It is because of the differences in the degree of competition, differences in cost base and turnover rate with risk. It shows some vague idea of just profit.
The first step in fixing price, under these methods is estimation of average cost. To estimate the average cost the firm has to determine its level of output in a given period and for this the firm takes into account its planned production.
If optimum level of output is determinable then optimum level of output is taken as standard output to estimate the average cost of production.
The next step is to calculate the total cost of that output which is taken as base to estimate the average cost of production.
Then the margin of profit is added to average cost of production to determine the price.
Limitations of the Cost plus Method:
(i) Demand is ignored:
There is no reciprocity between cost and demand for the goods. Demand is totally ignored in pricing.
(ii) Failure to show the forces of competition:
It fails to reflect the forces of competition fully.
(iii) Exaggeration of the precision of allocated costs:
It exaggerates the precision of allocated costs.
(iv) Based on cost concept:
It is based on concept of cost that may not be relevant for the decision of the price.