Business – 5.4 Costs – Approaches to costing | e-Consult
5.4 Costs – Approaches to costing (1 questions)
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Arguments in favour:
- Provides a clear view of the margin contributed by each unit after covering variable costs, helping firms to set prices above the contribution threshold.
- Simple to calculate and communicate, allowing quick pricing decisions in fast‑moving markets.
- Useful for short‑term pricing tactics such as discounts or promotional offers where fixed costs are sunk.
Arguments against:
- Ignores the long‑term impact of fixed costs and capacity utilisation; pricing solely on contribution may lead to under‑recovery of total costs.
- Does not consider competitor pricing, perceived value, or market elasticity, which are critical in competitive environments.
- Assumes variable costs remain constant, whereas in a competitive market input prices may fluctuate due to volume changes or supplier negotiations.
Overall, while contribution costing offers a useful short‑term benchmark, reliance on it alone for pricing in a competitive market can be risky. A more comprehensive approach that also incorporates total cost recovery, market demand analysis, and strategic positioning is advisable.