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Price of goods or products are decided according to the prevailing market condition. As a marketing strategy, sometimes products are sold below cost of production. An effective pricing decision must bear some relation to cost. Attempts must be made to ensure that the prices of products generate a desirable level of profits.
In connection with price determination, industries do enjoy some discretion in setting the prices of their products above or below the cost of production. They, therefore, set prices in relation to cost. They may consider it desirable to sell products at prices which bring them a normal profit.
Selling below cost for normal profit
Products are sold below cost of production for normal profit. Many industries price their products in such a manner that they cover the cost of production, distribution and normal profit. For instance, the textile industry, which is suffering from demand recession, has followed the policy of keeping the prices relatively stable. Large textile industries operating at a reasonable sales volume at these prices earn normal profits. In this marketing condition, the maintenance prices by large producers have provided an “umbrella” under which small manufacturers flourish.
Electronics industry has been facing an altogether different situation, for though advances in technology have facilitated reductions in the cost of production; yet no significant change in the prices of finished goods has been witnessed. Due to the high profit margin, a variety of competitors market goods below cost of production than those of reputed manufacturers.
Selling below Cost as a policy
There is a variety of forces which at times tempt companies to sell their products below the cost of production. Every producer has to incur certain expenses like rent, interest, wages, etc, which have to be recovered whatever the level of sales. Besides this, the expenditure on material and labor varies with the volume of the product.
But it is not desirable for a company to sell goods below its total cost of production. With a view to increasing sales, some manufacturers resort to the policy of selling below cost of production. But if the turnover is low, this may lead to heavy losses and distort the market. Moreover, once the price is reduced, it is difficult to return to the previous level. Therefore, the pricing policy followed at one time may substantially affect the company’s future pricing, beside affecting its sales.
Products are sold below cost for liquidation of Inventory:
When there is overstocking of finished goods and the demand is at a low ebb, it is desirable to sell the goods below cost. In fact, it is desirable to do so in certain circumstances; for example, if a company does not enjoy good financial health and there is extreme paucity of funds, and bankruptcy is apprehended, it is desirable to sell goods below cost. Even financially sound companies at times find it desirable to sell goods below cost. For example, if market prices show a declining trend, it is desirable to sell the goods at any price they bring rather than stock them for a period, where they may fetch even lower prices. A similar condition may arise in a firm dealing in fashion goods or perishable goods, when circumstances compel middlemen to sell goods at a low price.
Some retailers sell one or more standard goods below cost and the loss so sustained is made good by selling some other product at a relatively higher price or in some other way. At times, companies sell some goods below cost to provide service to its customers or to compete in a specific product line.