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Cost Plus Pricing: Simplest Method to Determine Your Prices

When it comes to pricing the products on your e-commerce store, you have a number of different options.

Some of these options are complicated and involve you studying and analyzing data in order to come up with a price point your customers would be happy to pay.

However, if you’re just starting out, or looking for a simpler way, often these other methods are just too complicated.

In these situations, one of the simplest methods you can use to price your products is the cost-plus pricing strategy.

In this post, we’re going to look at what this pricing strategy is, the pros and cons of using it on your store, as well as how to start implementing it straight away.

Let’s go.

What is cost-plus pricing?

Cost-plus pricing is effectively the idea where you take the cost of acquiring your products and running your business and add what sort of profit margin you would like per item.

cost plus pricing

Overhead costs + desire profit margin = cost + price.

The reason so many people opt for this pricing strategy lies with its simplicity.

When you think about it, working out your overhead costs isn’t too hard and then working out your desired profit margin means you’ll always have a clear idea as to how much revenue and profit your business could make.

If you’re just starting out in the world of e-commerce, this is often the strategy people like to start with.

This t-shirt sells for £29.37

Let’s imagine it costs you £5 to buy the t-shirt and £5 per item to host your products on Amazon.

That’s a total of £10 overheads.

Now if you want to make around £20 profit on each item, you need to sell these t-shirts for around £30.

Before you start thinking about what sort of profit margin or percentage you’d like for your items, it’s helpful to think about what your overhead costs actually are.

If you have a brick-and-mortar store, you obviously need to think about building rent and paying your staff.

But even if you have an e-commerce store, there are still overhead costs to think about.

For example:

  • Your domain
  • Your website hosting
  • Your rent (if you have an office space)
  • Storing your products in a warehouse
  • Shipping costs if you consolidate these for your customers
  • Salaries
  • Utilities
  • Raw materials (if you manufacture the products yourself)
  • Marketing budget
  • Credit card fees

What are the pros of cost-plus pricing?

There is a range of benefits of using a cost-plus pricing strategy. As we’ve already outlined, it’s usually the go-to strategy for those new to the game.

Too many e-commerce owners get pricing wrong, or confuse their customers with pricing that just doesn’t make sense, or worse, price their products so wrong that they don’t make any profit.

Cost + pricing is a good technique for those busy entrepreneurs who perhaps don’t have much time to think about their pricing.

It’s super easy to implement and always ensures you’re keeping your overhead costs at the front of your mind.

If you can find a good profit margin that your customers are willing to pay, it also means that you’ll always make a profit.

Also if you know your competitor’s prices and they’re more than yours, you know you can increase your proportionately. If you need help storing and analyzing your competitor’s prices, why not make use of a competitive price tracking tool.

prisync

Second to this, because every single customer will pay the same price, there is no discrimination or issues with some customers paying more or less than others.

For example, the price discrimination strategy often leads to upset customers when they find out their friends bought the same product from the same store for a fraction of the price.

Considerations to think about

But like every strategy, it’s not without its issues. We’ll now look at some of the considerations you need to keep in mind if you do decide to use this pricing strategy.

Leaving profit on the table

When you think about it, cost-plus pricing is effective because you get to decide what profit margin you generate per sale.

However, what do you do when your customers would’ve happily paid more.

In fact, if you use cost-based pricing, you don’t even know if they would have.

Because this strategy works mostly on desired profit and less on customer research, you don’t know if a customer would’ve willingly paid more for your product.

Likewise, you don’t know if the reason for a lack of a sale is because customers would rather pay less.

And remember, when the volume of the product you’re acquiring goes up, the cost usually goes down, this means that your profit could increase, but you won’t know this because you’re not actively looking at your costs on that level.

It only looks at internal factors

Without customers, what do you really have? A fancy website and no revenue. One of the core issues with cost-plus pricing is that it’s mainly internal.

You decide how much profit you’d like.

You decide how much to sell your products for.

However, what it doesn’t factor in are the needs of the customers. It also doesn’t factor in what your competition is doing and the whole premise of supply and demand.

Because of this, what you’re left with is a price that is super inflexible and can’t adapt to changes in the market.

Some overheads costs are hard to calculate

If you just sell one product, working out your overhead costs should be pretty simple, but if you sell a range of different products, it can be hard to allocate indirect business costs to the products specifically.

If you have a big marketing spend on one product, do you allocate this cost for all products or just that one individual product?

Think about your competition

For many people, going online to buy your products is worthwhile because it means you get a cheaper price.

Top retailers like Amazon understand that and as a result, change the prices on their website often hourly.

They optimize their prices based on the current demand of the market.

It’s why you might be able to get a Christmas tree in January for $40 but needs to spend $500 if you plan to buy it on December 20th.

If you use cost-plus pricing, you simply cannot make use of this data as often the profit margins will be lower at certain times of the year but you know you can recoup those costs at other times of the year.

Whether you like it or not, your competitors are shopping around online.

As you can see, Google itself gives you multiple options for where to buy your chosen product from.

The world of e-commerce has made it exponentially easier to research different products at different prices

You can’t segment your customers

One of the crucial aspects of effective e-commerce selling is the ability to segment your customers. When you segment customers, you understand that different segments of the market are willing and able to pay different prices.

If you account for that, you’ll be able to increase your profits – backed by data.

However, if you use cost-plus pricing, you’re unable to do that and won’t be able to maximize revenue for each product category.

Cost Plus Pricing Takeaways

If you’re just starting out, cost-plus pricing could be a viable strategy to get you started. It ensures you stick within your own pricing limitations and never earn less than your outgoing spend.

However, despite this, it doesn’t account for customer segmentation or allows you to really experiment with other pricing strategies.

So if you have a business model where the prices must stay the same ( dollar store, for example) cost + pricing could work out well for you, however if you really want to see an increase in profits, then why not experiment with cost-plus pricing for some of your products and some other advanced pricing for the rest.

So if you’ve started using cost-plus pricing but feel that it’s not the right strategy for you (for reasons listed above) make sure that when you do decide to change your strategy, you do so slowly.

The first thing to do is look for segments of customers who might be willing to pay more.

Then experiment with altering those prices.

Next look at the products in your store that don’t sell well. See if you could improve the way you market those products, or see if it’s simply a case of reducing the price so that it falls closer in line with what your customers are happy to pay.

Over time, you’ll have groups of products that have different pricing strategies. In this situation, data is your friend.

The more data you have on each of your products and their saleability, the better-informed decisions you can make.  

Have you ever used cost-plus pricing within your e-commerce store? Leave a comment below.

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