What’s So Bad About Cost-Plus Pricing?

Cost-plus pricing is used primarily because it is easy to calculate and requires little information.  Basically, this pricing method is accomplished by adding a standard mark up to a product after production and distribution costs have been met.  While it seems to ignore demand, image and the value of customer service, I would argue that if a provider truly doesn’t consider those other market factors, the business has problems that a cost structure can’t fix.

The true challenge to determining the fairest pricing structure for both the customer and the vendor is to develop a clear understanding of how to categorize costs.  Overhead costs, production costs, and YES! the costs associated with exceptional customer service and fast turn-around should all be considered when working to negotiate an optimal cost-plus pricing structure.  Too often the customer views only the product cost as the base line number for the negotiation on profit margin, without considering the cost of the infrastructure needed to satisfy the often-demanding customer service needs of the end users.  On the other side of the table, vendors prefer to lean towards value-based pricing which puts more weight on perception of product and service value rather than the actual costs associated with delivering orders on time and under budget.  After all, placing a dollar value on exceptional service is tricky business indeed.

However, only when a mutual understanding and final agreement is reached on the baseline cost of delivering that final product can a fair profit margin be negotiated.  This margin can be applied to all purchases, and the procurement team can feel confident that less-experienced buyers within the organization will enjoy the benefits of a well-designed pricing program. Once this happens, the buyer/vendor partnership can grow and thrive on a model that is based on transparency and mutual gain.

Note to buyers:  cost-plus pricing is a good thing only with a full understanding of the vendor costs to deliver the product and service your audience deserves, and your budget demands

Note to vendors:  cost-plus pricing is only scary if you haven’t been able to quantify the true costs of delivering quality product in a timely manner, with a customer service approach that exceeds customer expectations

Cost-plus pricing is not as simple as it may seem, but it’s worth the effort to figure it out!

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