GAUGE RELEVANT COSTS FOR PRICING DECISIONS

Evaluating the costs related to the pricing decision is often more difficult than it seems. Companies use different approaches for allocating costs, so the variable and fixed costs can become blurred. Nevertheless, definitions of these common pricing terms are relevant.

As mentioned earlier, variable costs are those that vary (in total) with production of the product or service. This could include costs for direct materials and labor. For a given production level, these are constant per unit and provide the floor for pricing decisions. In the long run, all costs must be covered. All costs should be considered when determining the long-term pricing of products. However, in the short term, any price obtained that exceeds variable costs can at least contribute to fixed overhead and (potentially) profit.