Cost Plus Pricing May Be The Preferred Method For Small Business But It's Filled With Risk

Pricing Is One Of the Four P's

Unashamedly this blog focuses most of its efforts on Promotion, Product and Place. Namely the 3 P's that costs the business money. Rarely if ever have we spoken about the equally important fourth P: namely Pricing which is coincidentally the only one of the four P's that earns the Business revenue so let's change that and have a discussion now.

                                                Image from:  http://www.trinityp3.com/2013/01/value-based-pricing

In truth I have been getting this same question for a while as to what is cost -plus costing, what are the pros and cons and how effective is it as a means of being able to set effective price levels for your business.

What Is Cost Plus Pricing

As the name suggests Cost - Plus Pricing is when you buy an item and you add some additional amount either in dollar terms or as a percentage of the cost price to calculate the sales price to plan to sell the item for.

How Is It Calculated

So for example if you buy a pen for cents a unit you might say we want to add fifty cents to the cost price and sell it for one dollar a pen, where this additional fifty cents will cover our additional costs and profit margin.

Perhaps a slightly more qualified example may be a s business that sells pizzas.
They know that it costs them $5 to make the pizza
They believe that they can sell 10,000 a year (or 27 a day).
They also project that their  operating costs for the year will be $100,000

There for the total cost of the pizza will be:

$100,000/ 10,000 =  $10 indirect cost per pizza plus $5 cost of cost of goods per pizza = $15/pizza.

Now they may wish to earn 25% profit on every pizza sold so the sales price would be:
$15 + $5 = $20 sales price per pizza.

Based on this the business would earn: $200,000 (i.e: 10,000 pizza sold at $10).

Pros and Cons Of The Cost Plus Pricing Strategy

Put simply the greatest argument that anyone can make for Cost - Plus pricing is it's simplicity.
You merely add or multiply the cost of the good by some nominated amount or percentage and you have your sales price. Simplicity itself.

However the negatives are I believe more compelling.  When you use this method you are assuming that your target market are willing and able to purchase your goods at the price you have come up with. But what if they are not able or willing to do it? In that case the product simply does not sell.

 The Best Use 

In the end based on the inherent drawback, the best use for Cost - Plus pricing is not to set prices purse, but rather to determine if  that market based on the current pricing levels and market dynamics is one you should be in or trying to get into. Many times this analysis will be proof you should just walk away and pick another market to go into business.

It is worth remembering also that at the end of the day any product or service is only ever worth what someone else is willing to offer you for it. Not what it's worth or what you paid for it, but only what they are willing to pay.

 And of course for more information on Pricing or anything else in marketing or digital media sign up for any of the seven free Digital Enterprise Program workshops and receive your free four hour coaching session for your business at:
http://www.vecci.org.au/business-solutions/digital-enterprise-program/workshops


So until next time, good luck and good marketing.
Regards,
Daniele.