Whether you are just purchasing bottled water from a convenience store or getting professional services from towing service Arlington va, the price for anything you get is often higher than the cost it took to produce it. In many cases, the selling price is determined using a cost-plus pricing strategy. This means the selling price is determined by adding a percentage to the production cost of a product. A cost-plus pricing strategy, otherwise known as markup pricing is a method where a fixed percentage is added on top of the cost to produce one unit of a product. The resulting number is the selling price of the product.
This pricing method looks solely at the unit cost and ignores the prices set by the competition. For this reason, it is often not the best fit for many businesses because it doesn’t take external factors such as competition, among others. This pricing strategy ignores consumer demand and competitor prices. It is often used by retail stores to price their products. Cost-plus pricing is often used by retail companies such as clothing, grocery, and department stores. If you are selling software as a service, this pricing method is not the best fit, because the value of your products provided is normally greater than the cost to produce them.
Cost-plus pricing formula
The cost-plus pricing formula is calculated by adding material, labor, and overhead costs and multiplying it by (1+ the markup amount). Overhead costs are costs that can’t directly be traced back to the material or labor costs and are often operational costs involved with creating a product. On the other end, markup is the percentage difference between the unit cost and the selling price of the product. Markup can be calculated by subtracting the unit cost from the sales price and dividing the resulting number by unit cost. What you get you then multiply the final result by 100 to get the markup percentage.
On the contrary side, the price can be set too high. Since the pricing strategy doesn’t look into issues such as competition, there is a risk that the selling price is too high. Doing so could result in a loss of sales if consumers choose to do business with a competitor who has lower prices. Additionally, there is no guarantee all costs will be covered. Sales volume is projected before pricing the product, and sometimes, this estimate is inaccurate. If sales are overestimated and a lower markup is used to price the product, that leaves disaster for chaos.
Cost plus pricing comes with its advantages and disadvantages. On the side of advantages, it is simple to use. Using this strategy doesn’t require extensive research. You just need to analyze your production cost, on issues such as labor, materials and overhead, so as to determine a markup price. Additionally, the price can be justified. The cost plus pricing strategy makes it easy to communicate to consumers why price changes are made. If a company needs to raise the selling price of its product line due to rising production cost, the increase can be justified. Additionally, it provides a consistent rate of return.