What is 'Variable Cost-Plus Pricing'

Variable cost-plus pricing is a pricing method in which the selling price is established by adding a markup to total variable costs. The expectation is that the markup will contribute to meeting all or a part of fixed costs, and yield some level of profit. Variable cost-plus pricing is especially useful in competitive scenarios such as contract bidding but is not suitable in situations where fixed costs are a major component of total costs.

BREAKING DOWN 'Variable Cost-Plus Pricing'

Variable costs include direct labor, direct materials, and other expenses that change in proportion to production output. A firm employing the variable cost-plus pricing method would first calculate the variable costs per unit, then add a mark-up to cover fixed costs per unit and generate a targeted profit margin. For example, assume total variable costs for manufacturing one unit of a product are $10. The firm estimates that fixed costs per unit are $4. To cover the fixed costs and leave a profit per unit of $1, the firm would price the unit at $15.

Appropriate Use of Variable Cost-Plus Pricing

This method of pricing can be appropriate for a company when a high proportion of total costs are variable. A company can have confidence that its markup will cover fixed costs per unit. If the ratio of variable costs to fixed costs is low, pricing of a product may end up being inaccurate and unsustainable for the company to make a profit. Variable cost-plus pricing may also be suitable for companies that have excess capacity. In other words, it would not incur additional fixed costs per unit by incrementally increasing production. Variable costs, in this case, would comprise most of the total costs (e.g., no additional factory space would need to be rented for extra production), which would place the firm in the situation cited above.

RELATED TERMS
  1. Variable Cost

    A variable cost is a corporate expense that changes in proportion ...
  2. Fixed Cost

    A fixed cost is an expense that remains the same regardless of ...
  3. High-Low Method

    In cost accounting, the high-low method is a way of attempting ...
  4. Operating Cost

    Operating costs are expenses associated with the maintenance ...
  5. Cost-Plus Contract

    A cost-plus contract is an agreement to pay expenses in a contract ...
  6. Current Index Value

    Current index value is the most current value for the underlying ...
Related Articles
  1. Managing Wealth

    Variable Annuities: The Pros and Cons

    Variable annuities are one of the most complicated financial instruments—weighing the pros and cons.
  2. Investing

    Understanding Marginal Cost of Production

    Marginal cost of production is an economics term that refers to the change in production costs resulting from producing one more unit.
  3. Retirement

    Variable Annuities: The Do-It-Yourself Pension Plan

    Variable annuities can cost more than mutual funds, but that might be worth the protection they can add to your retirement.
  4. Financial Advisor

    Life Insurance: Variable Vs. Variable Universal

    Do you know why you might need one policy versus the other? Read on to find out the difference between Variable and Variable Universal life insurance.
  5. Retirement

    How a Variable Annuity Works After Retirement

    These investments can provide extra income after you retire. Here’s a guide to when and how you will receive the payout.
  6. Investing

    Consider These Facts Before Choosing a Variable Annuity

    Variable annuities do have some benefits, but there are some disadvantages and misconceptions to take into account as well.
  7. Retirement

    How To Use The 4-Box Strategy For Retirement Income

    In today's volatile market, Generation X can't sit around waiting for things to improve. Gen X must implement innovative strategies for retirement planning.
  8. Retirement

    Update Your Variable Annuity With Section 1035

    Thanks to a special tax code clause, you can surrender a variable annuity without paying income tax.
RELATED FAQS
  1. Do production costs include all fixed and variable costs?

    Learn more about fixed and variable costs and how they affect production costs. Understanding how to graph these costs can ... Read Answer >>
  2. How Do Fixed and Variable Costs Affect the Marginal Cost of Production?

    Learn about the marginal cost of production and how it is affected by changes in fixed and variable costs. Read Answer >>
  3. How are fixed costs treated in cost accounting?

    Learn how fixed costs and variable costs are used in cost accounting to help a company's management with budgeting and controlling ... Read Answer >>
  4. What is the Difference Between Variable Cost and Fixed Cost in Economics?

    Learn what total costs are comprised of, what variable costs and fixed costs are, and the main difference between them. Read Answer >>
  5. What is the difference between fixed cost and total fixed cost?

    Learn what a fixed cost is, what a variable cost is, what total fixed costs are, and the difference between a fixed cost ... Read Answer >>
  6. How do fixed costs and variable costs affect gross profit?

    Learn about the differences between fixed and variable costs and find out how they affect the calculation of gross profit ... Read Answer >>
Trading Center