The Key Benefits of Cost Plus Pricing for Your Business

Cost plus pricing, also known as markup pricing, is one of the most common and straightforward pricing strategies used by businesses today. With cost plus pricing, you simply calculate the total cost to produce a product or deliver a service, then add a markup percentage to create your profit margin.

While value-based or competitive pricing strategies have their place, cost plus pricing offers some unique advantages that make it a go-to for many companies. In this article, we’ll explore the key benefits of using a cost plus pricing model and why it can be the right choice for certain businesses.

A Simple and Straightforward Approach

One of the biggest appeals of cost plus pricing is its sheer simplicity. There’s no complex calculations or advanced analytics required – you just need to know your costs of production and choose a suitable markup percentage.

To determine the retail price, you simply:

• Calculate your total per unit costs e.g. materials, labor, overheads
• Add a markup percentage e.g. 30% gross margin
• The result is your sale price

For example, if it costs a furniture maker $500 in materials and labor to produce a table and they want a 30% gross margin, their sale price would be $650 (500 x 1.3).

This straightforward formula means cost plus pricing can be easily understood and implemented by all staff. It also makes it simple to adjust prices in line with changing production costs.

Predictable Profit Margins

Another key advantage of cost plus pricing is its reliability and consistency. Since you’re working with fixed costs and markup percentages, it offers a highly predictable profit margin on each product sold.

You know that every time you manufacture and sell an item, you’ll achieve the exact same percentage of gross profit. This makes financial planning and forecasting much more straightforward compared to dynamic pricing models.

Cost plus pricing guarantees a minimum profit level, ensuring you’ll never sell products at a loss. Of course, this profit may not be maximized, but the predictability provides peace of mind to business owners.

Defence Against Rising Costs

With inflation and supply chain issues, production costs are risingsharply in many industries. When your pricing strategy factors in current costs of materials and labor, you can easily defend price increases that reflect your increased costs.

Rather than appearing arbitrary, you have clear proof to show customers and partners when justifying a change in price. Cost plus pricing enables transparency around your profit margins when costs fluctuate over time.

This logical, metrics-driven approach to pricing adjustments can help maintain trust and satisfaction, even when you unfortunately have to raise prices.

Well Suited to Certain Industries

While cost plus pricing has drawbacks in some contexts, it’s very well suited to particular industries where costs are relatively fixed. Examples include:

• Manufacturing – With machinery, raw materials, and labor making up a significant portion of costs.

• Professional services – Such as lawyers, accountants, consultants etc where expert staff time is the major cost.

• Wholesalers & distributors – That focus on efficient movement of products from suppliers to customers.

In these cases, competitive forces have less impact on pricing power, so a simple cost plus approach makes sense. Production expenses are relatively stable, so the model provides consistent profits.

Easier to Implement Than Dynamic Pricing

For retailers operating omni-channel sales across brick-and-mortar stores, ecommerce, mobile etc, implementing dynamic pricing can be extremely challenging.

While algorithms can adjust prices based on real-time demand data, integrating this across multiple sales channels is complex. It requires significant investment in analytics software and can be tough to manage organizationally.

Many smaller retailers stick with cost plus pricing to avoid the hassle of rolling out an advanced dynamic pricing strategy, which may not generate sufficient ROI for them anyway.

Helps Maintain Price Consistency

When selling products across different channels, varying pricing between platforms can damage customer trust and satisfaction. Consumers expect uniform prices, whether they buy online, in-store or via mobile.

Maintaining pricing discipline is much easier with cost plus pricing. Since the same markup is added to the identical cost base everywhere, it prevents discrepancies between channels. This consistency improves perceptions of brand fairness.

Allows Easy Markup Adjustments

One advantage of cost plus pricing is the flexibility to tweak your percentages in response to market demands. For example, you may choose to temporarily decrease markup on certain lines to drive volume, or increase it on premium products enabling greater profit capture.

Because the markup sits outside of the actual costs, it can be adapted without impacting underlying pricing structures across channels. This makes incremental markup tuning straightforward to boost revenues.

Supports Transparent Supplier Negotiations

For manufacturers sourcing components from external suppliers, cost-based pricing provides a logical framework for negotiations. You have clear visibility into itemized costs, making it easier to identify areas with room for improvement.

Rather than vague discussions over commercial terms, you can have detailed, metrics-driven conversations about production expenses. This enables collaborative cost control initiatives with suppliers to reduce pricing.

Potential Drawbacks to Consider

While cost plus pricing has some clear benefits, there are also downsides to evaluate before adopting it as your go-to strategy:

May not maximize profit potential – Fails to consider what price level customers are willing/able to actually pay based on product value.

Can undermine competitiveness – Competitor pricing pressures are ignored, risking loss of market share.

Encourages cost complacency – May reduce incentive to find production efficiencies and cost savings.

Harder to adapt pricing mid-product life – Less responsive to market changes once cost base is locked in.

Requires tight cost control – Model only works if you have excellent visibility and management of costs.

Doesn’t support price differentiation – Limited ability to adjust pricing based on customer segment value.

So while cost plus pricing has its merits, it shouldn’t be used in isolation. We recommend combining it with value-based, competitive analysis and other pricing techniques as part of an adaptive pricing strategy.

Implementing Cost Plus Pricing Effectively

If you decide cost plus pricing is suitable for your business needs, here are some tips for executing it successfully:

• Conduct competitor research – Benchmark your markup percentages versus competitors, even if costs differ.

• Analyze price sensitivity – Understand where you have flexibility to increase margins versus commoditized markets with less room to maneuver.

• Review regularly – Revalidate your markup as market conditions evolve to avoid missing profit opportunities.

• Maintain cost discipline – Keep focus on reducing production costs through supplier relations, lean manufacturing etc.

• Invest in pricing tools – Automate cost plus pricing across channels and geographies for efficiency.

• Combine with other models – Use cost plus pricing tactically alongside value-based, dynamic pricing etc.

• Test and learn – Run controlled experiments with markup adjustments to find revenue optimizing rates.

Cost plus pricing brings simplicity, predictability and flexibility to determining profitable price points. It makes adjusting to rising costs straightforward and keeps pricing consistent across channels. For manufacturers, wholesalers and other industries, it can be an efficient and effective approach.

However, it shouldn’t be the only trick you have. Combining cost plus pricing with value-based, competitive and dynamic techniques based on the product, lifecycle and market allows more adaptive pricing. But as a dependable formula for baseline pricing, cost plus will continue meeting many business needs.

So consider whether your operations could benefit from implementing a cost plus pricing strategy. With the right tools to automate calculation and updates across channels, it can help you calibrate your margins amid turbulent market conditions.