Don't you believe it ... Costs are the best basis for pricing

If there's a business faux pas that makes me queasy, it's this one.

by Alastair Dryburgh, head of Akenhurst Consultants,
Last Updated: 31 Aug 2010

Cost-plus pricing is widespread, but so many things are wrong with it that it's going to be hard fitting them all into this space. But here goes ...

Cost-plus ignores the value of knowledge. If your business has a future in the UK, it's a knowledge business. You aren't just selling stuff - you're selling the result of know-how, technical expertise, research and development, marketing and branding. Would you expect to buy Microsoft Office for £2, the cost of the CD and the box? Of course not. The value is in the code, not the physical manifestation.

It leads you into the commodity trap. Set your prices as cost-plus and you commit to compete just on price. If you price based on value to the customer, however, you commit to deliver a distinctive offering that your customers appreciate and will happily pay more for. Which would you rather spend your days doing?

It can even put you out of business. The combination of cost-cutting measures and cost-plus pricing can be disastrous. An engineering client of mine tried to boost profits by sourcing more cheaply from the Far East. He ended up achieving exactly the opposite: because prices were set at cost-plus-30%, every EUR100 he saved on components translated into EUR130 lost through lower prices. His road to hell was certainly paved with good intentions ...

Pricing ultimately comes down to pride. You can buy the same inputs, at the same prices, as your competitors; can you combine them to make something more valuable than they can? If you can, set your prices accordingly. But if you can't command a price premium, you know what you need to do.

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