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What is Cost-Plus Pricing?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 13 July 2014
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    Conjecture Corporation
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Cost-plus pricing is a strategy that is used to determine the retail and/or wholesale price of goods and services offered for consumption. Businesses of all sizes tend to use this simple pricing model as a guideline for arriving at sale prices that will allow the company to cover all costs associated with the production and sale of the products, and still make a reasonable profit from the effort. The basic formula works as well for calculating pricing goods, such as the cost of a meal in a cafe, as it does for pricing services, such as utilities or courier services.

The ultimate goal of cost-plus pricing is to allow the originator of a good or service to price goods and services in a manner that helps to ensure all costs associated with the effort are covered. At the same time, it helps to promote the creation of a situation where the originator makes a profit and remains competitive with companies that offer similar goods and services. Fortunately, only a few simple pieces of information are required to establish a solid pricing model for any business.

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The first key component is to establish what it costs to actually produce the end product or service. This involves considering all expenses that go into the production process, such as raw materials, labor and production costs, packaging, transport, and sales and marketing expenses. By dividing the cumulative expenses associated with producing the products by the number of units produced, it is possible to arrive at what is sometimes referred to as the unit cost. The unit cost represents the minimum price that must be charged in order for the producer to recoup his or her investment into the creation of the unit.

Next, there is the matter of determining the additional price to attach to each unit offered for sale. Many companies will use what is known as a percentage allocation to determine this amount. For example, if the unit cost for a given item comes to $10.00 in US Dollars (USD), the producer may choose to add $7.00 USD to the retail price for each unit, representing a 70% profit margin. For wholesale situations, the producer may choose to offer something along the lines of a 40% markup above expenses, offering wholesale clients a discount off the retail price that still allows the producer to earn a reasonable profit from each unit produced.

Another factor that will influence the percentage markup is local competition. Using the same example above, a company cannot reasonably expect to make money if the $17.00 USD retail price per unit is higher than similar products available in the same market. With that in mind, the percentage of the markup may be adjusted down to enhance the chances of capturing consumer attention and successfully capturing a section of the consumer market.

There are examples of a cost-plus pricing formula that get into more data and thus tend to be more complicated in scope. A simple, twofold approach as outlined above is often workable for small businesses, however, provided all expenses associated with the production and delivery of the finished goods or services is accounted for in the unit cost.

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Discuss this Article

jenkies
Post 3

Nice article! I am pretty much the least business-minded person ever, but this made sense to me -- thanks!

junelh
Post 1

I am a manufacturer of high quality fashion jewelry, what is the normal profit applied from cost to wholesale? Thank you.

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