When it comes to an apt definition of shadow pricing, it is important to explain this miscellaneous pricing strategy in two ways. On the one hand, shadow pricing is the practice of fixing a price of an intangible asset for which there is not a fixed market to obtain cost from. On the other hand, this pricing strategy is applied to set the highest price that a company decides to pay for a single additional unit of a specific type of supply or resource. Keeping in view the two definitions of shadow pricing, it can be said that at one point, this pricing strategy is implemented for cost-benefit evaluation where certain aspects cannot be measured in accordance with the market cost, while on the other, shadow pricing is deemed as the contribution margin and in order to maintain it, businesses need to carry on with a particular function.
A company decides to pay its employees for working beyond usual office hours i.e. overtime to make sure that a project is executed timely and successfully. With such a decision, the company can gain more projects from that client. So, the company allots a shadow price of a certain amount as the profit of the long-term association with the client. This means that the company is happy to pay that amount to the employees working late to complete the project on time.
Another instance of shadow pricing is a company that decides to sell one of their excess properties to the local government which will develop the property into a children’s park. So, the company sets a shadow price of the intangible item which is the benefit that the residents can enjoy after the children’s park is built. After that, the company compares the price with the profit it can earn by selling the property to the government.
How is Shadow Pricing Helpful for a Business?
This pricing strategy comes really handy when incremental decisions are required to be taken. For example, when a firm requires being aware of the benefits of investing on the long-term use of a certain resource, it can apply shadow pricing.
Is There Any Downside of Shadow Pricing?
Since shadow pricing is just a prediction, particularly when it is used for assigning a price to an intangible resource, it has equal chances of turning out to be an accurate or erroneous decision. No matter how much research you conduct to come up with estimates, there is a high probability of meeting with failure at the end as there is a hope of savoring success.
In conclusion, it can be said that since shadow pricing is not a versatile pricing strategy, it must be implemented for carrying out crucial financial analyses.