cost based pricing business plan

• What is Cost-Based Pricing? A Definitive Guide to Strategy

Cost-Based Pricing Strategy

Types of cost-based pricing strategy.

• Cost-Plus Pricing

Markup Pricing

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Price = Unit Cost + Expected Return on Cost as a Percentage

Price = Unit Cost + Markup Price

Price = Variable Costs + Fixed Costs / Unit Sales + Desired Profit

Price = (Total Cost + Desired Profit %) / Total Units Sold

(Fixed costs) / (number of units) + price per unit or 200,000 / 10,000 + 10 = 30

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In this blog you will learn about the importance of choosing the right pricing strategy for a successful business plan.

Why is a pricing strategy important for a business plan?

A business plan is a written document outlining a company’s core business practices – from products and services offered to marketing, financial planning and budget, but also pricing strategy. This business plan can be very lengthy, outlining every aspect of the business in detail. Or it can be very short and lean for start ups that want to be as agile as possible.

This plan can be used for external investors and relations or for internal purposes. A business plan can be useful for internal purposes because it can make sure that all the decision makers are on the same page about the most important aspects of the business.

A 1% price increase can lead to an 8% increase in profit margin.

A business plan could be very lengthy and detailed or short and lean, but in all instances, it should have a clear vision for how pricing is tackled. A pricing strategy ultimately greatly determines the profit margin of your product or service and how much revenue the company will make. Thorough research of consultancy agencies also show that pricing is very important. McKinsey even argues that a 1% prices increase can lead up to an 8% increase in profits. That is a real example of how small adjustments can have a huge impact!

It is clear that each business plan should have a section about pricing strategies. How detailed and complicated this pricing strategy should be depends for each individual business and challenges in the business environment. However, businesses should at least take some factors into account when thinking about their pricing strategy.

What factors to take into account?

The pricing strategy can best be explained in the marketing section of your business plan. In this section you should describe what price you will charge for your product or service to customers and your argumentation for why you ask this. However, businesses always balance the challenging scale of charging too much or too little. Ideally you want to find the middle, the optimal price point.

The following questions need to be answered for writing a well-structured pricing strategy in your business plan:

What is the cost of your product or service?

Most companies need to be profitable. They need to pay their expenses, their employees and return a reasonable profit. Unless you are a well-funded-winner-takes-all-growth-company such as Uber or Gorillas, you will need to earn more than you spend on your products. In order to be profitable you need to know how much your expenses are, to remain profitable overall.

How does your price compare to other alternatives in the market?

Most companies have competitors for their products or services, only few companies can act as a monopoly. Therefore, you need to know how your price compares to the other prices in the market. Are you one of the cheapest, the most expensive or somewhere in the middle?

Why is your price competitive?

When you know the prices of your competitors, you need to be able to explain why your price is better or different than that of your competitions. Do you offer more value for the same price? Do you offer less, but are you the cheapest? Or does your company offer something so unique that a premium pricing strategy sounds fair to your customer? You need to be able to stand out from the competition and price is an efficient differentiator.

What is the expected ROI (Return On Investment)?

When you set your price, you need to be able to explain how much you are expeciting to make. Will the price you offer attract enough customers to make your business operate profitable? Let’s say your expenses are 10.000 euros per month, what return will your price get you for your expected amount of sales?

Top pricing strategies for a business plan

Now you know why pricing is important for your business plan, “but what strategies are best for me?” you may ask. Well, let’s talk pricing strategies. There are plenty of pricing strategies and which ones are best for which business depends on various factors and the industry. However, here is a list of 9 pricing strategies that you can use for your business plan.

• Cost-plus pricing
• Competitive pricing
• Key-Value item pricing
• Dynamic pricing
• Premium pricing
• Hourly based pricing
• Customer-value based pricing
• Psychological pricing
• Geographical pricing

Most of the time, businesses do not use a single pricing strategy in their business but rather a combination of pricing strategies. Cost-plus pricing or competitor based pricing can be good starting points for pricing, but if you make these dynamic or take geographical regions into account, then your pricing becomes even more advanced!

