Best Alternative to the Cost Plus Pricing Strategy for eCommerce Businesses
10:44 May 25, 2023in Best practices in price monitoring by Marijana Bjelobrk
Reading Time: 7 minutes
As price is the element earning for you, you should wisely determine it. The eCommerce world is continuously and rapidly changing, as well as product and service pricing online, on a daily basis, aiming to acquire customers searching to purchase certain products or services at any given moment. Price brings a competitive advantage, therefore, you should test and tailor your pricing strategy to the industry, market conditions, your business goals, and customers’ purchasing behaviors.
We’re here to present another pricing strategy that might work for you. If it turns out that cost plus pricing wouldn’t be as beneficial to your business, we immediately offer an alternative. Let’s consider.
What is cost plus pricing?
Cost plus pricing is a pricing strategy commonly used among businesses, where the selling price of a product or service is determined by adding a markup (profit margin) to the cost of producing or providing that product or service.
The basic formula for cost plus pricing is:
Selling Price = Cost + (Cost x Markup Percentage)
In this formula, “Cost” refers to the total expenses incurred in producing or providing the product or service, including direct costs (such as materials and labor) and indirect costs (such as overhead expenses and administrative costs).
The “Markup Percentage” represents the desired profit margin or the percentage of profit businesses want to earn on top of the cost. The markup percentage is typically based on factors like industry standards, market conditions, and desired profitability.
For example, let’s say a company produces a product costing $50, and decide to apply a markup percentage of 20%. Using cost plus pricing, the selling price would be:
Selling Price = $50 + ($50 x 0.20) = $60
In this case, the company adds a $10 markup (20% of $50) to the cost of $50, resulting in a selling price of $60.
Did you know that cost plus pricing was utilized during World War II?
Cost plus pricing was notably utilized during World War II in the United States.
During the war, the U.S. government implemented cost plus pricing for contracts with defense contractors. This approach ensured that contractors would be reimbursed for their costs of production and receive a guaranteed profit margin. The rationale behind this strategy was to incentivize the production of essential goods and materials needed for the war effort. The government recognized that it would encourage contractors to meet production demands and maintain profitability in the face of increased expenses.
This historical context highlights how this pricing strategy has been used in unique circumstances to align economic incentives and support critical initiatives. Although its origins and implementation may not be attributed to a single individual or organization, it has played a role in various contexts throughout history.
Today, cost plus pricing is often used in industries where costs are more easily identifiable and predictable, such as manufacturing. It provides a straightforward approach to pricing by ensuring that the company covers its costs and earns a desired profit margin. However, it may not consider market demand or competitive pricing dynamics, so businesses should assess the market conditions and adjust the pricing strategy accordingly. Let’s consider the main advantages and disadvantages of this pricing strategy.
Simplicity and Transparency: provides a straightforward and transparent method for determining the selling price. It is relatively easy to calculate by adding a predetermined markup to the cost. This simplicity helps in setting consistent prices across products or services, making it easier for both the business and customers to understand.
Cost Recovery and Allocation: ensures that all the costs associated with producing or providing a product or service are covered and allocated to each product or service. By including both direct and indirect costs in the pricing calculation, businesses can ensure they recover their expenses and maintain financial stability. This helps in understanding the profitability of individual products or services and making informed decisions regarding their pricing, production, or discontinuation.
Profitability: businesses have more control over their desired profit margins. The markup percentage can be set to achieve the desired level of profitability. It allows businesses to ensure they earn a reasonable profit on each sale, which is especially important in industries with tight profit margins.
Flexibility in Cost Fluctuations: provides flexibility in adjusting prices based on changes in costs. If production costs increase, the business can adjust the selling price accordingly to maintain profitability. This allows for better cost management and adaptation to market conditions.
Supplier Relationships: In certain industries, cost plus pricing can facilitate better relationships with suppliers. By sharing cost information and allowing for a reasonable markup, it establishes a more transparent and collaborative environment, which can lead to improved negotiations and partnerships.
Ignoring Market Dynamics: doesn’t directly consider market demand, customer behavior, or competitive pricing. Relying solely on cost-based calculations may lead to pricing products or services at levels that are unattractive to customers or higher than what competitors offer. This can result in lost sales and reduced market share.
