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 pricing method used by the company is Cost-Plus Pricing, also known as Mark-up Pricing.

Explanation:
In cost-plus pricing, the selling price is determined by adding a fixed percentage (mark-up) to the total cost of producing a product.
It considers all production costs (both fixed and variable), and then adds a profit margin to ensure profitability.
The key issue here is that cost-plus pricing ignores market factors, such as competitor pricing, customer demand, and willingness to pay — which is what led to losses for Golden Ice Cream Ltd. when competitors entered the market.

(b) Advantages of Cost-Plus Pricing:

• Simplicity and Ease of Calculation:
  This method is straightforward to use. Once the cost of production is known, a fixed profit percentage is simply added to determine the price. It does not require complex market research or data analysis.
  Example: If the cost of one ice cream is Rs. 20 and a 25% margin is applied, the selling price is Rs. 25.
• Ensures Cost Recovery:
  By including all costs (raw materials, labour, overheads, etc.), the business ensures that every unit sold contributes to covering expenses and generating profit. This helps in avoiding losses, especially in predictable and stable markets.

Limitation to Note:
Cost-plus pricing ignores:

• Market conditions
• Competitor strategies
• Customer demand

Which makes it risky in dynamic or highly competitive markets — as seen in the case of Golden Ice Cream Ltd.