Cost-plus-method

The cost-plus-method is the pricing strategy small and medium sized business as well as large companies use most often. Searching for more information about the strategy in the internet you will find many comments reviling this method.

What is cost-plus about?

Cost-plus is stating that companies sum up their cost for a product or service and add a x% margin for their profit. In reality it is way more complex. Theory is saying that cost plus margin is generating the price. In reality there are much more impacts even if they are not obvious which will impact in the price. There is a basic set of information company owner have from the market which will impact their price decision.

Advantages of cost-plus-method

Cost-plus is an opportunity to ensure that your prices are generating profit expected. And this is the biggest advantage. Companies are diving into their cost structure to not forget about side costs. Side costs are things like scrap, preparation, vacation and sick leaves. Including them let they’ll know better about the room for negotiation available. They know which cost needs to be covered and built a foundation for further business decisions. This is the starting point to work on competitive cost or if it is needed you know your minimum price. It opens the eyes for price performance ratio from a business perspective when you want to understand which effort to take to provide a dedicated function.

Risks of cost-plus-method

The biggest risk of this method is if you do not include all costs you have. Sometimes people tend to see just the cost referring to a dedicated order. Beside a factor for the profit you want to achieve you should also calculate what indirect cost you need to split onto every order. As soon as this happens companies cannot be sure that their cost-plus-price is ensuring the margin they are looking for. It is a risk to their business.

Criticizer use to say that customers do not care about your cost. They know how much they want to spend to buy a product or service. But also that cannot be seen black and white.

Trends

A new way of using cost-plus I have seen in the past year is used in Sustainable and Fairtrade businesses. Some of those companies show a transparent cost-plus-calculation to their customers. One example I found on the homepage of a tea online shop selling Fairtrade organic tee to end customers.

I currently can find two function using this method. It puts the final price in relation. At the tea example the batch size is bigger than usual in end customer sales. So the price a customer have to pay seem high even if it isn’t compared with the standard 100gr batch size available in most stores. Due to showing the calculation the customer gets involved in the whole process and Fairtrade can be seen as executed to all members of the supply chain including the end customer. If the product is much cheaper than comparable products it also helps to explain that the lower price is not due to low quality.

I also saw this strategy at catering companies which offer high quality products to put the high price into perspective. They generate additional value to their customers as transparency is a key value when customers what to make sustainable purchase decisions. So customer are no only paying for a product named sustainable, organic and fair, they also pay to the proof.

Conclusion

What looks like an obvious cost-plus-strategy is a new way offering additional value to customers and to sell your product.

As you can see there are many ways to look at cost-plus-pricing. Which advantage it might have for a dedicated company needs to be evaluated case by case. If you have any question or want to review the current state or you pricing method you are more than welcome to contact me for a free first call.