Benefits and Drawbacks of Cost-Plus Pricing

The price of a product is sometimes much higher compared to the cost it required to produce it, whether you are buying a designer handbag or bottled water from a convenience store. On a lot of occasions, this selling price was figured out using a cost-plus pricing method. The final price is figured out by adding a percentage to the cost of production for an item.  

However, what really is cost-plus pricing? How do companies utilize it? 

What’s Cost-Plus Pricing? 

Markup pricing, commonly known as cost-plus pricing, is a pricing strategy where a predetermined percentage is added on top of the cost of producing a product. The result is then used for the product’s selling price.  

This pricing strategy ignores the prices set by competitors and solely looks at the cost of the product. Because of this, it is sometimes not ideal for a lot of companies since it does not consider external aspects, such as competitors.  

Oftentimes, cost-plus pricing is utilized by retail companies such as department stores, grocery, and clothing stores. On these occasions, there’s variation in the products being sold and various cost-plus percentages can be used to every item.  

Of course, you’ve got to weigh the pros and cons if you are thinking about utilizing a cost-plus pricing method.  

Benefits 

  • It Offers a Constant Rate of Return 

When properly calculated, the cost-plus pricing will lead to the recovery of all expenses. Also, you have to expect a constant rate of return because of the markup percentage.  

  • The Price can be Justified 

The cost-plus pricing method makes it simple to communicate to clients why changes in the price are done. If a business has to increase the selling price of its service or product because of the increase in production expenses, they can justify the increase.  

  • It Is Easy to Use 

You don’t need extensive research if you use this pricing method. You simply have to analyze the production expenses and figure out a markup price.  

Drawbacks 

  • There Is No Incentive to Efficiently Operate 

A company can probably make the same percentage from an item even if production expenses increase if they base the selling price. This gets rid of the incentive for the company to function more efficiently and reduce the expenses to produce their products. There is probably no chance that they will be successful in the future if they do not change their strategies to varying conditions.  

  • There is No Assurance That You Can Cover All Expenses 

Before pricing the product, sales volume is estimated. Oftentimes, this estimate isn’t accurate. Fewer products are sold and the expenses to create the product may not be covered if sales are overestimated and a low markup is utilized to price the product. Sometimes, this leads to a financial hit for the business. 

You can just markup your product to figure out its selling price with this method. However, you still have to weigh the pros and cons of cost-plus strategy to figure out if it is a perfect method for your company. 

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