Cost-plus Pricing

Definition 

Cost-plus pricing describes the practice of setting the price based on the marginal cost of producing a good or service and adding a mark-up. 

Explanation

The mark-up is often based on what is considered usual in the industry, and it assures that the resulting price is comparable to competitor offers. Also, it allows – to some extent – to account for differences in the quality of inputs as these are often reflected in different costs. For example, a larger product variant uses more material, therefore costs more and is sold at a higher price. A prominent example is the food pricing by restaurants that widely apply a 300% markup on their wholesale costs, which implies a 75% margin before rent, labor, and other fixed costs.

What to watch out for 

Cost-plus pricing is often unjustly mocked for only looking at cost and not at competition or value to the customer. However, it is arguably in line with the traditional view on pricing that focuses on fairness and often works well in established and stable markets.

It does not work well in dynamic markets with many price changes or promotions by competitors, or for products with high capital and low marginal costs such as software or in telco or hospitality. 

Sources & further reading

 

Dholakia, U. M. (2018). "When Cost-Plus Pricing Is a Good Idea," Harvard Business Review. Retrieved March 16, 2022, from https://hbr.org/2018/07/when-cost-plus-pricing-is-a-good-idea.

Cost-plus Pricing (investopedia.com)