Pricing strategies should not be left out of your business plan. Having a clear vision on how you are going to price your product(s) and service(s) helps you to achieve the best possible profit margins and revenue. If you are able to answer thoughtfully on the questions asked in this blog then you know that you have a rather clear vision on your pricing strategy.

If there are still some things unclear or vague, then it would be adviceable to learn more about all the possible pricing strategies . You can always look for inspiration to our business cases. Do you want to know more about pricing or about SYMSON? Do not hesitate to contact us!

Do you want a free demo to try how SYMSON can help your business with margin improvement or pricing management? Do you want to learn more? Schedule a call with a consultant and book a 20 minute brainstorm session!

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The Ultimate Guide to Pricing Strategies & Models

Discover how to properly price your products, services, or events so you can drive both revenue and profit.

FREE SALES PRICING CALCULATOR

Determine the best pricing strategy for your business with this free calculator and template.

Updated: 08/16/23

Published: 08/16/23

Pricing your products and services can be tough. Set prices too high, and you miss out on valuable sales. Set them too low, and you miss out on valuable revenue.

Thankfully, pricing doesn’t have to be a sacrifice or a shot in the dark. There are dozens of pricing models and strategies that can help you better understand how to set the right prices for your audience and revenue goals.

That’s why we’ve created this guide.

Whether you’re a business beginner or a pricing pro, the tactics and strategies in this guide will get you comfortable with pricing your products. Bookmark this guide for later and use the chapter links to jump around to sections of interest.

Pricing Strategy

Types of pricing strategies, how to create a pricing strategy, pricing models based on industry or business.

Conducting a Pricing Analysis

Pricing Strategy Examples

A pricing strategy is a model or method used to establish the best price for a product or service. It helps you choose prices to maximize profits and shareholder value while considering consumer and market demand.

If only pricing was as simple as its definition — there’s a lot that goes into the process.

Pricing strategies account for many of your business factors, like revenue goals, marketing objectives, target audience, brand positioning, and product attributes. They’re also influenced by external factors like consumer demand, competitor pricing, and overall market and economic trends.

It’s not uncommon for entrepreneurs and business owners to skim over pricing. They often look at the cost of their products (COGS) , consider their competitor’s rates, and tweak their own selling price by a few dollars. While your COGS and competitors are important, they shouldn’t be at the center of your pricing strategy.

The best pricing strategy maximizes your profit and revenue.

Before we talk about pricing strategies, let’s review an important pricing concept that will apply regardless of what strategies you use.

Free Sales Pricing Strategy Calculator

• Cost-Plus Pricing
• Skimming Strategy
• Value-Based Pricing

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Determine the Best Pricing Strategy For Your Business

Fill out this form to access the free template., price elasticity of demand.

Price elasticity of demand is used to determine how a change in price affects consumer demand.

If consumers still purchase a product despite a price increase (such as cigarettes and fuel) that product is considered inelastic .

On the other hand, elastic products suffer from pricing fluctuations (such as cable TV and movie tickets).

You can calculate price elasticity using the formula:

% Change in Quantity ÷ % Change in Price = Price Elasticity of Demand

The concept of price elasticity helps you understand whether your product or service is sensitive to price fluctuations. Ideally, you want your product to be inelastic — so that demand remains stable if prices do fluctuate.

Cost, Margin, & Markup in Pricing

To choose a pricing strategy, it’s also essential to understand the role of cost, margin, and markup — especially if you’d like your pricing to be cost-based . Let’s dive into the definition for each.

Cost refers to the fees you incur from manufacturing, sourcing, or creating the product you sell. That includes the materials themselves, the cost of labor, the fees paid to suppliers, and even the losses. Cost doesn’t include overhead and operational expenses such as marketing, advertising, maintenance, or bills.

Margin (in this case, gross margin) refers to the amount your business earns after you subtract manufacturing costs.

Markup refers to the additional amount you charge for your product over the production and manufacturing fees.

