Cost Based Pricing

Costs MUST Play a Role in Price

Cost based pricing simply means that your price is at least partly based on your costs, whether you ultimately go with a cost-plus pricing strategy or some other strategy.

The first idea many people have when setting their prices is to try and undercut the competition with lower prices. This reduces your profits, of course, so in turn, you have to reduce your costs.

Depending on how you do that, you could cripple your business, especially if you're a small business trying to compete with bigger marketplace players on price alone.

A cost based pricing strategy, however, as well as clever assessment of your necessary expenses, could uncover pockets of profit you were unaware of before. (Sometimes it's important to bring in an objective outsider to look for these opportunities.)

Here's a simple formula for cost based pricing:

Retail Cost + the image of your business = pricing

Getting Started With Cost Based Pricing

First off, do you know what the competition is charging? The more familiar you are with their offering, the better you can set pricing relative to theirs.

For instance, WalMart gets great wholesale prices because they buy skagillions of dozens of everything they sell.

On the other hand, you may offer a boutique environment that charges higher prices per unit, partly because you're not quite WalMart (yet!), and also because you may not WANT to become a WalMart.

Not only that... Do you think you can actually survive if you charge less than WalMart does? In a price war, there will be only one winner – and it won't be you.

Suggestions for Cutting Costs for Lower Pricing

If cost based pricing is proving to be challenging for you, you might benefit from some of the following suggestions...

Renegotiate pricing or terms with your suppliers. If you are a reliable payor, you might be able to get great payment terms that extend your timeline for payments.

Reduce nonessentials. For example, do you really need to be in that downtown office tower? More people work from home today than ever before. And with online business so readily manageable, you may not need a "bricks and mortar" establishment.

Cut down on the inventory. How much do you really need? Just because the volume break comes at 10,000 brochures, you may be doing yourself a disservice if you go for it.

In my business, we "went for it" – spent $14,000 on fantastic little brochures. They were extremely well received. However, when we changed our pricing and then relocated, they became obsolete and we were left with $7500 fantastic, yet useless, brochures. Imagine how I felt when I personally took them to the dump and dumped them!

Adjust your product line to promote only those items that sell the most. The market is telling you something. Listen to it!

Material, labor and overhead make up the total cost of any product or service. But what about opportunity costs?

There's a story about Picasso sitting casually at a café, doodling on a napkin. Another guest approached him and asked if she could have the napkin, to which Picasso said, "Yes, for $10,000." The woman was shocked and asked, "$10,000 for ten minutes' work?" Picasso replied, "No, madame, $10,000 for 25 years' work."

How to Do Cost-Based Pricing

Materials and overhead are the basic expenses you need to cover first. Overhead includes the expenses you have to pay even if you don’t sell anything: licensing, rent, electricity, insurance. So you need to adjust these regularly to reflect inflation, salary increases and other costs.

By the way, if you'd like to learn more about how to use bookkeeping to augment cost based pricing strategies, you'll want to check out our Business Buffet "Help Yourself" video learning series:
Business Buffet on Marketing – helping small business help itself to profit, by making business learning fun.

You CAN use cost based pricing to set a price that will work for both you and your customers.

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