People often question how they can implement cost-plus pricing in their business. Typical questions are:
- Is it profitable to use a cost-plus pricing strategy in my business?
- What would be the problems that I’ll have to face while implementing this strategy?
So, here I am with the answer to all your questions.
What is cost-plus pricing?
Cost-plus pricing is a strategy in which you can determine the price of your product simply by adding a mark-up to the total cost of your product.
There is a simple formula for it:
(Material Cost + Labour Cost + Overhead Cost) x (1 + Mark-up) = Price
All the costs that you incur to operate a business are called Overhead Costs. You can categorise your overhead costs into three broad categories:
- Fixed Overhead Costs like property tax, web hosting, business insurance, etc.
- Variable Overhead Costs like electricity, staff events, water, etc.
- Semi-Variable Costs like staff bonuses, traditional bookkeepers, janitorial services, etc.
The amount of profit you want to earn would determine the mark-up that you can apply in this formula.
You want to sell speakers, and according to your targets, you want to keep 20% as profit on each unit of the speaker.
Let’s assume that your overall costs make up £60.
So, you can easily determine the price of your speaker as follows:
£60 x (1 + 0.20) = £72
Should I use cost-plus pricing?
Regular and conventional fashion brands use this pricing to cover up their costs without compromising their profits and sales margins.
However, cost-plus might not be considered as an effective pricing strategy nowadays as there are many customers out there who scroll through various websites to look for the best deal.
Understanding how cost-plus pricing might affect your business is an important aspect.
Let’s suppose that an electronics retail store added a mark-up of 50% to her cost without considering the prices of her competitors.
She was offering an RO purifier at £649 while her competitor was offering the same RO purifier with the same features for £549.
If you were the customer, what would you have preferred?
So, it is really important to understand the benefits and limitations of any strategy that you are considering to implement in your business.
Maximising profits with cost-plus pricing:
Despite the fact that cost-plus pricing might affect your business, we can maximise the output from this strategy, if we merge it with other business strategies.
Using a software program like Smartfeed could be a great option to consider so that you can evaluate the prices of competitors while taking care of your own costs as well.
Cost-plus pricing would work great when used thoughtfully as a part of a dynamic pricing strategy.
All in all, cost-plus pricing enables you to easily and conveniently determine the price of your product by adding a target mark-up with the overall costs incurred to produce each unit.
It is an easy and quick method to determine the price of a lot of products in one go, but it has many limitations which can be overcome by merging it with other pricing strategies.
Frequently asked questions:
Q1. What are the benefits of cost-plus pricing?
Cost-plus pricing would provide the following benefits:
- Doesn't cost anything
- Covers all costs
Q2. What are the downsides of cost-plus pricing?
- Ignorance of competitor prices
- Neglecting of product value
- Fixed price- does not allow you to test sale at different prices
- Ineffective in long-term
- Drives businesses to lower their costs to earn more profit.