The World’s Worst Pricing Model | Forbes

The world’s worst pricing model is also one of the world’s most popular. It is cost-plus. I’m talking about anything where the price is based on a mark-up applied to costs. Notice that this includes all professional service providers who charge hourly or daily rates!

Cost-plus pricing has many apparent advantages. It is simple to use, appears systematic, even “scientific” and can be easily audited. It avoids the need to get to grips with the psychology of pricing. On the debit side, though, it can leave huge amounts of money on the table and in some cases destroy a business.

Take as an example a €100 million European engineering business. I was asked to review its operations, and discovered that the Italian company was achieving margins of 70% on some types of business for which the U.K. company only achieved 25%. The reason was cost-plus pricing. Sometimes this business was asked to supply fairly standard components but on other occasions it was asked to design systems with a particular performance. This needed a level of engineering skill which the customer did not possess but this business did, and this was where the difference arose. The British priced these projects at cost of components plus a margin, while the Italians took a view on the value of their engineering expertise and priced accordingly.

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The World’s Worst Pricing Model.