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    What Is Cost-Plus Pricing Strategy

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    Agung Hartanto
    Cost-plus pricing is a common strategy that ensures a company sells a product or service for more than it costs to produce by adding a fixed percentage, usually established by the company, to the unit cost. The unit cost is calculated by adding direct material, labor, and overhead costs. Once the accurate unit cost is determined, the cost-plus amount is simply added to establish the sales price. While this strategy ensures profitability, it assumes unit costs are competitive and may remove incentives for improving efficiency since profits are guaranteed regardless of costs. It also does not account for all market factors that could influence pricing.

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    What Is Cost-Plus Pricing Strategy

    Uploaded by

    Agung Hartanto
    35 views2 pages
    Cost-plus pricing is a common strategy that ensures a company sells a product or service for more than it costs to produce by adding a fixed percentage, usually established by the company, to the unit cost. The unit cost is calculated by adding direct material, labor, and overhead costs. Once the accurate unit cost is determined, the cost-plus amount is simply added to establish the sales price. While this strategy ensures profitability, it assumes unit costs are competitive and may remove incentives for improving efficiency since profits are guaranteed regardless of costs. It also does not account for all market factors that could influence pricing.

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    Cost-plus pricing is a common strategy that ensures a company sells a product or service for more than it costs to produce by adding a fixed percentage, usually established by the company, to the unit cost. The unit cost is calculated by adding direct material, labor, and overhead costs. Once the accurate unit cost is determined, the cost-plus amount is simply added to establish the sales price. While this strategy ensures profitability, it assumes unit costs are competitive and may remove incentives for improving efficiency since profits are guaranteed regardless of costs. It also does not account for all market factors that could influence pricing.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    35 views2 pages

    What Is Cost-Plus Pricing Strategy

    Uploaded by

    Agung Hartanto
    Cost-plus pricing is a common strategy that ensures a company sells a product or service for more than it costs to produce by adding a fixed percentage, usually established by the company, to the unit cost. The unit cost is calculated by adding direct material, labor, and overhead costs. Once the accurate unit cost is determined, the cost-plus amount is simply added to establish the sales price. While this strategy ensures profitability, it assumes unit costs are competitive and may remove incentives for improving efficiency since profits are guaranteed regardless of costs. It also does not account for all market factors that could influence pricing.

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    What Is Cost-Plus Pricing Strategy?

    by Scott Shpak; Updated November 06, 2018

    Cost-plus is a marketing strategy used for pricing goods and services.


    Cost-plus pricing is, perhaps, the most common way of establishing a profitable selling price for
    a product or service, since it ensures that a company sells a product for more than it had cost
    the company to make the product, provided that the cost calculations are accurate. Usually,
    pricing on the cost-plus model adds a fixed percentage on top of unit cost. This may be
    established by the company, and sometimes, it's a negotiating point with re-sellers who want to
    gain a competitive edge.

    Establishing Unit Cost


    Central to the cost-plus strategy is the accurate definition of unit cost, since undervaluing the
    true cost of providing a product or service means that the cost-plus price doesn't produce the
    intended profit. For a company following generally accepted accounting principles, calculating
    unit cost is generally straight forward.

    Unit cost is calculated by adding direct material costs, direct labor costs and an allocation of the
    company's overhead expenses. For example, if a company makes only one product, 100
    percent of overhead expenses, or fixed costs, would be added to the unit cost price. If the
    company adds a second product, perhaps 50 percent of fixed costs would be attributed to each
    product, unless the new product represented a different proportion of the company's sales. The
    point is to account for all of the company's fixed costs through unit cost allocation, so that unit
    cost calculations present accurate break-even pricing, as the basis for its cost-plus strategy.

    Creating a Cost-Plus Model


    The cost-plus calculation itself is simple. Once the accurate unit costs are calculated, the
    cost-plus value is simply added to unit cost. This doesn't include all market factors or influences,
    however. There are costs such as return of unsold goods, for example, that may not be
    accountable at the time of cost-plus pricing, except on a past-performance or projection basis.
    Client contracts may also influence cost-plus pricing. For instance, a client who negotiates a
    guaranteed maximum price contract could limit the cost-plus value, tying the producing
    company to terms of the contract, even if production costs increase after the contract goes into
    effect.

    The Pros and Cons of Cost-Plus Pricing


    The simplicity of the cost-plus strategy is perhaps its most attractive advantage. Establishing a
    profitable sales price is easy, if you know the unit cost and the cost-plus amount. For example,
    in a sales negotiation, a company representative can quickly calculate new pricing, if a potential
    buyer increases an offer to purchase. If the representative knows that the cost-plus amount is
    30 percent over unit cost, the representative could offer percentage incentives of, say, 10 to 15
    percent for certain volume purchases, without accidentally pricing a product at a loss. Cost-plus
    pricing ensures profitability and also provides a way of ensuring profit margins even as
    production costs increase.

    The primary drawback of cost-plus pricing is the assumption that unit cost is competitive.
    Consider a company that manufactures a toaster for a $20.00 unit cost, to which it adds a 30
    percent cost-plus amount for a retail price of $26.00. A competing company that makes a similar
    toaster for $10.00 unit cost has a remarkable advantage. Pricing competitively, the other
    company makes $16.00 of profit per sale, and they could even impact the more expensive
    company by selling their toaster at half-price while maintaining 30 percent profitability.

    Cost-plus strategy also removes some incentive for streamlining production efficiencies. Since
    the cost-plus margin is assured regardless of production costs, a company may not seek to
    lower its costs to either gain market advantage or increase profit margins. In fact, as sometimes
    happens with government procurement contracts issued on a cost-plus basis, a disreputable
    business may pad its costs or alter overhead allocations to create artificially inflated selling
    prices.

    In practice, cost-plus pricing may be part of a more flexible pricing strategy, one that factors in
    categories such as market competition and pricing, rather than concerning itself with generating
    fixed percentages of profit that are vulnerable to market conditions.

    https://smallbusiness.chron.com/cost-plus-pricing-strategy-1110.html

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