What Is the Concept of True Cost Pricing?

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The concept of "true cost pricing" is part of a burgeoning economic and social philosophy. It uses cost externalization as its foundation. The idea is that many companies achieve profits, not by creating value, but by exploiting resources in a way that damages our ecology and society. True cost pricing would create prices reflective of all costs, not just the cost to the company who made the product, but every subsequent cost of its manufacture.

Externalization of Costs

  • Externalization of costs happens when a company shifts a cost from their income statement to somebody else's. It may be a cost expressed in dollars. It may be a cost measured in damage to the environment. For example, consider a company that bypasses business in a country with well-conceived forest management practices so they can take advantage of a lack of regulations in another. As a result, they manufacture a cheaper product. They sell more for less. But, while the company may have profited in dollars, their profit was made at the result of an environmental expense -- perhaps an expense that effects all of us. So, they didn't operate more effectively; they just translated the environmental damage into profit.

Create New Cost Models

  • An accurate cost model would translate the ecological damage in our example into a monetary value. So, the company, if it wanted to engage in an unsound ecological practice, would have to pay for it financially, not just morally or socially. The cost would then be reflected in the price of their goods, so consumers could not reward them for an attempt at externalizing costs. Without an economic advantage to pursuing ecologically or socially damaging practices, they would be forced to focus solely on value to compete.

Create Tax Codes Reflective of Accurate Cost Models

  • The so-called "Cap and Trade" proposal is an example of implementing true cost pricing. In the Cap and Trade scheme, companies would have to purchase carbon credits commensurate with the amount of carbon emissions they create. The requirement would localize costs of producing greenhouse gasses to the companies who make them. This would link environmental damage, carbon output and the price of goods. Companies who avoid producing excessive greenhouse gases pay less money, offer less expensive products and get rewarded for financially, not just socially and morally.

Regulation

  • Generally, in true cost pricing philosophies, the government first levies a tax on certain practices people deem costly to the environment or society as a whole. Then companies have to manufacture goods within the constraints of the tax structure. The market function decides how to react to products made under the new system with what is likely a price that reflects the 'true cost' of production, inclusive of ecological and social costs. Sometimes, the government passes the manufacturing process and goes right to the user. Sin taxes such as tobacco taxes can be considered true cost pricing levied against the very people who will be harmed by the practice.

References

  • Photo Credit Hemera Technologies/AbleStock.com/Getty Images
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