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When Cost-Plus Pricing Is a Good Idea | Harvard Business Review

The Strategic and Tactical Benefits of Cost-Plus Pricing
Despite these limitations, there are sometimes strategic and tactical reasons to use cost-plus pricing. When implemented with forethought and prudence, cost-plus pricing can lead to powerful differentiation, greater customer trust, reduced risk of price wars, and steady, predictable profits for the company.

No pricing method is easier to communicate or to justify. Cost-plus pricing is inherently fair and nondiscriminatory to customers. What can be a more reasonable explanation for a price increase than to state, “Our input costs went up by 8% this year, so we are raising our prices by 8%”? Clothing retailer Everlane goes even further, using cost-plus pricing to make its value proposition of “radical transparency” come alive. For every garment it sells, Everlane provides a detailed breakdown of costs for materials, labor, duties, and transport, along with its markup. This way, customers can easily verify Everlane’s emphasis on paying fair wages to workers manufacturing its garments and actively endorse this company value by buying its products.

Cost-plus pricing is the very antithesis of value-based pricing, which seeks to discover differences between customers’ economic valuations and to exploit them by customizing prices. Just consider the consumer outrage generated by Uber’s surge pricing, Coca-Cola’s dynamic vending machine pricing based on outside temperature, or the variable rate pricing of electric utilities. In all these cases, many customers saw the seller’s value-based pricing moves as nothing more than gouging. Cost-plus pricers don’t face this risk. Sure, they may underprice their products for some customers, but they will sleep peacefully at night knowing customers consider their prices to be fair.

Another pragmatic benefit of cost-plus pricing is that it is simple to implement. Every frontline retail employee or bartender with a calculator can apply a markup percentage to wholesale costs and calculate the asking price, something that many mom-and-pop stores and bars appreciate.

If the major competitors in a market use cost-plus pricing, it stabilizes price levels. The amount of risk associated with pricing decisions is lowered for all players. Prices remain relatively stable, particularly when the higher-cost suppliers in the market offer higher-quality products and when lower-cost sellers offer lower-quality products. Companies are less likely to engage in price wars if they base their prices mainly on costs instead of competitors’ prices.

via When Cost-Plus Pricing Is a Good Idea.

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