Having difficulty setting a price for your product? Cost-plus pricing is a pricing strategy commonly used by businesses to determine the selling price of a product or service. This approach involves adding a markup to the cost of producing or providing a good or service to arrive at the final selling price.
In this blog post, I cover what cost-plus pricing is and discuss some strategies for implementing it into your business.
What is Cost-Plus Pricing?
Cost-plus pricing is a pricing strategy where the selling price of a product or service is determined by adding a markup to the cost of producing or providing it. The markup is usually expressed as a percentage of the cost and is used to cover overheads, indirect costs, and profit. The formula for cost-plus pricing is:
Selling Price = Cost + Markup (I.e. $100 = $80 + $20)
The cost includes all the direct and indirect costs associated with producing or providing the product or service. Think materials, labour, and any other expenses directly related. If you sell physical products or services, you can probably already think of a few. In fact, 70% of business spending goes towards labour.
Indirect costs include overheads such as rent, utilities, insurance, and marketing expenses. The markup is the amount added to the cost to arrive at the selling price.
Cost-plus pricing is commonly used in industries such as manufacturing, construction, and consulting, where costs are relatively easy to calculate and vary significantly from project to project.
Advantages of Cost-Plus Pricing
These are some of the pros of using a cost-plus pricing strategy.
- Easy to Calculate: Cost-plus pricing is a relatively easy pricing strategy to implement. Businesses can easily calculate their costs and add a fixed percentage markup to arrive at a selling price.
- Guaranteed Profit: By adding a markup to the cost of producing or providing a product or service, businesses can ensure they make a profit on each sale.
- Stable Prices: Cost-plus pricing can help businesses maintain a stable price for their products or services over time. This is because the markup percentage is fixed, and changes in costs are absorbed into the selling price.
- Transparency: Cost-plus pricing offers transparency to customers as they can see how the selling price of a product or service is calculated. This can help build trust and loyalty among customers.
Disadvantages of Cost-Plus Pricing
There are some downsides of cost-plus pricing, which include the following.
- Ignores Market Demand: Cost-plus pricing does not take into account market demand or competition. As a result, businesses may set their prices too high or too low, resulting in lost sales or reduced profits.
- Ignores Value: Cost-plus pricing does not consider the value that the product or service provides to the customer. This means that businesses may set prices that do not reflect the value that customers perceive the product or service to provide.
- Inflexibility: Cost-plus pricing can be inflexible, as changes in costs or market conditions may require adjustments to the markup percentage or selling price. This can lead to lost sales or reduced profits if the business is slow to react to changes.
- Cost Inefficiencies: Cost-plus pricing can also lead to cost inefficiencies, as businesses may not have a strong incentive to minimize costs since they can pass them on to customers through the markup.
Final thoughts on cost-plus pricing
Cost-plus pricing offers several advantages for businesses, including ease of calculation, guaranteed profit, stable prices, and transparency. However, it also has some disadvantages, such as ignoring market demand and value, inflexibility, and potential cost inefficiencies.
Businesses should carefully consider these advantages and disadvantages before implementing cost-plus pricing and ensure that it aligns with their overall pricing strategy and business goals.
I’ve used it for many of my businesses with good success, and will continue to do so.