Cost-plus discourages change and ignores customer value

  • 17 Mar 2018

17 Mar 2018

You learnt it at school. As did your parents and your grandparents. The cost-plus pricing method. Even though the method dates back to the time when people first started conducting trade, it is still the most popular pricing method and used by approximately 60 per cent of the world’s businesses. The cost-plus method might seem to be eminently sensible, and financially sound, but it doesn’t give you any leeway for business development or segmentation and price differentiation. Above all, it ignores customer value – the most crucial factor in every business transaction.

Obviously, your competitors’ prices must be factored into your pricing formula. And when their prices have been arrived at just by aggregating costs, it’s easy to follow suit since your alternatives might seem limited. But your competitors’ pricing should be only one of many variables in your price equation. Otherwise, you run the risk that it’s your competitors who control your prices, with absolutely no regard for your customers’ needs, preferences and willingness-to-pay. In our view, your competitors’ prices should merely serve as a trigger for you to differentiate and improve your offerings.

In fact, the cost-plus method drastically narrows down your options and ability to change your prices, simply because it states that your prices are wholly determined by your costs. Moreover, cost-plus would seem to have a restraining influence on innovation and creativity and a company’s ability to re-design its offerings, due in large part to the low incentive to change anything since cost-plus offers very limited financial scope to improve profit margins. Actually, with cost-plus and effective sourcing and production processes, it requires no more than simple arithmetic to conclude that your profits will steadily shrink.

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