Now, let’s cover some common pricing strategies. As we do so, it’s important to note that these aren’t necessarily standalone strategies — many can be combined when setting prices for your products and services.

• Competition-Based Pricing
• Dynamic Pricing
• High-Low Pricing
• Penetration Pricing
• Skimming Pricing
• Psychological Pricing
• Geographic Pricing

Now, let's dive into the descriptions of each pricing strategy — many of which are included in the template below — so you can learn about what makes each of them unique.

Discover how much your business can earn using different pricing strategies with HubSpot's free sales pricing calculator so you can choose the best pricing model for your business.

Download Template

1. competition-based pricing strategy.

Competition-based pricing is also known as competitive pricing or competitor-based pricing. This pricing strategy focuses on the existing market rate (or going rate ) for a company’s product or service; it doesn’t take into account the cost of their product or consumer demand.

Instead, a competition-based pricing strategy uses the competitors’ prices as a benchmark. Businesses who compete in a highly saturated space may choose this strategy since a slight price difference may be the deciding factor for customers.

With competition-based pricing , you can price your products slightly below your competition, the same as your competition, or slightly above your competition. For example, if you sold marketing automation software , and your competitors’ prices ranged from $19.99 per month to $39.99 per month, you’d choose a price between those two numbers.

Whichever price you choose, competitive pricing is one way to stay on top of the competition and keep your pricing dynamic.

Competition-Based Pricing Strategy in Marketing

Consumers are primarily looking for the best value which isn’t always the same as the lowest price. Pricing your products and services competitively in the market can put your brand in a better position to win a customer’s business. Competitive pricing works especially well when your business offers something the competition doesn’t — like exceptional customer service, a generous return policy, or access to exclusive loyalty benefits .

2. Cost-Plus Pricing Strategy

A cost-plus pricing strategy focuses solely on the cost of producing your product or service, or your COGS . It’s also known as markup pricing since businesses who use this strategy “markup” their products based on how much they’d like to profit.

To apply the cost-plus method, add a fixed percentage to your product production cost. For example, let’s say you sold shoes. The shoes cost $25 to make, and you want to make a $25 profit on each sale. You’d set a price of $50, which is a markup of 100%.

Cost-plus pricing is typically used by retailers who sell physical products. This strategy isn’t the best fit for service-based or SaaS companies as their products typically offer far greater value than the cost to create them.

Cost-Plus Pricing Strategy in Marketing

Cost-plus pricing works well when the competition is pricing using the same model. It won’t help you attract new customers if your competition is working to acquire customers rather than growing profits. Before executing this strategy, complete a pricing analysis that includes your closest competitors to make sure this strategy will help you meet your goals.

3. Dynamic Pricing Strategy

Dynamic pricing is also known as surge pricing, demand pricing, or time-based pricing. It’s a flexible pricing strategy where prices fluctuate based on market and customer demand.

Hotels, airlines, event venues, and utility companies use dynamic pricing by applying algorithms that consider competitor pricing, demand, and other factors. These algorithms allow companies to shift prices to match when and what the customer is willing to pay at the exact moment they’re ready to make a purchase.

Dynamic Pricing Strategy in Marketing

Dynamic pricing can help keep your marketing plans on track. Your team can plan for promotions in advance and configure the pricing algorithm you use to launch the promotion price at the perfect time. You can even A/B test dynamic pricing in real-time to maximize your profits.

4. High-Low Pricing Strategy

A high-low pricing strategy is when a company initially sells a product at a high price but lowers that price when the product drops in novelty or relevance. Discounts, clearance sections, and year-end sales are examples of high-low pricing in action — hence the reason why this strategy may also be called a discount pricing strategy.

High-low pricing is commonly used by retail firms that sell seasonal items or products that change often, such as clothing, decor, and furniture. What makes a high/low pricing strategy appealing to sellers? Consumers enjoy anticipating sales and discounts, hence why Black Friday and other universal discount days are so popular.

