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
Try it: interactive calculator
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?
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.