Contribution margin-based pricing is a pricing strategy where the selling price of a product is determined by considering the contribution margin, which is the difference between the product’s selling price and variable costs per unit. This approach focuses on covering the variable costs associated with producing each unit and contributing toward fixed costs and profit.
The formula for Contribution Margin is:
Contribution margin=Selling Price−Variable Cost per Unit
The Contribution Margin-Based Pricing formula is often expressed as:
Selling Price=Variable Cost per Unit+Desired Profit Margin
This pricing method is useful for businesses to ensure that each unit sold contributes sufficiently to cover both variable costs and fixed costs, ultimately leading to a desired level of profitability. It provides a clearer understanding of the impact of variable costs on pricing decisions and helps in setting prices that align with overall business goals.