High-Low Pricing Strategy in Marketing

If you want to keep the foot traffic steady in your stores year-round, a high-low pricing strategy can help. By evaluating the popularity of your products during particular periods throughout the year, you can leverage low pricing to increase sales during traditionally slow months.

5. Penetration Pricing Strategy

Contrasted with skimming pricing, a penetration pricing strategy is when companies enter the market with an extremely low price, effectively drawing attention (and revenue) away from higher-priced competitors. Penetration pricing isn’t sustainable in the long run, however, and is typically applied for a short time.

This pricing method works best for brand new businesses looking for customers or for businesses that are breaking into an existing, competitive market. The strategy is all about disruption and temporary loss … and hoping that your initial customers stick around as you eventually raise prices.

(Another tangential strategy is loss leader pricing , where retailers attract customers with intentionally low-priced items in hopes that they’ll buy other, higher-priced products, too. This is precisely how stores like Target get you — and me.)

Penetration Pricing Strategy in Marketing

Penetration pricing has similar implications as freemium pricing — the money won’t come in overnight. But with enough value and a great product or service, you could continue to make money and scale your business as you increase prices. One tip for this pricing strategy is to market the value of the products you sell and let price be a secondary point.

6. Skimming Pricing Strategy

A skimming pricing strategy is when companies charge the highest possible price for a new product and then lower the price over time as the product becomes less and less popular. Skimming is different from high-low pricing in that prices are lowered gradually over time.

Technology products, such as DVD players, video game consoles, and smartphones, are typically priced using this strategy as they become less relevant over time. A skimming pricing strategy helps recover sunk costs and sell products well beyond their novelty, but the strategy can also annoy consumers who bought at full price and attract competitors who recognize the “fake” pricing margin as prices are lowered.

Skimming Pricing Strategy in Marketing

Skimming pricing strategy can work well if you sell products that have products with varying life cycle lengths. One product may come in and out of popularity quickly so you have a short time to skim your profits in the beginning stages of the life cycle. On the flip side, a product that has a longer life cycle can stay at a higher price for more time. You’ll be able to maintain your marketing efforts for each product more effectively without constantly adjusting your pricing across every product you sell.

7. Value-Based Pricing Strategy

A value-based pricing strategy is when companies price their products or services based on what the customer is willing to pay. Even if it can charge more for a product, the company decides to set its prices based on customer interest and data.

If used accurately, value-based pricing can boost your customer sentiment and loyalty. It can also help you prioritize your customers in other facets of your business, like marketing and service.

On the flip side, value-based pricing requires you to constantly be in tune with your various customer profiles and buyer personas and possibly vary your prices based on those differences.

Value-Based Pricing Strategy in Marketing

Marketing to your customers should always lead with value, so having a value-based pricing model should help strengthen the demand for your products and services. Just be sure that your audiences are distinct enough in what they’re willing to pay for — you don’t want to run into trouble by charging more or less based on off-limits criteria .

8. Psychological Pricing Strategy

Psychological pricing is what it sounds like — it targets human psychology to boost your sales.

For example, according to the " 9-digit effect ", even though a product that costs $99.99 is essentially $100, customers may see this as a good deal simply because of the "9" in the price.

Another way to use psychological pricing would be to place a more expensive item directly next to (either, in-store or online) the one you're most focused on selling . Or offer a "buy one, get one 50% off (or free)" deal that makes customers feel as though the circumstances are too good to pass up on.

And lastly, changing the font, size, and color of your pricing information on and around your products has also been proven, in various instances, to boost sales.

Psychological Pricing Strategy in Marketing

Psychological pricing strategy requires an intimate understanding of your target market to yield the best results. If your customers are inclined to discounts and coupons, appealing to this desire through your marketing can help this product meet their psychological need to save money. If paying for quality is important to your audience, having the lowest price on the shelf might not help you reach your sales goals. Regardless of the motivations your customers have for paying a certain price for a product, your pricing and marketing should appeal to those motivations.

9. Geographic Pricing Strategy

Geographic pricing is when products or services are priced differently depending on geographical location or market.

