Pricing

4. Your Costs

4.1 A cost-plus approach to pricing has many disadvantages.

• It does not take into account the level of demand and competition.
• The price you need to charge depends on the volume you sell, which in turn will depend on the price you charge.
• The mistake to avoid is failing to include all your costs in your analysis. If you do this, you will end up undercharging.
• Cost-plus pricing reduces the pressure to control costs.

4.2 Although your costs do not tell you what your prices should be, they do tell you whether they are viable.

• If you charge less than your direct variable costs, you will make a loss.
• If you charge more than your direct costs, each sale will make a contribution towards covering your fixed costs and ultimately making a profit.
• The contribution each sale makes towards covering your fixed costs tells you what volume you need to sell to reach breakeven.

4.3 Your cost structure may influence your strategy.

• If you have high costs relative to your competitors, you will need to position your product with a premium price.
• The higher the proportion of fixed costs, the more important it will be to generate high sales volumes.
• Some costs are unrecoverable if sales are not made soon enough.

4.4 Analysing your costs can be a useful benchmarking exercise.

• In the absence of other reasons, margins below industry norms suggest your costs are too high or your prices too low.
• Industry margins provide a rough guide to the prices which may be achievable when considering new products.
• Differences in costs can be a useful way of creating consistent pricing across a range of products or markets.
• Analysing the additional costs can help to prevent you from undercharging for special orders or demanding customers.