Why Cost-Plus Pricing Costs Your Business Money
Cost-plus pricing would appear to be a logical business model:
It's easy to implement. Simply decide your desired margin and adjust prices accordingly.
It ensures a reasonable margin. By using the same markup on all products, you know that you are getting a specified margin.
Your competition is predictable. If you know your competitions' standard markup you can always price appropriately.
It's fair. Every customer is charged the same price so there is no "discrimination" whether the customer is rich or poor.
Unfortunately, employing cost-plus pricing leaves a lot of money on the table. Why? It doesn't maximize your profits or take into account human psychology.
Of course, you should always know the minimum price you're willing to accept (known as cost-plus floor pricing), and your customers should always be willing to pay that. But we're talking about how to make the most money for your business while best serving your customers' needs.
The Truth About Cost-Plus Pricing
The reality is you should always price based on what your customers are willing to pay. For example, fast food chains and hotel room service accomplish the same thing (getting you fed) yet neither is based on the cost-plus pricing model.
It costs McDonald's roughly two cents to make the large soda that costs $1.69 to buy. And you'll never find a bargain eating at the Ritz-Carlton. Yet both pricing systems have been in place for decades if not longer.
How do you start maximizing profit and moving away from cost-plus pricing? Let me suggest a modified cost-plus approach to start.
Keep your current pricing model, but look for customer segments willing to pay more -- then charge a higher margin to those customers. Or, if you have a good/better/best product family, raise the margin on the "best" product. You will quickly see that there is a lot of money to be made by pricing based on customer value rather than your costs.
Over time you can slowly add more segments and/or more techniques. Soon your cost-plus pricing model will disappear, and you'll have even more customers than before!