This strategy may be used if a customer from another country is making a purchase or if there are disparities in factors like the economy or wages (from the location in which you're selling a good to the location of the person it is being sold to).

Geographic Pricing Strategy in Marketing

Marketing a geographically priced product or service is easy thanks to paid social media advertising. Segmenting by zip code, city, or even region can be accomplished at a low cost with accurate results. Even as specific customers travel or permanently move, your pricing model will remain the same which helps you maintain your marketing costs.

Download our free guide to creating buyer personas to easily organize your audience segments and make your marketing stronger.

Like we said above, these strategies aren’t necessarily meant to stand alone. We encourage you to mix and match these methods as needed.

Below, we cover more specific pricing models for individual products.

Pricing Models

While your pricing strategy may determine how your company sets fees for its offerings overall , the below pricing models can help you set prices for specific product lines. Let's take a look.

1. Freemium

A combination of the words “free” and “premium,” freemium pricing is when companies offer a basic version of their product hoping that users will eventually pay to upgrade or access more features.

Unlike cost-plus, freemium is a pricing model commonly used by SaaS and other software companies. They choose this model because free trials and limited memberships offer a peek into a software’s full functionality — and also build trust with a potential customer before purchase.

With freemium, a company’s prices must be a function of the perceived value of their products. For example, companies that offer a free version of their software can’t ask users to pay $100 to transition to the paid version. Prices must present a low barrier to entry and grow incrementally as customers are offered more features and benefits.

Freemium Pricing in Marketing

Freemium pricing may not make your business a lot of money on the initial acquisition of a customer, but it gives you access to the customer which is just as valuable. With access to their email inboxes, phone number, and any other contact information you gather in exchange for the free product, you can nurture the customer into a brand loyal advocate with a worthwhile LTV .

2. Premium Pricing

Also known as prestige pricing and luxury pricing, a premium pricing model is when companies price their products high to present the image that their products are high-value, luxury, or premium. Prestige pricing focuses on the perceived value of a product rather than the actual value or production cost.

Prestige pricing is a direct function of brand awareness and brand perception. Brands that apply this pricing method are known for providing value and status through their products — which is why they’re priced higher than other competitors. Fashion and technology are often priced using this model because they can be marketed as luxurious, exclusive, and rare.

Premium Pricing in Marketing

Premium pricing is quite dependent upon the perception of your product within the market. There are a few ways to market your product in order to influence a premium perception of it including using influencers, controlling supply, and driving up demand.

3. Hourly Pricing

Hourly pricing, also known as rate-based pricing, is commonly used by consultants, freelancers, contractors, and other individuals or laborers who provide business services. Hourly pricing is essentially trading time for money. Some clients are hesitant to honor this pricing strategy as it can reward labor instead of efficiency.

Hourly Pricing in Marketing

If your business thrives on quick, high-volume projects, hourly pricing can be just the incentive for customers to work with you. By breaking down your prices into hourly chunks, customers can make the decision to work with you based on a low price point rather than finding room in their budget for an expensive project-based commitment.

4. Bundle Pricing

Bundle pricing is when you offer (or "bundle") two or more complementary products or services together and sell them for a single price. You may choose to sell your bundled products or services only as part of a bundle, or sell them as both components of bundles and individual products.

This is a great way to add value through your offerings to customers who are willing to pay extra upfront for more than one product. It can also help you get your customers hooked on more than one of your products faster.

Bundle Pricing in Marketing

Marketing bundle deals can help you sell more products than you would otherwise sell individually. It’s a smart way to upsell and cross-sell your offerings in a way that is beneficial for the customer and your revenue goals.

5. Project-Based Pricing

Project-based pricing is the opposite of hourly pricing — this approach charges a flat fee per project instead of a direct exchange of money for time. It is also used by consultants, freelancers, contractors, and other individuals or laborers who provide business services.

Project-based pricing may be estimated based on the value of the project deliverables. Those who choose this pricing model may also create a flat fee from the estimated time of the project.

