The cost-plus pricing strategy is a cost-based approach to setting prices for your products and services. It’s also known as markup pricing. This cost-plus price can be calculated by adding a fixed percentage or dollar amount to your cost of production, which may vary depending on the type of product you are selling and who your customer base is.
This strategy is great for both businesses that produce goods, such as manufacturers, wholesalers, importers and retailers. This approach also works well for big businesses because they have economies of scale; it allows them to lower prices below those offered by competitors who are smaller and costlier to run. However, as this pricing method looks solely at the unit cost, it may not be the best fit for businesses because it doesn’t take external factors, like competitors, into account.
The cost-plus pricing formula
The cost-plus pricing formula is straightforward, cost of production + cost per unit x number of units= retail price.
For example, if you produce a product that costs $0.50 to make and your cost-plus pricing is set at 50%, the final cost for your customers will be $0.75 ($0.50 cost of production plus $0.25 mark up).
This strategy can also create an opportunity to charge more than the market value for certain products or services – such as consulting fees during the busy season when demand outstrips supply. However, this may not always work in every industry because it’s difficult to convince potential customers that they should pay more just because there are fewer competitors supplying goods or services in a given area.
Advantages and disadvantages of cost-plus pricing strategy
Advantages
This cost-based method is simple and straightforward. There are no complicated calculations, and it’s easy to track the cost of production over time based on a constant markup percentage or dollar amount. It also helps you keep your prices competitive with other companies in the same industry because all competitors have a similar cost structure. This approach also allows for some price discrimination – charging more than market value when demand outstrips supply but less during times when there’s excess inventory that needs to be moved off the shelf.
When using this pricing strategy, there is no need to research prices in your industry or market. This can save time because instead of looking up what competitors charge per unit or service delivered (which may be difficult), all information needed will already be collected by a company expert who has studied the field extensively. On top of saving time, by not having to conduct intensive price research you’ll also save money on marketing costs like paying for surveys and focus groups which would have been otherwise necessary.
Disadvantages
The cost-plus pricing strategy doesn’t take into account the cost of marketing your product or service. This means you may need to spend more money in order to reach customers and increase sales volume.
Cost-plus pricing also isn’t very flexible. If costs increase for a raw material, or if the demand for your product decreases then you still have to charge customers the same price and incur losses. Moreover, competitors may be able to increase their prices in response when they know that cost-plus sellers cannot change theirs. This can lead to them securing more clients who are drawn by lower costs than those offered by cost-plus sellers.
Conclusion
Successful pricing strategy is often one of the most difficult decisions a business owner has to make. To ease this decision, consider the cost-plus pricing formula. This simple equation will help you determine what your price should be in order for your products or services to turn a profit.
The advantages of using this type of pricing are that it’s easy to calculate, gives an accurate representation of how much money needs to come from each sale, and doesn’t require any guessing when determining the demand curve (which may not always sell).
You’ll also need to weigh up the disadvantages with this approach as some customers may think that they’re being overcharged due to their lack of understanding about these calculations.
If you need help setting your pricing strategy, get in touch with us today.