Cost-plus pricing: Strategy, examples, and how it compares to other models

November 20, 2024 10 min

Author:
Keith Rabkin, CEO of PandaDoc

Cost-Plus pricing: Strategy, examples, and how it compares to other models

We've all compared pricing to find the best deal or value for our money. But we can't just slap a price tag on something and expect to hit our revenue targets.

Many more factors contribute to pricing decisions and finding the most effective pricing strategy for your business.

Your pricing model influences your revenue and brand perception when customers compare your products and pricing to your competitors.

When you want to determine the best selling prices for your products or services, three of the most popular models are cost-based pricing, competitor-based pricing, and value-based pricing.

While the best pricing strategy will depend on several factors, cost-plus pricing is one of the most simple and commonly used methods.

Let's explore how this pricing strategy works, look at some cost-plus pricing strategy examples, how it compares to other methods, and which industries may benefit from cost-plus pricing.

What is cost-plus pricing?

Simply put, cost-plus or markup pricing is the cost to create your product or service plus your desired markup or profit margin.

To determine your selling price, you must take the following elements into account:

• Cost of goods sold (COGs): The direct cost of creating a product or service. This can include raw materials, storage costs, overhead costs, labor costs, and any other internal costs.
• Margin or markup: A fixed percentage added to the costs. You determine this, and it can vary by product or service line.

How do you calculate cost-plus pricing for a business?

Once you've determined the cost of goods sold and your markup percentage, it's simple to calculate the selling cost using the cost-plus method.

Cost-plus pricing formula

Plug these values into the following formula to determine your selling price.

Selling price = (Cost of goods sold) * (1 + target profit)
Target profit should be in a decimal format, e.g. (20% = .20)

Cost-plus pricing example

Here are two examples from two industries to illustrate how the cost-plus pricing formula works.

Manufacturing

Let's consider a furniture manufacturing company that produces wooden chairs.

• Unit cost to produce one chair:
  • Raw material costs: $50
  • Labor: $20
  • Overhead (utilities, rent, etc.): $10
  • Total cost: $80
  • Desired profit margin: 30%

Selling price calculation:
Selling price = (Cost of goods sold) * (1 + target profit)
$80 * (1 + .3) = $104
The selling price for each chair, using cost-plus pricing, is $104.

Software/Tech

Let's consider a SaaS company offering project management software.

• Cost components:
  • Developer salaries: $50,000
  • Cloud hosting: $10,000
  • Software licensing: $5,000
  • Customer support: $15,000
  • Total cost: $80,000
  • Desired profit margin: 40%

Selling price calculation:
$80,000 * (1 + .4) = $112,000

The selling price for the software product, using cost-plus pricing, would be $112,000.

Why use a cost-plus pricing strategy?

Benefits of cost-plus pricing

Using cost-plus pricing to determine the price of a product is fairly simple and straightforward.

Easy to use

The necessary components to calculate your selling price with cost-plus pricing are your costs and your desired profit margin. This means you can compute pricing fairly quickly.

"One of the biggest pros of cost-plus pricing is its simplicity…especially useful for companies with stable production costs," Tiago Pita

Built-in profitability

Cost-plus pricing ensures you will see a profit based on those costs and your markup.

"By setting a fixed markup, you know that every sale is covering your costs and providing a profit."

Builds customer trust and transparency

The cost-plus pricing model is easy for your customers to understand. Changes in selling prices reflect increased production costs.

"Adopting a cost-plus pricing method helps businesses to build trust with customers…" Jeremy Bogdanowicz

Disadvantages of cost-plus pricing

Doesn't demonstrate product value proposition (UVP)

Neglecting to consider the value in your pricing can lead to underselling the true product value.

Doesn't consider competition

In competitive markets, cost-plus pricing can lead to inconsistent pricing on similar products.

"In highly competitive markets... cost-plus pricing can work against you," Mushfiq Sarker

Doesn't allow price segmentation

A single price across segments only partially captures the value your product might offer.

Doesn't account for product innovation

Focusing solely on production costs may neglect customer feedback that could influence pricing.

Which industries commonly use cost-plus pricing?

Cost-plus pricing works well in industries where transparency and cost control are priorities.

Cost-based pricing may be beneficial when:

• Costs don't fluctuate significantly.
• Unique goods or services where competitor data isn't readily available.

Cost-plus pricing company example

Everlane uses a cost-plus pricing strategy to maintain transparency with customers by sharing their product costs and price markups.

Cost-plus pricing vs. other pricing models

Cost-plus pricing vs. value-based pricing

Value-based pricing takes into account perceived customer value.

• Tiered pricing: Packages with different features based on customer needs.
• Subscription-based pricing: Charged a recurring fee based on access level.

Cost-plus pricing vs. target costing

Target costing works backward from what customers are willing to pay.

Cost-plus pricing vs. marginal cost pricing

Marginal cost pricing sets prices high enough to cover additional costs of selling one more product.

Cost-plus pricing vs. market-based pricing

Market-based pricing balances customer expectations with competitive offerings.

Cost-plus pricing and finding the best strategy for your business

Cost-plus pricing offers a straightforward method that may be ideal for stable cost businesses.

When considering your pricing strategy, evaluate your industry, customer base, and competitive landscape to find the best fit for your business goals.