ML Engineering

Absorption cost approach: It is a method of setting price under which includes the cost of all variable
attributes and all the fixed attributes. Then upon absorbing the full cost it may add a markup for profit.

In the scenario ML is using absorption costing basis on machine hour. In this approach the pricing is set
on how much machine hour a facility uses plus all the fixed costs. In cases of jobs which are shorter in
duration will yield lower cost than those are using days to complete. This will result in difference in
quotation of price. The increase in unused capacity increases the difficulty in quoting price even more
because the cost of unused capacity is mostly fixed due to the underutilization of capacity. As ML has to
incorporate the fixed cost into their pricing mechanism so they have to involve the cost of unused
capacity in their price which might yield an unrealistic pricing in contrast to market and can make the
product barely profitable because it has to earn a long margin to cover all its costs.

Marginal cost approach sets the price at or slightly over the variable cost of producing a single unit. It
aims to set the price at a level at the cost of producing one additional unit.

In the case for ML marginal costing approach will lower its cost of production hence due to variable
costing it will decrease the pricing level. They do not have to worry about incorporating unused capacity
into pricing anymore because fixed portion will not be added. But by adopting this approach they will be
rendering their products in their lowest price possible hence they will ignore a prospectus profit margin
but can retain those price sensitive customers who might leave the product if the price is slightly
increased.

B.

If ML adopts marginal pricing strategy they will set their price slightly above their variable costs of
producing an extra unit. This might help them in re gaining entrance to the price sensitive market and
can help them to capture the customers who are highly price sensitive. The company can earn some
incremental profit from selling to these customers. But by doing so they will be forgoing their original
high level of profit margin so it might be harder for them to set high price later because they might lose
customers by doing so. So returning to the MD’s point of view the conclusion which can be derived that
he is just looking for increasing their products sale by just covering the variable cost which will yield
lower profit but increased market share.