Lack of Differentiation: doesn’t take into account the unique value proposition or differentiation of products or services. It treats all products as if their costs and values are the same. In competitive markets, customers often consider factors beyond price, such as quality, features, brand reputation, and customer service. Focusing solely on costs can undermine efforts to position products or services as distinct and valuable in the market.
Margin Compression: In industries where competition is intense or profit margins are thin, relying solely on cost plus pricing can lead to margin compression. If competitors have more efficient cost structures or are employing alternative pricing strategies, they may be able to offer lower prices or higher value propositions. This can put pressure on businesses to either lower prices and accept lower margins or find alternative ways to differentiate themselves.
Limited Pricing Flexibility: it may limit the ability to respond quickly to market changes or implement dynamic pricing strategies. If costs fluctuate significantly or market conditions change rapidly, businesses using cost plus pricing may find it challenging to adjust prices accordingly. This can result in missed opportunities or pricing products or services out of sync with market realities.
Cost Misallocation: attempts to allocate costs to products or services, but it may not accurately reflect their true cost drivers. Indirect costs and overhead expenses are typically allocated based on broad assumptions or simple formulas, which may not capture the actual cost contribution of each product or service. This can result in skewed profitability analysis and suboptimal pricing decisions.
Potential for Underpricing or Overpricing: does not guarantee optimal pricing. If costs are miscalculated or the chosen markup percentage is inappropriate, it can lead to underpricing, where the business fails to adequately cover costs and generate sufficient profit. Conversely, overpricing can occur if the markup percentage is set too high, resulting in reduced customer demand and lost sales opportunities.
Cost plus pricing in eCommerce
Here’s how cost plus pricing can be utilized in an eCommerce setting:
- Determining the cost: In eCommerce, the cost includes not only the production or procurement costs but also additional expenses related to online operations. This can include costs like inventory management, website maintenance, payment gateway fees, shipping and fulfillment costs, packaging materials, customer support, and marketing expenses specific to online channels. All these costs should be considered when calculating the total cost.
- Markup percentage: Once the total cost is determined, you need to decide on an appropriate markup percentage. This can be influenced by various factors such as your desired profit margin, industry standards, competition, and customer price sensitivity. The markup percentage should take into account the unique aspects of eCommerce, such as the need to cover online expenses and potentially lower overhead costs compared to physical stores.
- Competitive analysis: While cost plus pricing provides a foundation for setting prices, it’s essential to monitor market and competitors’ prices in eCommerce. Conduct a competitive analysis to evaluate how your prices compare. If your prices are significantly higher or lower, you may need to adjust your markup percentage or consider other pricing strategies to remain competitive.
- Dynamic pricing: Unlike traditional businesses, eCommerce platforms offer flexibility in implementing dynamic pricing strategies. You can monitor market demand, competitor pricing, and other variables to adjust your prices in real time. This allows you to optimize your pricing strategy based on factors like seasonal fluctuations, inventory levels, or promotional campaigns.
Certainly, cost plus pricing can be a good starting point for pricing in eCommerce, but your competitiveness depends on other factors such as customer behavior, market trends, and pricing psychology.
Best Alternative for eCommerce Businesses
The best alternative to cost plus pricing strategy for eCommerce businesses is value-based pricing. Value-based pricing focuses on determining the price of a product or service based on the perceived value it delivers to customers. Instead of primarily considering the internal costs of production, value-based pricing takes into account customer preferences, market dynamics, and the benefits that customers derive from the product or service.
Here are the key steps involved in implementing a value-based pricing strategy for eCommerce businesses:
- Customer Segmentation: Identify different customer segments based on their needs, preferences, and willingness to pay. Understand the specific value drivers for each segment and the unique benefits they seek.
- Value Assessment: Assess the value proposition of the product or service from the customer’s perspective. Understand the specific benefits, solutions, or outcomes that customers derive from using the product or service. This may include factors such as convenience, time savings, quality, reliability, innovation, and customer support.
- Market Research: Conduct market research to gather data on customer preferences, competitor pricing, and market demand. This helps in understanding how customers perceive the value of your offerings relative to competitors.
- Pricing Strategies: Develop pricing strategies that align with the value proposition. This can include premium pricing for products or services with unique features or superior quality, or penetration pricing to gain market share by offering a lower price initially.
