Why setting rates requires that you know your full costs....

For enterprisewide applications, calculating the full cost of products/services is essential for product profitability analysis and pricing strategies.

For internal service providers, calculating rates (a price list) is essential that charge back (fee-for-service). But for others, rates are also valuable for competitive benchmarking (outsourcing comparisons) and to price incremental work that arises mid-year.

Rates must represent the full cost of the deliverable. If they do not, some clients will be overcharged (and the organization will appear uncompetitive) while other clients will be undercharged. Ultimately, where rates are set too high, clients will find another way to get the work done (outsourcing and decentralization), leaving the department only with lines of business that are losing money (where rates are set too low).

Thus, it's critical to calculate rates base on true, full costs.

A chapter from a book on why budgeting and rate-setting should be an integrated process....