Project-Based Pricing in Marketing

Leading with the benefits a customer will derive from working with your business on a project can make project-based pricing more appealing. Although the cost of the project may be steep, the one-time investment can be worth it. Your clients will know that they’ll be able to work with you until the project is completed rather than until their allotted hours are depleted.

6. Subscription Pricing

Subscription pricing is a common pricing model at SaaS companies, online retailers, and even agencies who offer subscription packages for their services.

Whether you offer flat rate subscriptions or tiered subscriptions, the benefits of this model are endless. For one, you have all but guaranteed monthly recurring revenue (MRR) and yearly recurring revenue. That makes it simpler to calculate your profits on a monthly basis. It also often leads to higher customer lifetime values .

The one thing to be wary of when it comes to subscription pricing is the high potential for customer churn . People cancel subscriptions all the time, so it's essential to have a customer retention strategy in place to ensure clients keep their subscriptions active.

Subscription Pricing in Marketing

When marketing your subscription products, it's essential to create buyer personas for each tier. That way, you know which features to include and what will appeal to each buyer. A general subscription that appeals to everyone won't pull in anyone.

Even Amazon, which offers flat-rate pricing for its Prime subscription, includes a membership for students. That allows them to market the original Prime more effectively by creating a sense of differentiation.

Now, let’s discuss how to build a pricing strategy of your own liking.

1. Evaluate pricing potential.

You want to make a strategy that is optimal for your unique business. To begin, you need to evaluate your pricing potential. This is the approximate product or service pricing your business can potentially achieve in regard to cost, demand, and more.

Some factors that can affect your pricing potential include:

• Geographical market specifics
• Operating costs
• Inventories
• Demand fluctuations
• Competitive advantages and concerns
• Demographic data

We’ll dive deeper into demographic data in the next step.

2. Determine your buyer personas.

You have to price your product on the type of buyer persona that’s looking for it. When you look at your ideal customer, you’ll have to look at their:

• Customer Lifetime Value
• Willingness to Pay
• Customer Pain Points

To aid in this process, interview customers and prospects to see what they do and like, and ask for your sales team’s feedback on the best leads and their characteristics.

3. Analyze historical data.

Take a look at your previous pricing strategies. You can calculate the difference in closed deals, churn data , or sold product on different pricing strategies that your business has worked with before and look at which were the most successful.

4. Strike a balance between value and business goals.

When developing your pricing strategy, you want to make sure the price is good to your bottom line and your buyer personas. This compromise will better help your business and customer pool, with the intentions of:

• Increasing profitability
• Improving cash flow
• Market penetration
• Expanding market share

5. Look at competitor pricing.

You can’t make a pricing strategy without conducting research on your competitors’ offerings. You’ll have to decide between two main choices when you see the price difference for your same product or service:

• Beat your competitors’ price - If a competitor is charging more for the same offering as your brand, then make the price more affordable.
• Beat your competitors’ value - Also known as value-based pricing , you can potentially price your offering higher than your competitors if the value provided to the customer is greater.

To see the competition’s full product or service offering, conduct a full competitive analysis so you can see their strengths and weaknesses, and make your pricing strategy accordingly.

So we’ve gone over how to create a pricing strategy, now let’s discuss how to apply these steps to different businesses and industries.

Not every pricing strategy is applicable to every business. Some strategies are better suited for physical products whereas others work best for SaaS companies. Here are examples of some common pricing models based on industry and business.

Product Pricing Model

Unlike digital products or services, physical products incur hard costs (like shipping, production, and storage) that can influence pricing. A product pricing strategy should consider these costs and set a price that maximizes profit, supports research and development, and stands up against competitors.

👉🏼 We recommend these pricing strategies when pricing physical products : cost-plus pricing, competitive pricing, prestige pricing, and value-based pricing.

Digital Product Pricing Model

Digital products, like software, online courses, and digital books, require a different approach to pricing because there’s no tangible offering or unit economics (production cost) involved. Instead, prices should reflect your brand, industry, and overall value of your product.