- Dynamic Pricing: Leverage the flexibility of eCommerce platforms to implement dynamic pricing strategies. Monitor market conditions, customer behavior, and competitor pricing to adjust prices in real time. This allows you to optimize pricing based on demand, inventory levels, or promotional campaigns.
- Communication: Clearly communicate the value proposition and benefits to customers through effective marketing and product descriptions. Highlight the unique value your products or services offer compared to competitors.
Value-based pricing allows eCommerce businesses to capture the value they deliver to customers while also accounting for market dynamics and customer perceptions. By aligning prices with customer value, businesses can potentially increase profitability, improve customer satisfaction, and differentiate themselves in the market.
It’s important to note that value-based pricing requires a deep understanding of customer preferences, market research, and ongoing monitoring of competitors and market conditions. Regular assessment and adjustments based on customer feedback and market trends are crucial to the success of a value-based pricing strategy.
Define Your Ideal Pricing Strategy
Cost plus pricing is a straightforward strategy that ensures cost recovery while allowing businesses to set desired profit margins. However, to maximize profitability, businesses should consider incorporating market-based pricing strategies, competitor analysis, customer segmentation, and other factors. eCommerce businesses are advised to incorporate value-based pricing to overcome the limitations of cost plus pricing strategy. Certainly, businesses should investigate misconceptions of value-based pricing strategy beforehand. It is important to strike a balance between cost considerations and customer value to achieve optimal pricing strategies in the dynamic eCommerce landscape.
Hopefully, this article gives you insights into two pricing strategies to consider when defining your pricing strategy.
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What is the main advantage of cost-plus pricing? The main advantage of cost-plus pricing is that it is simple and straightforward. This pricing strategy is easy to understand and implement, since it involves adding a markup or fixed percentage to the cost of the product or service to arrive at the sale price.What is the best pricing strategy for e commerce? ›
- Cost-Based Pricing. This pricing strategy is commoner than the rest on the list. ...
- Competitor-Based Pricing. ...
- Consumer-Based Pricing. ...
- Dynamic Pricing. ...
- Bundle Pricing. ...
- Loss Leader Pricing. ...
- Price Skimming. ...
- Break-Even Prices.
What is the main advantage of cost-plus pricing? The main advantage of cost-plus pricing is that it is simple and straightforward. This pricing strategy is easy to understand and implement, since it involves adding a markup or fixed percentage to the cost of the product or service to arrive at the sale price.What are the 4 types of pricing methods? ›
What are the 4 major pricing strategies? Value-based, competition-based, cost-plus, and dynamic pricing are all models that are used frequently, depending on the industry and business model in question.What is the opposite of cost-plus pricing? ›
The opposite of cost-plus pricing is value-based pricing. Unlike cost pricing, value-based pricing looks at how valuable your offerings are to your target customers. Rather than examining your costs, value-based pricing requires significant market research (e.g., customer surveys, consumer demographics, etc.).What are the top 3 e commerce strategies that are the most effective? ›
Ecommerce strategies are interconnected plans that drive your business operations. There are three major ecommerce strategies to consider: product strategy, customer relationships, and corporate considerations. Each of these must work together to ensure the best possible outcomes for your brand.What 3 strategies are used for pricing products? ›
- Cost-Based Pricing.
- Value-Based Pricing.
- Competition-Based Pricing.
Cost Plus Pricing is a very simple pricing strategy where you decide how much extra you will charge for an item over the cost. For example, you may decide you want to sell pies for 10% more than the ingredients cost to make them. Your price would then be 110% of your cost.How do you solve cost-plus pricing? ›
A simple formula is cost-plus pricing = break-even price * profit margin goal. Break-even price is the total cost to the firm of producing the product or service. Profit margin goal is the firm's desired/expected profit level. Multiply the cost to provide a service by the desired profit margin.Why cost-plus pricing is the best? ›
The main advantage of cost-plus pricing is that it is simple and straightforward. This pricing strategy is easy to understand and implement, since it involves adding a markup or fixed percentage to the cost of the product or service to arrive at the sale price.
