Setting the right price for your product or service is crucial to the success of your business. The pricing strategy you use can make or break your ability to turn a profit Two popular pricing methods are plus pricing and target pricing, but they approach pricing from very different perspectives
In this comprehensive guide we’ll look at the key differences between plus pricing and target pricing and when each strategy makes sense to use. By understanding the pros and cons of each approach you’ll be able to make smart pricing decisions tailored to your business goals and market.
What is Plus Pricing?
Plus pricing, also known as cost-plus pricing, is a straightforward method of calculating product or service prices based on production costs. Here are the basics of how it works:
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Determine the total cost to produce one unit of a product or service
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Costs include materials, labor, overhead
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Add a markup percentage to the total cost as profit
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The markup percentage depends on industry standards and profit goals
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The total cost plus the markup equals the retail price
For example, if a product costs $50 to make and you add a 100% markup, the retail price would be $100 ($50 + 100% of $50).
Plus pricing is popular because it’s simple to calculate and guarantees a minimum profit margin. However, it has some downsides:
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Doesn’t factor in market demand or customers’ perceived value
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No incentive to lower production costs
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Inflexible pricing can’t respond to changes in the market
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Prices can end up higher than what buyers are willing to pay
What is Target Pricing?
Target pricing takes a market-driven approach to setting prices based on customer demand and perceived value. The key steps are:
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Research target customer demographics and the market
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Estimate price customers are willing to pay based on product value
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Set a target price that aligns with customer perceptions
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Calculate target cost to produce the product to maintain profit goals
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Engineer the product to meet the target cost
For example, research might show customers value a product at $100. If a 30% profit margin is desired, the target cost to produce the product would be $70. The company would then engineer the product to meet that cost goal.
Target pricing advantages include:
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Considers what price the market will actually bear
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Focuses on customer perceptions and value
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Motivates lowering production costs
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Results in competitive market-driven prices
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Adapts to changing market conditions
The downsides of target pricing can be higher upfront research costs and difficulty estimating customer demand.
Key Differences Between the Pricing Strategies
| Plus Pricing | Target Pricing |
|---|---|
| Sets prices based on costs | Sets prices based on customer value |
| Simple to calculate | More complex process |
| Profit margin is added on top of costs | Target cost is derived from price |
| Doesn’t adapt well to the market | Responsive to market changes |
| Higher risk of overpricing | Lower risk of overpricing |
When to Use Each Pricing Approach
Use plus pricing when:
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Your costs are relatively fixed
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You operate in a steady market with fixed industry pricing
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You have few direct competitors
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Buyers are less price sensitive
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You want simplicity and predictability
Use target pricing when:
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You want to penetrate a new market
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Your costs are variable based on volume
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You have many direct competitors on price
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Buyers are highly price sensitive
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You want to respond quickly to market changes
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Your priority is optimizing market share
Real World Examples of Plus and Target Pricing
Plus Pricing Example
Law firms routinely use plus pricing to set their hourly billing rates. A lawyer’s hourly rate might be calculated as:
- Lawyer’s base salary: $150,000
- Plus benefits at 30% of salary: $45,000
- Plus estimated overhead per lawyer: $50,000
- Total cost per lawyer: $245,000
- Billable hours per year: 1,800
- Total cost per hour = $245,000/1,800 = $136
- Add 100% markup: $136 x 2 = $272
- Hourly rate: $272
This simple plus pricing formula lets law firms cover costs and make a profit on each lawyer.
Target Pricing Example
Apple uses target pricing when launching new iPhone models. They research buyers’ expected demand at various price points and perceived value of new features. This data guides pricing new models to balance maximizing unit sales with revenue and profit goals.
If a new iPhone model offers innovative features but costs more to produce, Apple may set a higher target price justified by the added value to buyers. Conversely, if market factors drive down buyers’ expected value, Apple would engineer for a lower target cost and sale price.
Setting the Optimal Price for Your Business
As you can see, plus and target pricing represent very different schools of thought on pricing. Plus pricing is best suited to stable cost environments focused on covering expenses plus profit. Target pricing aligns pricing with market conditions by putting the customer’s value perception first.
To find the right balance for your business, consider your market, competitors, business model, and objectives. Set specific pricing goals and metrics to optimize. Test and refine your pricing strategy over time. The ideal approach often combines elements of plus and target pricing tailored to your unique situation.
With the right strategy driving your price setting, you’ll be able to maximize sales, revenue and profit goals for long-term success. Carefully leveraging plus pricing and target pricing concepts can lead you to that pricing sweet spot.
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Module 12: Managerial Decisions Search for:
- Create a report outlining the data to support a cost-plus pricing or target costing decision
Cost-plus pricing, is when a company figures out their total cost of a product and adds the profit as a “mark-up” above the cost. If a company has a more unique item, that consumers are willing to pay a premium for, cost-plus pricing can be effective. These companies are called PRICE-MAKERS. They get to decide, based on the fact that their item can be differentiated from other products on the market, and priced based on this justification.
So, if a company’s cost to make a widget is $5.00 and they want a 50% profit, they will charge $7.50 for the widget calculated as follows:
We can also look at cost plus pricing like this:
Total Costs + Desired Profit = Desired Revenue
$5.00 + ($5.00 x 50%)= $7.50
Target costing, involves looking at what the company wants for a profit, the price for the product that the market will bear, and then determines how to potentially cut costs to reach the desired profit. Products with a lot of competition, or that are not unique, may need to be priced in this manner. These companies are called PRICE-TAKERS. They need to price based on a market average, or to meet the pricing that the market will bear, due to other substitute products being available at the same or lower prices.
So in our widget example, it would be calculated in this way:
This concept looks like this:
Revenue − Desired Target Profit = Costs
($7.50 − $2.50 = $5.00)
When we look at this process, the pressure is put on the buyers at the company to find the lowest priced components in order to lower costs and create the desired profit for the company.
There is a great deal of pressure to keep costs low and profits high. In a competitive market, it may not be possible to get the desired profit without competitively pricing the item and then lowering costs through an effective purchasing system.
Some items, such as the fuchsia Hupana Running Company high tops, won’t have that pressure, but what if you sell paper clips? People may not be willing to pay more for a paper clip no matter how much you spend on your components, right?
Picking how to price your products, cost-plus pricing or target pricing will depend on the market for your product and what price the consumers are willing to pay.
Target Costing and Cost-Plus Pricing
Is target costing the same as cost-plus pricing?
Target costing and cost-plus pricing are not the same things, but both are important parts of the pricing life cycle of a product. One occurs to determine manufacturing costs, while the other is used to determine the selling price.
What are plus pricing and target pricing?
Both of these methods help companies determine the best price for their particular product based on the company’s specific goals. In this article, we define what plus pricing and target pricing are, offer examples of both pricing strategies and list several advantages and disadvantages of these pricing models. What is plus pricing?
How does cost-plus pricing work?
Cost-plus pricing starts with an estimate of the costs incurred to build a product, and a certain profit percentage is added to establish the price. Companies often use this method when it is difficult to determine a reasonable market price.
What is the difference between cost plus pricing and value based pricing?
To determine the selling price of a product, the cost plus pricing method considers the total costs of making a product. On the other hand, value based pricing relies on the potential customers’ perceived product value. Discover the benefits and drawbacks of cost-plus pricing with our comprehensive guide.
