Traditional pricing models have been based upon cost where prices are set at a higher amount than the variable costs of the product.
This is how you derive a contribution towards fixed costs.
Using this type of pricing model, the marketer adds an amount to the costs which may be expressed as a percentage markup or dollar figure.
It is often used in retail because it is easy to apply.
It can also suit some manufacturers where volume applies or the market is price-driven.
Cost-plus pricing is often used to price custom products, such as the construction of a building.
Cost-plus pricing involves keeping track of the costs of producing the building, then adding an additional dollar amount or percentage of costs to arrive at the final price.
Advantages To Cost-Based Pricing.
– Super easy. Take your costs and add a percentage to them.
– Flexible. You can add a different percentage to different product lines.
– If costs go up, it is easy to adjust prices.
– Super simple to calculate.
– Is easy for a marketer to defend pricing.
– May suit a manufacturer with scalable production based on demand.
Disadvantages To Cost-Based Pricing.
–Ignores product demand or the influence price may have on demand.
– Ignores what competitors are doing with their pricing.
– If costs increase, so must the price.
– Ignores brand positioning so may forfeit additional profit.
– It provides no incentive to improve cost efficiency.
Expected Return.
Cost models can also be calculated backwards. This is a common model for very small businesses such as sole operator ventures and service businesses.
To calculate an expected return, the marketer sets a profit objective, deducts their costs and divides the remaining amount by number of units to reach a price point.
For Example:
Say I want to earn $100,000 per annum. My direct costs are $10,000 and I want to work for 1,000 hours. The formula for reaching my price point is:
$110,000 = $110,000 – $10,000 (costs) = $100,000.
$100,000/1000 (hours) = $100 per hour.
Tips About Cost-Based Pricing.
In today’s marketing-driven world, cost-based pricing is much less relevant than it once was. The application of cost-based pricing, while easy to apply and administer, does not maximize company profitability because it ignores market and competitive forces.
- If the marketer has invested in establishing a brand position, it is not the optimum pricing model to apply.
- For low cost providers, marketers should look to price below competitors, using competitive price points as their guide.
- For premium brand providers, a customer-based model is much more suitable.
Although still commonly used in retail (a sector that historically doubles the variable cost of product to determine price, a technique known as keystone pricing), even retailers are beginning to incorporate other pricing techniques in response to competition.
Of particular interest to this group should be those techniques that make it hard to compare prices or make it easy to compare prices depending upon the position of the retailer and the objective of the pricing.
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