Paul’s Pricing Dictionary: Cost-plus Pricing

P 75x75Cost-plus pricing, n. gerund, delusional.

  1. From “The Strategy & Tactics of Pricing” Nagle & Holden, 2nd edition (1987 & 1995):

Cost-plus Pricing:

– “carries an aura of financial prudence”

– “blueprint for mediocre financial performance”

– “impossible to determine product’s cost before a price has been set”

cost = ƒ(volume) = ƒ(price) but if price = ƒ(cost) then you create an infinite loop which can will lead to the wrong solution (“flawed circularity”)

– creates a catastrophic cycle of a decline when competition increases: volumes decline, then overheads allocated to the products will increase leading to increased prices, which in turn will drive volumes down, increases overheads …. etc

2. Cost-plus pricing assumes costs are accurate, which is rarely the case, and, in reality, there is no good way of defining – let alone allocating – overheads:

cost = ƒ(allocations) = ƒ(volume) = ƒ(price), and again, if price = ƒ(cost) then you create an infinite loop which can will lead to the wrong solution (“flawed circularity” or – again, speaking in engineering rather than tabloid terms – catastrophic)

3. Sub-optimized pricing. Every price created by cost-plus pricing is either too high or too low. Every price could and should be improved.

Previously thought to be archaic but apparently in wider use than originally thought.

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