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The Role of Costs in Pricing

A business costwill be defined simply as a business expense. Although it does complicate matters to some degree,it is important to understand that there are actually many types of cost. As a result, cost accountants have identifi ed several useful ways to classify business costs. Among the most important of these are:

Fixed and variable costs

_ Mixed costs

_ Step costs

_ Direct and indirect (overhead) costs

_ Controllable and noncontrollable costs

_ Other costs including:

_ Joint costs

_ Incremental costs

_ Standard costs

_ Sunk costs

_ Opportunity costs

These various types of cost are listed simply to demonstrate that the term cost, especially as used by those working in the area of cost accounting,must be well understood before the effect on pricing decisions can be examined.

It is also important to recognize that many cost percentages change as volume changes. Costs, when expressed as apercentage of revenues (calculated as: Expense/ Revenue=Expense %) are typically reduced when sales are high, andincrease when sales volume is lower. This is so because while some costs are variable—for example, food and beveragecosts—other costs—for example, rent, insurance, and some labor—are fixed,and thus are the same when revenues are high as they are when revenues are low.

Variable (cost): An expense that generally increases as sales volume increases and decreases

as sales volume decreases. Also known as a variable expense. In the hospitality industry, examples includethe cost of food, beverages, and hotel guest room supplies.

Fixed (cost): An expense that remains constant despite increases or decreases in volume. Also known as a fi xed expense. In the hospitality industry, examples include the costs of illuminating exterior signage, overheadmusic and liquor liability insurance premiums.


Implementing Strategic Pricing

You have learned that to be properly understood, a price must be viewed from the perspective of the seller and the buyer. Sophisticated RMs do just that. Regarding price, these RMs understand that:

1. Prices act as signals to buyers and sellers. When prices are low enough, they send a “buy” signal to buyers (customers), who can now afford the things they want and are able and willing to pay for. When prices are high enough, they send a “sell” signal to producers who seek to optimize their profi t by offering more products and services for sale.

2. Prices encourage efficient production. Prices encourage businesspeople to produce their goods at the lowest possible cost. Despite the illogic of using costs to dictate prices, it is true that the less it costs to produce an item, the more likely it

is that its producers will earn a profi t. Firms that are cost effi cient can produce more goods with fewer materials and lower labor costs than can fi rms that are ineffi cient. While these efforts are clearly in the best interests of sellers, buyers also benefi t directly because they are provided with the things they want at the lowest sustainable prices.

3. Prices help ration scarce resources. Prices help determine who will receive the entire economy’s, or a single business’s, output of goods and services. The prices charged for some goods are greater than some buyers are willing or able to pay. As a result, prices ensure that goods and services go primarily to those buyers who value them most.

Price is an important (and this book will maintain it is the most important) part of acompany’s marketing mix. As a result, those responsible for establishing the prices of a firm’sproducts and services are critical to the company’s success. But who in the fi rm should be responsible, and accountable,for its strategic pricingefforts?

Strategic pricing: The application of data and insight to effectively match prices charged with buyer’s perceptions of value.



1. What are supply and demand laws?

2. What are the variable and fixed costs?

3. How prices encourage efficient production?



1. Hayes, D. & Miller, A. (2011). Revenue Management for the Hospitality Industry. Hoboken, NJ: John Wiley & Sons, Inc.

Topic 3. Value

3.1. The Role of Value in Pricing

3.2. The Relationship Between Quality and Price

3.3. The Relationship Between Service and Price

3.4. The Link Between Quality, Service, and Price


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