An atrocious doubt for those who calculate prices is how much overhead costs to include.
The most obvious answer to this doubt is the unit overhead cost, which results from the total overhead spending divided by the quantity produced or sold.
Even so, there may be better solutions. Eventual overhead cost reductions can result in more competitive prices, increasing quantity sold, inventory turnover, cash flow, and operational efficiency.
Following this reasoning, some experts even recommend using the marginal unit cost to set prices, that is, the cost of an additional unit exempt from overhead costs. In marginal cost defense, they argue that since the level of activity at which the company operates always covers the indirect expense, an additional unit of product becomes equal to the variable cost of that unit. Therefore, any sales price higher than this variable cost will produce a positive result for the offerer.
It is worth remembering, however, that although correct, this logic contains some challenges that one must recognize.
The first of these challenges concerns the offerer’s operating capacity.
Price reductions that increase sales may require a corresponding increase in production volume and customer service, which is sometimes impossible. A pig slaughterhouse may have some idle slaughter capacity, but its heat treatment facilities are limited. Other times are control bodies that do not allow production increase for sanitary or environmental reasons. And so on.
The second has to do with price memory.
Reduced prices for a buyer create a price reference that extends over time. Reversing this situation can be difficult, especially for buyers with high bargaining power.
The third obstacle brings us to other buyers.
Customers who do not benefit from the special price and are pressured by the competition may demand the same treatment. They may ask why we should pay $1.60/kg for wheat flour if our competitor sells it at $1,95/kg and has a gross margin of 30%.
And the fourth challenge refers to managing these more affordable prices.
From what production and sales level can the value of allocated overhead be reduced? What is the discount limit granted due to the reduction in the portion of overhead addressed to each product? To which customers, by which sellers, or in what situations will this special discount be granted? Who will authorize these prices and be held responsible for the results, favorable or unfavorable, obtained?
Despite these considerations, pricing with overhead cost manipulation may prove viable, notably when it uses plausible reasons and prices that can be replicated under identical marketing conditions for the same and other customers.
C. L. Eckhard, author of Pricing in Agribusiness: setting and managing prices for better sales margins.
Claudio Luiz Eckhard is a former professor, business consultant, and author of the books “Ajustando o Rumo”[Adjusting the Business Course], “Gestão pela Margem”[Management by Margin], “A Empresa Saudável”[The Healthy Company], and “Pricing no Agribusiness”[Pricing in Agribusiness].