👉🏼 We recommend using these pricing strategies when pricing digital products: competition-based pricing, freemium pricing, and value-based pricing.

Restaurant Pricing Model

Restaurant pricing is unique in that physical costs, overhead costs, and service costs are all involved. You must also consider your customer base, overall market trends for your location and cuisine, and the cost of food — as all of these can fluctuate.

👉🏼 We recommend using these pricing strategies when pricing at restaurants: cost-plus pricing, premium pricing, and value-based pricing.

Event Pricing Model

Events can’t be accurately measured by production cost (not unlike the digital products we discussed above). Instead, event value is determined by the cost of marketing and organizing the event as well as the speakers, entertainers, networking, and the overall experience — and the ticket prices should reflect these factors.

👉🏼 We recommend using these pricing strategies when pricing live events: competition-based pricing, dynamic pricing, and value-based pricing.

Services Pricing Model

Business services can be hard to price due to their intangibility and lack of direct production cost. Much of the service value comes from the service provider’s ability to deliver and the assumed caliber of their work. Freelancers and contractors , in particular, must adhere to a services pricing strategy.

👉🏼 We recommend using these pricing strategies when pricing services: hourly pricing, project-based pricing, and value-based pricing.

Nonprofit Pricing Model

Nonprofits need pricing strategies, too — a pricing strategy can help nonprofits optimize all processes so they’re successful over an extended period of time.

A nonprofit pricing strategy should consider current spending and expenses, the breakeven number for their operation, ideal profit margin, and how the strategy will be communicated to volunteers, licensees, and anyone else who needs to be informed. A nonprofit pricing strategy is unique because it often calls for a combination of elements that come from a few pricing strategies.

👉🏼 We recommend using these pricing strategies when pricing nonprofits: competitive pricing, cost-plus pricing, demand pricing, and hourly pricing.

Education Pricing Model

Education encompasses a wide range of costs that are important to consider depending on the level of education, private or public education, and education program/ discipline.

Specific costs to consider in an education pricing strategy are tuition, scholarships, additional fees (labs, books, housing, meals, etc.). Other important factors to note are competition among similar schools, demand (number of student applications), number and costs of professors/ teachers, and attendance rates.

👉🏼 We recommend using these pricing strategies when pricing education: competitive pricing, cost-based pricing, and premium pricing.

Real Estate Pricing Model

Real estate encompasses home value estimates, market competition, housing demand, and cost of living. There are other factors that play a role in real estate pricing models including potential bidding wars, housing estimates and benchmarks (which are available through real estate agents but also through free online resources like Zillow ), and seasonal shifts in the real estate market.

👉🏼 We recommend using these pricing strategies when pricing real estate: competitive pricing, dynamic pricing, premium pricing, and value-based pricing.

Agency Pricing Model

Agency pricing models impact your profitability, retention rates, customer happiness, and how you market and sell your agency. When developing and evolving your agency’s pricing model, it’s important to take into consideration different ways to optimize it so you can determine the best way to boost the business's profits.

👉🏼 We recommend using these pricing strategies when pricing agencies: hourly pricing, project-based pricing, and value-based pricing.

Manufacturing Pricing Model

The manufacturing industry is complex — there are a number of moving parts and your manufacturing pricing model is no different. Consider product evolution, demand, production cost, sale price, unit sales volume, and any other costs related to your process and product. Another key part to a manufacturing pricing strategy is understanding the maximum amount the market will pay for your specific product to allow for the greatest profit.

👉🏼 We recommend using these pricing strategies when pricing manufacturing: competitive pricing, cost-plus pricing, and value-based pricing.

Ecommerce Pricing Model

Ecommerce pricing models are how you determine the price at which you’ll sell your online products and what it'll cost you to do so. Meaning, you must think about what your customers are willing to pay for your online products and what those products cost you to purchase and/or create. You might also factor in your online campaigns to promote these products as well as how easy it is for your customers to find similar products to yours on the ecommerce sites of your competitors.

👉🏼 We recommend using these pricing strategies when pricing ecommerce: competitive pricing, cost-based pricing, dynamic pricing, freemium pricing, penetration pricing, and value-based pricing.