Value pricing is perhaps the most important pricing strategy of all. This takes into account how beneficial, high-quality, and important your customers believe your products or services to be.What is the difference between markup pricing and cost-plus pricing? ›
What is cost-plus pricing? Cost-plus pricing is also known as markup pricing. It's a pricing method where a fixed percentage is added on top of the cost it takes to produce one unit of a product (unit cost). The resulting number is the selling price of the product.Why is cost-plus pricing problematic? ›
One of the biggest problems with cost-plus pricing is that it gives no consideration to marketability. A price is typically set without thought as to whether the targeted customers perceive the product as a good value at that point.Why is cost-plus pricing criticized? ›
Variable cost-plus pricing is not suitable for a company that has significant fixed costs or fixed costs that increase if more units are produced; any markup on the variable costs on top of the fixed costs per unit might result in an unsustainable price for the product.What is another name for cost-plus? ›
Cost-plus contracts may also be known as cost-reimbursement contracts.What is four C's in e-commerce? ›
The intersection of the 4 Cs: Content, Creators, Community, and Commerce has led to social commerce.What is the most successful ecommerce model? ›
Business to Consumer (B2C)
This is the most popular e-commerce business model, and it typically requires the least amount of time to make a sale.
- Regulation of product pricing. It's natural for customers to compare prices between brands. ...
- Maintaining high quality products. ...
- Improving store accessibility. ...
- Making a wonderful first impression. ...
- Securing your shipments. ...
- Taking advantage of m-commerce.
The 3 C's of Pricing Strategy
Setting prices for your brand depends on three factors: your cost to offer the product to consumers, competitors' products and pricing, and the perceived value that consumers place on your brand and product vis-a-vis the cost.
Cost plus pricing is the simplest method of determining price, and embodies the basic idea behind doing business. You make something, sell it for more than you spent making it (because you've added value by providing the product), and buy something nice with the difference.
Cost plus pricing involves adding a markup to the cost of goods and services to arrive at a selling price. Under this approach, you add together the direct material cost, direct labor cost, and overhead costs for a product, and add to it a markup percentage in order to derive the price of the product.What are two advantages of cost-plus pricing? ›
This can save you time and money, and reduce the risk of underpricing or overpricing your products or services. Another benefit of cost-plus pricing is that it ensures that you cover your costs and make a profit. You can adjust your markup according to your financial goals and market conditions.What is cost-plus pricing projects? ›
What is cost-plus pricing? Cost-plus pricing is a pricing method where the seller determines their price by adding a profit margin to the cost of the product. This type of pricing can be advantageous for sellers because it ensures that they will make a profit on each sale.What are the two forms of cost-plus pricing? ›
This appears in two forms: full cost pricing and direct-cost pricing. Full cost pricing takes into consideration both variable, fixed costs and a % markup. Direct-cost pricing is variable costs plus a % markup. Cost-plus pricing is a pricing method used by companies to maximize their profits.What is cost-plus pricing format? ›
Cost-plus pricing is a pricing strategy by which the selling price of a product is determined by adding a specific fixed percentage (a "markup") to the product's unit cost. Essentially, the markup percentage is a method of generating a particular desired rate of return.What is cost-plus 20 percent? ›
Cost-plus pricing is a basic pricing strategy that involves determining the cost of goods or services, and then adding a fixed percentage (the margin) as the markup. For example, if your total costs are $100 and you want a 20% profit margin, you would add $20 to arrive at a selling price of $120.What is a criticism of full cost-plus pricing? ›
The following are disadvantages of using the full cost plus pricing method: Ignores competition. A company may set a product price based on the full cost plus formula and then be surprised when it finds that competitors are charging substantially different prices. Ignores price elasticity.What is a cost pricing strategy? ›
Cost-plus pricing strategy or cost-based pricing strategy is an essential strategy that takes into account the total cost of making a product and adds a markup to that to determine the real price of a product.What is the most popular method of pricing? ›
Hence the most common method used for pricing is cost plus or full cost pricing.What is best price provider strategy? ›
A best-cost provider strategy — giving customers more value for the money by satisfying buyers' expectations on key product attributes (e.g., quality, features, performance, or service) while beating their price expectations.
Dynamic Pricing Strategy
Amazon is known for its dynamic pricing or what is also known as repricing strategy. In this strategy, the prices of products don't remain constant but change often depending on competitor prices, demand and supply, and market trends.
