What's Wrong With Cost Plus?

Jul 14, 2015

 

Cost-plus is probably the most common approach to pricing but it overlooks one critical fact: customers couldn't care less about your costs.

 

In many businesses (including retail floral) the cost-plus approach to pricing rules. The idea is simple – total your costs, add a profit factor and put the price on the sticker.

The problem is that customers don't about your costs. Imagine you are a florist and you deal with three wholesalers that charge similar prices. Suddenly one of them raises their prices substantially, and they are no longer competitive with the other two.

You call and they tell you one or more of many possible stories. Maybe one of their delivery drivers had one accident too many and they're now facing higher insurance premiums. Maybe they need a new flower cooler. Maybe they had to hire the owner's son at an inflated salary. The common thread is that their costs have gone up.

Would you care? Would you pay more for their products when you had less expensive alternatives? Probably not. You value their product according to what you can charge for it and what you would pay elsewhere. Their costs don't play any part in that.

It's the same when you are the vendor and setting prices. Your customers have no interest in your costs. If you overpay on a lease you can't assume customers will pay more for your product. If you overpay your wholesalers you can't expect your customers to make it up.

Now – if you pay more for a location in a prestigious area it might increase the value of your brand, and the value people place on your products. If you buy better, more expensive product it might have the same effect. In both situations you can charge more, but not because of increased costs. You can charge more because customers place a higher value on your product.

The good news is that some customers and some situations may let you charge more than a simple cost plus formula would suggest. If a customer highly values your product and is prepared to pay a lot for it, why would you choose to be constrained by a conservative cost-plus formula?

An understanding of your costs is absolutely essential, but costs should not dictate price.



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