming price” (6 marks). February 2025: “Skimming price” (6 marks). For a methods essay, give the overview table and two lines on each method; for skimming, give meaning, conditions, example, merits and demerits, and contrast it with penetration.