What is cost-plus pricing?
Cost-plus pricing describes setting the price based on the marginal cost of producing a good or service and adding a markup.
Explanation
Companies often base their markups on what is considered usual in the industry, which assures that the resulting price is comparable to competitor offers. Also, markups allow companies—to some extent—to account for differences in the quality of inputs, as these are often reflected in different costs.
For example, a more extensive product variant uses more material, costs more, and is sold at a higher price. A prominent example is restaurant food pricing, which widely applies a 300% markup on their wholesale costs. This implies a 75% margin before rent, labor, and other fixed costs.
What to watch out for
Cost-plus pricing is often unjustly mocked for only looking at cost and not at competition or value to the customer. However, it is arguably in line with the traditional view on pricing that focuses on fairness and often works well in established and stable markets.
It does not work well in dynamic markets with many price changes or promotions by competitors or for products with high capital and low marginal costs, such as software, telco, or hospitality.
Further reading
Dholakia, U. M. (2018). "When Cost-Plus Pricing Is a Good Idea," Harvard Business Review. Retrieved March 16, 2022
Cost-plus Pricing - Investopedia
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