3.4.3 Cost-based pricing

Cost-based pricing is the least customer-orientated and includes cost-plus and mark-up pricing methods.

Cost-plus pricing is commonly advocated by accountants and engineers because it is simple to use and guarantees that the company meets a predetermined profit target. The method works by calculating the total production costs and then adding on a fixed percentage profit in order to arrive at the price.

Unfortunately, this approach does not take account of how the customers will react to the quoted price. If, in the eyes of the customer, the price does not represent value for money this will have a negative impact on sales.

Conversely, if the customers see the price as representing very good value for money then the company may not have sufficient stocks to meet demand, therefore allowing new competitors to enter the market.

Mark-up pricing is similar to cost-plus pricing and is the method used by most service retailers. For example, a retailer will buy in stock and add on a fixed percentage to the bought-in price (a mark-up) in order to arrive at the shelf price.

This method is identical to the cost-plus method except for two factors. First, the entrepreneurial retailer will be in close contact with the customers and can therefore develop an intuitive idea of what they are prepared to pay and, second, they can dispose of unsold stock by discounting it back to cost and selling it in the sales.