Cost-based pricing is one of several strategies firms can use to set prices for goods and services.
Price is one of the four key elements of the marketing mix. A well thought out pricing strategy can help businesses position their products or services, and has a profound effect on how consumers view the company. There are several cost-based strategies for setting the price of a product or service.
Cost-Plus Pricing
A cost-plus pricing strategy involves setting the price at the cost of production, including both fixed and variable costs, with the addition of a decided-upon profit margin. For example, it costs a company $2 per unit in raw materials and manufacturing, and fixed costs are currently at $3 per unit. The total cost to the company is $5 per unit. Management decides that they want to price the units with a 25-percent markup, so adding 25 percent to $5 comes to $6.25 per unit. This pricing strategy works well, as long as the company has its costs figured correctly.
Renegotiating Terms with Suppliers
Reduce costs by renegotiating contracts with your suppliers. If you have a good relationship with a supplier, you may be able to lock in at a lower price, or even negotiate a new payment plan. These savings can help lower your initial costs and keep your final price competitive.
Cut Back on Inventory
Another way to reduce your operating costs involves cutting down inventory. Take a look at the number of orders taken over the course of a year and determine the appropriate amount of inventory to have on hand. You can also reduce overall costs by limiting unnecessary or nonessential expenses.
Disadvantages of Cost-Based Pricing
While cost-based pricing strategies are operationally efficient, they do have their disadvantages. For instance, since profits increase along with costs (and hence, prices) it is easy for firms to lose incentive in the development of cost controls. Also, if all pricing decisions are based on costs, and not market conditions, perceived value or any other conditions, it is possible for a company to price a product too low.
Tags: pricing strategy, company unit, price product, setting price