The “cost plus” model of pricing is very attractive in that it is very simple:
Add up costs, Add a margin, Add a formula for supporting services costs- and there you have an “ex works” price to present to your customers.
The simplicity of “cost plus” pricing while enticing is also quite dangerous as a cost plus model frequently leads to a series of pricing errors which impact company performance. The top 3 errors we have witnessed in organizations that use a “cost plus” pricing system (model) are:
1) Valuable orders are lost: Cost plus pricing does not take into account the value a customer receives from your product/service offerings
2) Little incentive to decrease costs: As management considers “higher cost equals higher margin” there is not the same driving desire to ruthlessly eliminate unnecessary costs
3) The costs are not correct to begin with: A series of assumptions built into the costing systems lead the company to incorrectly understand where they are making money and where they are not
The first error- the loss of valuable orders- is surprisingly particularly in B2B frequently misunderstood. A movement to a value based pricing system from a “Cost plus” system does not imply lowering prices and indiscriminate discounting and rather is oriented to understanding clearly:
A) Which are the criteria that lead customers to choose your company as a supplier
B) What is the value you are generating for your customer that they are prepared to pay for
C) What type of sustainable pricing model your company can build with their customers that generates an acceptable return for both you and your customers
Frequently the “cost plus” model was adopted years ago and certainly served the company for a number of years- what has changed now is the overall business environment in which suppliers and vendors are working together- and this means that movement towards orientation of value based pricing will serve you and your organization over time to create the performance levels you need for success.
How does your company address pricing today and how will it address this challenging area in the future?