Geographical Pricing

Geographical Pricing is the practice of modifying a basic list price based on the geographical location of the buyer. It is intended to reflect the costs of shipping to different locations.

There are several types of geographic pricing:
•FOB origin (Free on Board origin) - The shipping cost from the factory or warehouse is paid by the purchaser. Ownership of the goods is transferred to the buyer as soon as it leaves the point of origin. It can be either the buyer or seller that arranges for the transportation.
•Uniform delivery pricing - (also called postage stamp pricing) - The same price is charged to all.
•Zone pricing - Prices increase as shipping distances increase. This is sometimes done by drawing concentric circles on a map with the plant or warehouse at the center and each circle defining the boundary of a price zone. Instead of using circles, irregularly shaped price boundaries can be drawn that reflect geography, population density, transportation infrastructure, and shipping cost. (The term "zone pricing" can also refer to the practice of setting prices that reflect local competitive conditions, i.e., the market forces of supply and demand, rather than actual cost of transportation.)
Zone pricing, as practiced in the gasoline industry in the United States, is the pricing of gasoline based on a complex and secret weighting of factors, such as the number of competing stations, number of vehicles, average traffic flow, population density, and geographic characteristics. This can result in two branded gas stations only a few miles apart selling gasoline at a price differential of as much as $0.50 per gallon.

Many businesspeople and economists state that gasoline zone pricing merely reflects the costs of doing business in a complex and volatile marketplace. Critics contend that industry monopoly and the ability to control not only industry-owned "corporate" stations, but locally owned or franchise stations, make zone pricing into an excuse to raise gasoline prices virtually at will. Oil industry representatives contend that while they set wholesale and dealer tank wagon prices, individual dealers are free to see whatever prices they wish and that this practice in itself causes widespread price variations outside industry control.

•Basing point pricing - Certain cities are designated as basing points. All goods shipped from a given basis point are charged the same amount.
•Freight-absorption pricing - The seller absorbs all or part of the cost of transportation. This amounts to a price discount, and is used as a promotional tactic

Cost-Plus Pricing
Cost-plus pricing is a strategy that is used to determine the retail and/or wholesale price of goods and services offered for consumption. Businesses of all sizes tend to use this simplistic pricing model as a guideline for arriving at sale prices that will allow the company to cover all costs associated with the production and sale of the products, and still make a reasonable profit from the effort. The basic formula for cost-plus pricing works as well for calculating pricing goods such as the cost of a meal in a café as it does for pricing services such as utilities or courier services.
The ultimate goal of cost-plus pricing is to allow the originator of a good or service to price goods and services in a manner that helps to ensure all costs associated with the effort are covered. At the same time, cost-plus pricing helps to promote the creation of a situation where the originator makes a profit and remains competitive with companies that offer similar goods and services. Fortunately, only a few simple pieces of information are required to establish a solid cost-plus pricing model for any business.

The first key component to calculating cost-plus pricing is to establish what it costs to actually produce the end product or service. This involves considering all expenses that go into the production process, such as raw materials, labor and production costs, packaging, transport, and sales and marketing expenses. By dividing the cumulative expenses associated with producing the products by the number of units produced, it is possible to arrive at what is sometimes referred to as the unit cost. The unit cost represents the minimum price that must be charged in order for the producer to recoup his or her investment into the creation of the unit.

Calculating price using the cost-plus method
There are several ways of determining cost, and the profit can be added as either a percentage markup or an absolute amount. One example is:
P = (AVC + FC%) * (1 + MK%)
Where:
P = price
AVC = average variable cost
FC% = percentage apportionment of fixed costs
MK% = percentage markup
For example: If variable costs are 30 dollars, the allocation to cover fixed costs is 10 dollars, and you feel you need a 50% markup then you would charge a price of 60 dollars:
P = (30 + 10) * (1 + 0.50)
P = 40 * 1.5
P = 60
**This equation states that 50% of the Total costs will be added on top of the total costs to get the selling price

An alternative way of doing a similar calculation is:
P = (AVC + FC%) / (1 − MK%)
** This equation states the total costs are 50% of the selling price**
These two mark up equations are slightly different, and yield different results. The first equation (40*1.5=60) The second equation (40/(1-.5)=80
If you are in the USA, it should be noted carefully that any pricing on a cost-plus contract can be audited by the government. How to do this pricing, what items can be included, and how the calculations are to be made is governed by the FAR (or Federal Acquisition Regulations). Failure to follow the precepts of FAR can lead to decreased contractor revenue or, in extreme cases, claims of penalties against the contractor under the False Claims Act and Contract Disputes Act.
To make things simpler, some firms, particularly retailers, ignore fixed costs and just use the purchase price paid to their suppliers as the cost term. They indirectly incorporate the fixed cost allocation into the markup percentage. To simplify things even further, sometimes a fixed amount is applied rather than a percentage. This fixed amount is usually determined by head-office to make it easy for franchisees and store managers. This is sometimes referred to as turnkey pricing.
Another variant of cost plus pricing is activity based pricing. This involves being more careful in determining costs. Instead of using arbitrary expense categories when allocating overhead, every activity is linked to the resources it uses.
Cost will need to be recalculated and the percentage markup wills likely need to be adjusted as the product goes through its life cycle. This is sometimes referred to as product life cycle pricing, although it is seldom done deliberately or in a planned and organized manner. Price skimming and penetration pricing are also types of product life cycle pricing but they are demand based pricing methods rather than cost based.


Advantages of Cost-Plus Pricing
1.Easy to calculate
2.Minimal information requirements
3.Easy to administer
4.Tends to stabilize markets - insulated from demand variations and competitive factors
5.Insures seller against unpredictable, or unexpected later costs
6.Ethical advantages

Disadvantages of Cost-Plus Pricing
1.Provides no incentive for efficiency
2.Tends to ignore the role of consumers
3.Tends to ignore the role of competitors
4.Use of historical accounting costs rather than replacement value
5.Use of “normal” or “standard” output level to allocate fixed costs
6.Inclusion of sunk costs rather than just using incremental costs
7.Ignores opportunity costs
8.Contractors may not focus on performance because the cost is always covered by the client