Pricing is always a tricky issue. Determining a correct price that a customer will pay for your product or service, is always a point of debate among team members, since the price appears to be either too high, or too low. I find the cost plus pricing mode usually adopted by many business owners as being the simplest, and most straight forward way to determine pricing.

Price = (Cost of Production + Misc Costs) + Profit Margin

This is a good workable model and I have used it extensively while pricing products & services. When advising startups, I find the two most common mistakes usually made when adopting this approach are :

1. Under estimating cost elements: In the first part of the equation, calculating the cost of production is in most cases, a relatively simple exercise irrespective of whether one is producing a product or providing a service. Mistakes are usually made in appropriating miscellaneous costs to the overall cost of production. Components such as marketing, administration and fixed costs have to be inbuilt into the pricing, to ensure that the the cost of production is fully representative of all the resources going into production and delivery. Hoping to recover these expenses by increasing profit margin components is not the best of strategies.

2. Profit Margin Calculations: The last component of the equation is where debate occurs in the team, to gauge whether to adopt a lower % buffer or a higher one. I believe this is dependent on current market place, pricing adopted by competitors and most importantly, your own expectations. Businesses are inherently set up to make profit. Hence, if you start off with low costing structures, it is much harder to scale upwards, whereas it is easier to come down. A lot of thought must therefore be put into setting the profit margin component.

Is cost plus pricing the best pricing strategy that a company could use? I do believe it is dependent on a case to case basis. I am more inclined towards premium pricing models which instead of using base cost as an indicator, use the value that you bring to the customer. I will discuss this strategy in greater detail in another blog post.