Cost-plus pricing is a business pricing strategy that begins with a calculation of all costs involved in producing or acquiring a product. After your company determines the cost to market a good, it adds a certain percentage of markup to achieve profit objectives.
How Cost-Plus Works
Common cost categories for a company include direct materials costs, direct labor costs and overhead. While variable costs are those that directly affect the production or acquisition of a good, you must account for fixed overhead costs when setting prices. Therefore, you allocate a portion of overhead to each product made or acquired. Next, add on the determined markup for the good. Some companies have a standard markup for all goods. Others use different markups for different categories. If costs are $10 and you want a 40 percent markup, the price is $14.
Pros and Cons
Small-business owners use a cost-plus model because it is conservative and ensures your price points achieve a certain margin. The drawback is that, unlike market-driven strategies, a cost-plus approach gives no credence to what customers are willing to pay. Therefore, you can set a $14 price point, but goods may sit on a shelf until you have to discount them to clear space.
Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007. He has been a college marketing professor since 2004. Kokemuller has additional professional experience in marketing, retail and small business. He holds a Master of Business Administration from Iowa State University.