Define and discuss Cost of Service Pricing
Cost of service pricing takes a marginal-cost approach to pricing. Cost of service pricing can also be analyzed as a total cost or fully allocated cost approach to price setting, where the price charged by a carrier for a movement of a commodity represents the recovery of the related costs to make the movement. Here:
Price = FC + VC + Profit.
Price is determined by the allocation of fixed costs and variable costs to the commodity movement and adding a margin for profit. Relating pricing to total costs or fully allocated costs does not take into account such considerations as competition and elasticity of demand affecting the price charged.
The presence of common costs raises some problems for cost-of-service pricing, particularly the average cost approach. If rates are based upon average of fully allocated costs, it becomes necessary to apportion these costs by some arbitrary means.
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