The two broad, new-product pricing strategies are market-skimming and market-penetration.What is competitive pricing strategy? ›
What Is Competitive Pricing Strategy? Competitive pricing is the process of strategically selecting price points for your goods or services based on competitor pricing in your market or niche, rather than basing prices solely on business costs or target profit margins.Is price skimming the same as cost-plus pricing? ›
The cost-plus pricing strategy generally maintains the same price, although users might raise it incrementally as inflation affects overhead prices. In contrast, the price skimming strategy involves charging an initial premium price for a product. Often, the product's price may reduce over time.What is cost-plus 50% markup? ›
While there is no set “ideal” markup percentage, most businesses set a 50 percent markup. Otherwise known as “keystone”, a 50 percent markup means you are charging a price that's 50% higher than the cost of the good or service. Simply take the sales price minus the unit cost, and divide that number by the unit cost.Is cost-plus pricing the same as cost based pricing? ›
Cost-plus pricing is a common method of cost-based pricing and uses the total cost of goods sold (COGS) as the primary basis of pricing goods and services. Companies calculate and use a fixed percentage that represents the expected return on producing and then selling goods.What is the profit margin for cost plus? ›
Cost-plus pricing, sometimes called gross margin pricing, is perhaps the most widely used pricing method. The manager selects as a goal a particular gross margin that will produce a desirable profit level. Gross margin is the difference between how much the goods cost and the actual price for which it sells.Is cost plus really cheaper? ›
Can You Save Money By Using Cost Plus Drugs? Cost Plus Drugs doesn't accept insurance, but it may still be the cheapest way to get medication. “In most cases, even without insurance, our prices are less than what you would pay when using your insurance at a typical pharmacy,” says Oshmyansky.What are the disadvantages of cost plus contract? ›
Cost Plus Contract Disadvantages
For the buyer, the major disadvantage of this type of contract is the risk for paying much more than expected on materials. The contractor also has less incentive to be efficient since they will profit either way.
Two common types of contracts are fixed-price, for which the project's total cost is predetermined, and cost-plus, for which expenses are estimated but the final price is determined at the project's end.
In a cost-reimbursable contract, also known as cost-plus contracts, the organization agrees to pay the vendor for the cost of performing the service or providing the goods. Cost-reimbursable contracts are most often used when the scope of work or the costs for performing the work are not well known.How do I choose a good pricing strategy? ›
- Determine your value metric. ...
- Evaluate pricing potential. ...
- Review your customer base. ...
- Determine a price range. ...
- Review competitors' pricing. ...
- Consider your industry. ...
- Consider your brand. ...
- Gather feedback from customers.
Cost-plus pricing, also known as mark-up pricing, is the easiest way to determine the price of a product. You make the product, add a fixed percentage on top of the costs, and sell it for the total.What is an example of a cost plus pricing strategy? ›
Cost Plus Pricing is a very simple pricing strategy where you decide how much extra you will charge for an item over the cost. For example, you may decide you want to sell pies for 10% more than the ingredients cost to make them. Your price would then be 110% of your cost.Which pricing strategy would be most commonly used for new products? ›
When launching new products, businesses often use a pricing strategy called penetrative pricing. This involves setting a low initial price for the product to attract customers and encourage them to try it out. Then, the price can increase once the product has been established in the market.Which pricing strategy best to follow for a company that is looking to maximize its market share would do well? ›
Lowering prices is a solid strategy to help a company win market share. Lower, more attractive prices can attract consumer attention and loyalty. That can increase the all-important sales that drive market share higher.
Penetration pricing is a marketing strategy used by businesses to attract customers to a new product or service by offering a lower price during its initial offering.What is Walmart's pricing strategy? ›
Low Price Leadership
Walmart's core strategy is low-price leadership, which involves offering goods and services at lower prices than its competitors. This has enabled Walmart to become the world's largest retailer by selling many products at everyday low prices.
|Price point||Percent of Sellers|
Amazon's marketplace famously developed according to the “flywheel” model, where low prices drove greater popularity with shoppers, which in turn drove more sellers to the platform, which increased competition, which lowered prices. Meanwhile, Walmart pioneered and has always followed an “everyday low price” strategy.
What Is Competitive Pricing? Competitive pricing is the process of selecting strategic price points to best take advantage of a product or service based market relative to competition.What is the most aggressive pricing strategy? ›
The most aggressive pricing strategy is the competitive pricing strategy.What are 3 ways that pricing decisions are determined by? ›
Three important factors are whether the buyers perceive the product offers value, how many buyers there are, and how sensitive they are to changes in price. In addition to gathering data on the size of markets, companies must try to determine how price sensitive customers are.