Cost Plus Pricing
Cost-plus pricing is a pricing strategy used by companies where the selling price of a product is determined by adding a specific dollar amount or percentage (the “markup”) to a product’s unit cost.
The formula for cost-plus pricing is:
Selling Price = Cost per Unit + (Cost per Unit * Markup Percentage)
This pricing method ensures that a company can cover its costs for producing a product and achieve a predetermined level of profit with each sale.
For example, if a company makes a toy that costs $10 to produce and they use a cost-plus pricing strategy with a 30% markup, the selling price of the toy would be $13 ($10 + ($10 * 0.30)).
While cost-plus pricing is straightforward to implement and ensures a consistent rate of return on each product sold, it does not take into account consumer demand, the price elasticity of demand, or the prices charged by competitors. Therefore, it may not be the optimal pricing strategy in all market conditions or industries.
Example of Cost Plus Pricing
Let’s consider a simple example of a furniture manufacturer:
Suppose the furniture manufacturer produces wooden chairs. The cost of raw materials (wood, screws, etc.) and direct labor for each chair is $50. This is the cost per unit to produce a chair.
If the company follows a cost-plus pricing strategy and decides to set a markup of 60%, it would calculate the selling price of each chair as follows:
Selling Price = Cost per Unit + (Cost per Unit * Markup Percentage)
= $50 + ($50 * 0.60)
= $50 + $30
= $80
Therefore, the selling price of each chair, using the cost-plus pricing method, would be $80.
This ensures that the company covers its costs and makes a profit of $30 on each chair sold. However, it’s important to remember that the company would also need to ensure that this price point is acceptable to customers and competitive in the market. If competitors are selling similar chairs for $70, for example, the company might need to consider a lower markup or find ways to reduce its production costs.
