According to cost based pricing definition, it is a pricing method which is based on the cost of manufacturing, production, and distribution. Usually, the price of the product is decided after adding a percentage of manufacturing cost to the selling price for making a profit. Cost-based pricing is considered one of the simplest ways of calculating the price of any product or service. The pricing strategy can be categorized into two namely full-cost pricing and direct-cost pricing.
The full cost based pricing depends on various factors such as fixed cost and percentage markup. Direct-cost pricing consists of variable costs and percentage markup. One of the major criteria that determine the success of cost-plus pricing is when marginal revenue is equal to the marginal cost. From the viewpoint of pricing strategy, Cost based pricing strategy is easy to use as compared to value-based pricing. It is one of the easiest pricing methods available.
What is Cost-Based Pricing?
Cost based pricing is used for optimizing the profit. It is calculated by assessing the cost of production and adding a certain profit percentage to the price for deciding the final price point for selling. This kind of pricing strategy makes sure that the company fetches a profit margin that ensures the expected rate of return. As mentioned above, cost based pricing is used extensively owing to its simplicity and the amount of information needed for expected profits. Cost plus pricing is a better alternative to the value based pricing if the data on cost and demand is not easily available. According to experts, the cost based pricing method is a rational approach for the optimization of profit.
Cost Based Pricing Vs Value Based Pricing
If you wish to understand cost based pricing, it is important to have a look at the value-based pricing as well. The value-based pricing strategy is determined on the basis of how buyers perceive the value of a specific product/ service.
It is apparent that evaluating the perception of the buyers is not an accurate or rational way of deciding the price. Hence, cost based pricing is more accurate than value based pricing.
Let us explain you difference of cost-based pricing and value-based pricing in below table:
Cost Based Pricing Strategy
In short, cost based pricing strategy adds a markup to the price of the products above the cost of production and manufacturing. The strategy consists of adding a specific percentage on the top of cost of production/ unit. Unlike the value-based pricing, the cost based pricing strategy ignores the competitor prices as well as consumer demand.
While determining the cost-based price for a product, there are a few key considerations. While making the calculations, you need to add certain aspects such as labor, overhead costs, material, etc. Then a markup percentage is added to the cost. This is the basic strategy for calculating the cost based pricing.
There is another method for calculating the cost based pricing known as target-return or break-even pricing. In this type of pricing strategy, the price of a specific product is decided by the cost of manufacturing, production, and delivery minus the markup percentage. In this case, the cost-based pricing is used for calculating the units that a company needs to sell for compensating the cost of production and delivery. Here, the pricing strategy is different from the basic one as there is no markup pricing added for generating profit.
It is to be known that companies don’t always need to calculate the cost based pricing manually. There are various platforms, resources, and agencies that enable a company to calculate the cost plus pricing.
Cost based Pricing Example
To understand cost based pricing, it is important to have a look at a few examples. There are buyers that expect transparency and don’t appreciate cloudy prices for products and services.
Transparency in the pricing strategy is the key to gaining a competitive advantage. When a company adopts the cost-based pricing approach that uses cost plus pricing as the primary strategy, the company reveals every aspect of the pricing strategy such as production cost, manufacturing, and delivery and the markup percentage. In this case, customers can witness the origin of the product price which is not possible in the value based pricing as it is based on the cost of each element right from material to transportation.
Here’s an example of another cost-based pricing method known as break-even pricing. If an attorney wishes to use a break-even cost based pricing method for calculating the cost of service they offer. Hypothetically, the cost of operating a firm is $200000 dollars and the attorney charges 200 dollars per hour. They need to work for around 1000 hours for achieving break-even in this case. If the attorney aims to reach 10% of return on cost, they must work 100 extra hours. It is a simple example that offers perspective on how much one needs to work for achieving the expected return.
Companies that Use Cost Based Pricing Strategy
Some of the major companies that use cost based pricing strategy are Ryanair and Walmart. They are one of the low-cost producers in their industries. They work by setting lower prices and fetching huge competitive advantage via cost reduction. Reducing the price leads to a smaller margin but it also contributes towards great sales and profits which compensates for the profit margin.
Walmart and Ryanair use cost based pricing as a major strategy leading to a bigger competitive advantage via lower prices. Companies that generate higher cost also make use of cost based pricing. They charge higher prices and benefit from higher margins. They need to balance between the willingness to sell more and the price margin. These companies choose cost based pricing as compared to value based pricing.
Cost based pricing can be used easily that too without manual calculations as you can choose from the services. As compared to the value based pricing, cost based pricing relies on precise information and accuracy. Even in the absence of such information, companies can use internal factors for setting the best price point for the product. It is important to set realistic expectations about profit as it will benefit everyone.
Benefits of Cost Based Pricing Strategy
1. Profitability: Every business is looking to make a profit. Now, in the manufacturing industry, it becomes more challenging as the overheads are many and revenue generation is done on even larger scale. So, tracking everything can be very tedious. Cost based pricing helps in generating better profits and ensuring future sustainability and growth.
2. Cost Control: This kind of pricing strategy can help track the costs incurred by your company. It effectively promotes managed finances. PriceIntelGuru’s platform can help you identify your costs and bring better operational efficiency in the company.
Powerup with Cost-Based Pricing and PriceIntelGuru
To summarize, cost-based pricing stands as a powerful cornerstone for the manufacturing industry. By incorporating the true costs of production into pricing decisions, manufacturers can ensure profitability, recover investments, maintain competitiveness, exercise effective cost control, establish transparency with customers, and secure long-term viability.
With cost-based pricing as their guiding compass, manufacturing companies can navigate the complex market landscape with confidence, making sound business decisions that fuel growth, innovation, and sustainable success. By embracing the principles of cost-based pricing, manufacturing companies can lay a solid foundation for financial stability, strategic decision-making, and continued growth, ultimately propelling them toward a prosperous future in their industry. So, why wait, book a demo today!