Cost Based Pricing: Definition, Types, Advantages, and Disadvantages
Cost-based pricing is one of the pricing strategies widely used by companies.
In this strategy, the selling price of a product or service is determined based on the total production costs incurred, then added to the percentage of profit desired by the company.
Cost-based pricing has become popular in various industries because it provides certainty for companies that the selling price can cover all costs incurred and provide a profit margin.
This method is very effective for companies that want to maintain financial stability without having to monitor competitor prices intensively. This strategy is also quite popular because of its ease of implementation.
Definition of Cost-Based Pricing
Cost-based pricing is a pricing strategy in which a company determines the selling price of a product or service based on the total production costs incurred.
This strategy aims to ensure that the selling price of the product can cover all costs incurred, as well as provide adequate profit for the company.
In this method, all costs associated with the production process, such as raw material costs, labor, overhead, and distribution, are added up first.
After that, the company adds a markup or percentage of desired profit to produce the final selling price.
Quoting from Indeed, cost-based pricing is a method that allows companies to set prices according to the costs incurred to produce goods or provide services.
In this strategy, companies focus on cost elements as the main basis for determining prices, rather than considering competitor prices or market conditions.
Cost-based pricing also plays an important role in helping companies maintain financial stability, especially in uncertain market conditions.
In situations where production costs suddenly increase, for example due to an increase in raw material prices, the company can adjust the selling price of the product to remain in accordance with the costs incurred
Types of Cost Based Pricing
Quoting from Dealhub, there are several methods in cost-based pricing that are commonly used by companies.
Each method has a different calculation method and purpose, depending on the business needs and target market of the company.
Here are the types of cost-based pricing that you need to know more about:
Cost Plus Pricing
Cost plus pricing is the simplest and most frequently used pricing method in the business world.
In this method, the company adds a percentage markup or fixed profit to the production cost per unit of product. In other words, the selling price is based on the total production costs plus the desired profit margin.
For example, if the production cost per unit of a product is Rp50,000 and the company wants to apply a markup of 20%, then the selling price that will be offered to consumers is Rp60,000 (from the calculation of Rp50,000 + (20% x Rp50,000) = Rp60,000).
Break Even Pricing
This strategy aims to determine the break-even point where the company neither makes a profit nor a loss. This strategy is the right way to calculate how many units of product must be sold in order to cover all production costs.
For example, if the total production and operational costs are Rp500,000 and the price per unit of product is set at Rp50,000, the company must sell 10 units to reach the break-even point.
Target Profit Pricing
Target profit pricing is a cost-based pricing method that considers a certain profit target that the company wants to achieve, while still keeping the product price competitive in the market.
The company calculates the total cost and the targeted profit, then divides it by the number of units produced.
For example, if the total production cost is Rp500,000 and the company wants to make a profit of Rp100,000, then the total target becomes Rp600,000.
If the company wants to produce 100 units, the price per unit offered is IDR 6,000.
This method provides flexibility for companies to set selling prices according to profit targets, as well as considering production capacity and market demand.
Advantages and Disadvantages of Cost Based Pricing
Reported from SPP, here are the advantages of using cost-based pricing:
- Easy to Implement: Cost-based pricing is a simple strategy because it does not require extensive competitor research. You only need to calculate production costs and add the desired margin.
- Guarantee Profit: By applying a fixed markup, companies can ensure that every sale generates profit.
- Transparency: Cost-based pricing is an approach that makes it easier for customers to understand the basis for pricing. In fact, 60% of consumers consider transparency to be an important factor in building trust in a brand.
- Easy to Explain: When there is a price increase, customers are more likely to accept it if the reason is an increase in production costs.
Quoting from Competera, cost-based pricing also has several disadvantages:
- Ignores Market Demand: Cost-based pricing is a strategy that does not consider competitor prices and consumer perceptions of value.
- Lack of Innovation: Companies tend to focus on fixed margins and are less motivated to improve efficiency or innovate.
- Difficulty Calculating Indirect Costs: Cost-based pricing is a method that sometimes makes it difficult to calculate indirect costs such as marketing and distribution.
- Does Not Guarantee Sales: Although it generates profit per unit, there is no guarantee that consumers will buy at that price.
Interested in learning more about pricing strategies? You can take the Marketing Pricing Strategy class from prasmul-eli.
In this class, you will understand the basic principles of determining the right price for the sustainability of products and companies.
You will also learn various alternative pricing strategies that can be applied to your business.
Don't miss the opportunity to improve your understanding of pricing strategies!
