What is Special Order Pricing?
Special order pricing is a short-term managerial decision about whether to accept a one-time order at a price below the normal selling price, typically when a company has idle production capacity. The decision focuses on whether the order's incremental revenue exceeds its incremental (relevant) costs.
A special order should be accepted if the special price exceeds the variable cost per unit and any additional fixed costs specific to the order, generating positive incremental profit — assuming excess capacity and no effect on regular sales.
- •Uses idle capacity
- •Special price still exceeds variable cost
- •Adds incremental profit
- •No effect on regular sales price
- •Capacity stays idle
- •Risk of price cannibalizing regular sales
- •No incremental profit captured
- •May set precedent for future discounts
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Step-by-step worked examples
A company has idle capacity and can accept a special order of 2,000 units at $18/unit. Variable cost is $12/unit, and the order requires no extra fixed costs. Should it accept?
Incremental profit = (18−12) × 2,000 − 0 = 6 × 2,000 = 12,000 Since profit is positive ($12,000), accept the special order.
Same offer, but accepting requires renting special equipment for $5,000.
Incremental profit = (18−12) × 2,000 − 5,000 = 12,000 − 5,000 = 7,000 Still positive, so still accept — but profit falls to $7,000.
A buyer offers $10/unit for 3,000 units. Variable cost is $12/unit, no extra fixed cost. Should the company accept?
Incremental profit = (10−12) × 3,000 − 0 = −2 × 3,000 = −6,000 Negative result — reject the special order, it would lose $6,000.
Flashcards
Quick quiz
Q1.Special price $20/unit, variable cost $14/unit, order of 1,000 units, no extra fixed cost. Incremental profit?
Q2.Using the same numbers, but $2,000 in extra fixed costs are required. New incremental profit?
Q3.What must be true for a company to safely apply special order pricing?
Q4.A special order's incremental profit is negative. What should the company do?
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Common mistakes
Comparing the special price to the full absorption cost (including allocated fixed overhead). — Correct: Compare the special price to the variable cost plus any additional (avoidable) fixed costs only.
Accepting a special order when the company is at full capacity without considering displaced sales. — Correct: Only accept if there's idle capacity, or account for the lost contribution margin from displaced regular sales.
Ignoring whether the order will affect prices charged to regular customers. — Correct: Consider the risk that regular customers learn of the lower price and demand it too.
Treating all fixed costs as relevant to the decision. — Correct: Only fixed costs that change because of the special order (incremental fixed costs) are relevant.
FAQ
What is special order pricing?
It's the decision to accept a one-time order at a price below the normal selling price, usually to use idle production capacity.
What is the special order pricing formula?
Incremental profit = (special price − variable cost per unit) × order quantity − additional fixed costs.
What are examples of special order pricing?
A wholesale buyer requesting a bulk order at a discounted price during a slow production period is a classic example.
How do you calculate a special order decision?
Multiply the contribution margin per unit (price minus variable cost) by the order quantity, then subtract any extra fixed costs; accept if the result is positive.