Blogcast #2: When You Should Use Cost-Plus Pricing

<p><span style="font-weight: 400;">Many companies use</span> <strong>cost-plus pricing</strong><span style="font-weight: 400;">. In fact, I’d say nearly all hardware companies, and service companies with fixed costs, use cost-plus pricing in some way. And yet, pricing people know this isn’t ideal (or at least, they should) since it leaves money on the table.</span></p> <p><span style="font-weight: 400;">Most of the time, cost-plus pricing doesn’t make sense. Imagine you build a product for $10, and want a 50% margin. This means you price is at $20. But what if your market</span> <em><span style= "font-weight: 400;">would</span></em> <span style= "font-weight: 400;">pay you $50? Shouldn’t you try to capture that? And what if your market would only pay you $15? At $20, you either leave money on the table, or you don’t sell. It’s an arbitrary number, based on what you want – rather than a meaningful figure, based on your customer’s willingness to pay. </span></p> <p><strong>We should always, as much as possible, price based on how much our buyer is willing to pay. Easily said, hard to do.</strong></p> <p><span style="font-weight: 400;">Now, why do companies use cost-plus pricing? It’s usually because they want to cover their costs while being competitive on price. Finance set margin goals for the company, and this becomes the cost-plus price-setting mechanism. Note however, that this is</span> <em><span style= "font-weight: 400;">not</span></em> <span style= "font-weight: 400;">a great reason to do cost plus. It might look like you’ll meet your margin goals on paper, but it doesn’t optimize the return on your innovation.</span></p> <p><strong>That being said, I</strong> <strong><em>can</em></strong> <strong>think of a couple of instances when it makes sense to use cost-plus pricing:</strong></p> <p><span style="font-weight: 400;">If you have tens of thousands of products to price, it would be cumbersome and unrealistic to use</span> <strong>value-based pricing (VBP)</strong> <span style= "font-weight: 400;">on every