What is a Cost-Plus Pricing Strategy?

By Evan Godfrey | Small Business

Cost-plus pricing is a simple and easily controllable pricing strategy that can be used to boost profits in almost any business.

Cost-Plus Pricing

Determine the expense associated with producing a product and add an additional amount to that number to generate profit. Cost-plus pricing is relatively simple, as it only requires the unit cost and desired profit margin for calculation. Unit cost consists of all fixed and variable costs associated with making a product and bringing it to market –including raw materials, labor, utilities, packaging, transportation, marketing, and overhead. Profit margin is the markup on each unit sold, which can vary for retail and wholesale sales.

Cost-plus pricing is a straight-forward and effective strategy because it ensures that all costs are covered before profits are calculated. Unlike some pricing methods which hedge seasonal losses against profitable time-periods, cost-plus pricing has the added advantage of generating steady profit at an established, consistent rate. However, shifting market factors, competitor behavior, and consumer activity must be closely monitored to ensure that the profit margin used in cost-plus pricing is one that maximizes net gains and avoids arbitrary decision-making. As it is easier to retain consumers by scaling prices downward, an uninformed pricing decision has the potential to destabilize a business.

Hidden Costs to Watch Out For

Remember to constantly monitor the variables involved in a cost-plus pricing system. As cost-plus pricing determines prices based on overhead and production costs, savings in these areas will be passed onto consumers, instead of being realized as additional profit. While there are circumstances in which lower priced products will gain an edge on competitors, this decision should be made by managers. Unless the profit margin is adjusted accordingly, breakthroughs in efficiency will not benefit the company.

Conversely, rising production costs increased the price of a product. Again, price increases should be a management decision, rather than one based solely on mathematics. It may be a better business decision to weather higher production costs, as opposed to making your customers pay higher prices for your product.

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