Question

‘Golden Ice Cream Limited’ is a manufacturer and supplier of ice creams. They set the price of their various ice cream varieties based on manufacturing estimates. The company had been earning good profits over the last many years as there were no competitors in the market for their ice creams. However, during the last year, the company incurred heavy losses. On investigation they noticed that while setting the prices, they did not take into account the actions of competitors, which may have led to these losses. Additionally, the pricing method used by the company includes sunk cost and ignores opportunity costs. (a) Identify the pricing method used by the company. (b) Explain any two advantages of the pricing method identified in (a) above.

Hint:

Cost-plus pricing = Total cost + Profit margin. It’s simple, but risky in competitive markets!

Answer 1

(a) Pricing Method:
The company employs Cost-Plus Pricing, also referred to as Mark-up Pricing.

Explanation:
This method sets the selling price by adding a predetermined percentage (mark-up) to the total production cost. It incorporates all production expenses (fixed and variable) and a profit margin to ensure profitability. A significant drawback is that cost-plus pricing disregards market dynamics, including competitor pricing, customer demand, and perceived value, which proved detrimental to Golden Ice Cream Ltd. when competitors entered the market.

(b) Advantages of Cost-Plus Pricing:

• Simplicity and Ease of Calculation:
  This pricing approach is uncomplicated. Once production costs are determined, a fixed profit percentage is applied to establish the price. It does not necessitate extensive market research or complex data analysis.
  Example: A cost of Rs. 20 per ice cream with a 25% margin results in a selling price of Rs. 25.
• Ensures Cost Recovery:
  By accounting for all costs (raw materials, labor, overheads, etc.), businesses guarantee that each sale covers expenses and contributes to profit. This strategy helps prevent losses, particularly in stable and predictable markets.

Limitation to Note:
Cost-plus pricing does not account for:

• Market conditions
• Competitor strategies
• Customer demand

This oversight renders it risky in volatile or highly competitive markets, as demonstrated by the experience of Golden Ice Cream Ltd.