Cost-Based Pricing Pros and Cons

So our first model is cost based pricing. So in cost based pricing basically all it is is taking a look at what your costs are, And then there’s a normal markup in the industry. It’s actually set by the industry or it set by the product or service that you’re selling because everybody uses the same markup and that’s the problem with it.

There’s not a lot of flexibility in the pricing. There’s not a lot of imagination that you can input into the pricing as well. It kind is what it is. Now. This is generally applied to commodity-based products, right? also can be applied to products that have little or no differentiation. So it’s really hard for a consumer to tell one product or another since its commoditize they can really just close their eyes, pick a product and they’re going to be fine. And that really then suggest why cost-based pricing is actually used.

Some examples of cost-based pricing models, and we looked at a bunch of them earlier, but I just want to point out a couple things like basic apparel that/ is very hard to tell the difference between one type of basic apparel, Another type of basic apparel like a shirt or a pair of jeans as an example, and also Home Goods, staple products things that you find in a grocery store Like we have olive oil, water, motor oil as well. We even have grains like couscous in back of us and maybe some bath products as well. Again, not a lot of differentiation , staple products that are sold across the board, right?

Now, in a service industry there are also is cost-based pricing as well. But it’s more rare the case not a lot of service businesses use cost based pricing because in service businesses, you actually have differentiation or you can bring out differentiation where it is used when you have low-skilled or no skilled workers that you’re actually bringing out to your customers that you’re using for your customers. So things like an india-based call center will have a lot of caught, it would be based on cost based pricing not market-based pricing in that example. Because there’s little to no differentiation between the varying call centers as an example.

So there are some advantages to cost based pricing, one it’s predictable, you’re going to know exactly what your profit margins ends. There’s no imagination. It’s essentially a math equation that you can do. So it is pretty simple. Another one it is be very transparent, to customers It’s actually extremely transparent, customers actually might even know your margin, that’s both a good thing and a bad thing.

We’ll get to that in just a moment, also negotiations, There’s really no negotiations in this process, customers would be very hard to negotiate on a cost-based using a cost base method because the competitors are going to be the same as you and everything is pretty much brought down to the lowest cost possible possible typically in this model, and then lastly is profits are predictable. It’s always nice to have predictable profits. Unfortunately, they’re not usually as high in this particular model. So there are some disadvantages as well with cost based pricing. The first one is you’re not really getting what customers are willing to pay.

You’re getting what the market is telling you that you’re forced to deliver basically at a certain cost which is not the greatest thing in the world. You’re not able to take advantage of opportunities that may arise, so you’re kind of kind of stuck into a model and if something an opportunity arises you may not be able to adjust your pricing, because everybody else in the industry is also going to take advantage of that opportunity possibly or you’re going to be forced into sticking to that same price, right? So there’s not a lot you can do you’re kind of locked, in if you will. As just advantage just like an advantage.

When a customer is transparent to you, which can be considered an advantage. It’s also actually a disadvantage where customers, well, know your margin and that in some Industries and some cases actually is a disadvantage as well. And then finally you’re not getting credit for any value-add, if you actually do attempt to add value. You’re probably not going to get credit for it because the customer is not going to value it in this model.