Pricing Analysis

Pricing analysis is a process of evaluating your current pricing strategy against market demand. Generally, pricing analysis examines price independently of cost. The goal of a pricing analysis is to identify opportunities for pricing changes and improvements.

You typically conduct a pricing analysis when considering new product ideas, developing your positioning strategy, or running marketing tests. It's also wise to run a price analysis once every year or two to evaluate your pricing against competitors and consumer expectations — doing so preemptively avoids having to wait for poor product performance.

How to Conduct a Pricing Analysis

1. determine the true cost of your product or service..

To calculate the true cost of a product or service that you sell, you’ll want to recognize all of your expenses including both fixed and variable costs. Once you’ve determined these costs, subtract them from the price you’ve already set or plan to set for your product or service.

2. Understand how your target market and customer base respond to the pricing structure.

Surveys, focus groups, or questionnaires can be helpful in determining how the market responds to your pricing model. You’ll get a glimpse into what your target customers value and how much they’re willing to pay for the value your product or service provides.

3. Analyze the prices set by your competitors.

There are two types of competitors to consider when conducting a pricing analysis: direct and indirect.

Direct competitors are those who sell the exact same product that you sell. These types of competitors are likely to compete on price so they should be a priority to review in your pricing analysis.

Indirect competitors are those who sell alternative products that are comparable to what you sell. If a customer is looking for your product, but it’s out of stock or it’s out of their price range, they may go to an indirect competitor to get a similar product.

4. Review any legal or ethical constraints to cost and price.

There’s a fine line between competing on price and falling into legal and ethical trouble. You’ll want to have a firm understanding of price-fixing and predatory pricing while doing your pricing analysis in order to steer clear of these practices.

Analyzing your current pricing model is necessary to determine a new (and better!) pricing strategy. This applies whether you're developing a new product, upgrading your current one, or simply repositioning your marketing strategy.

Next, let’s look at some examples of pricing strategies that you can use for your own business.

Dynamic Pricing Strategy: Chicago Cubs Freemium Pricing Strategy: HubSpot Penetration Pricing Strategy: Netflix Premium Pricing: AWAY Competitive Pricing Strategy: Shopify Project-Based Pricing Strategy: Courtney Samuel Events Value-Based Pricing Strategy: INBOUND Bundle Pricing: State Farm Geographic Pricing: Gasoline

Pricing models can be hard to visualize. Below, we’ve pulled together a list of examples of pricing strategies as they’ve been applied to everyday situations or businesses.

1. Dynamic Pricing Strategy: Chicago Cubs

I live in Chicago five blocks away from Wrigley Field, and my friends and I love going to Cubs games. Finding tickets is always interesting, though, because every time we check prices, they’ve fluctuated a bit from the last time. Purchasing tickets six weeks in advance is always a different process than purchasing them six days prior — and even more sox pricing at the gate.

This is an example of dynamic pricing — pricing that varies based on market and customer demand. Prices for Cubs games are always more expensive on holidays, too, when more people are visiting the city and are likely to go to a game.

(Another prime example of dynamic pricing is INBOUND , for which tickets get more expensive as the event nears.)

2. Freemium Pricing Strategy: HubSpot

HubSpot is an example of freemium pricing at work. There's a free version of the CRM for scaling businesses as well as paid plans for the businesses using the CRM platform that need a wider range of features .

Moreover, within those marketing tools, HubSpot provides limited access to specific features. This type of pricing strategy allows customers to acquaint themselves with HubSpot and for HubSpot to establish trust with customers before asking them to pay for additional access.

3. Penetration Pricing Strategy: Netflix

Netflix is a classic example of penetration pricing : entering the market at a low price (does anyone remember when it was $7.99?) and increasing prices over time. Since I joined a couple of years ago, I’ve seen a few price increase notices come through my own inbox.

Despite their increases, Netflix continues to retain — and gain — customers. Sure, Netflix only increases their subscription fee by $1 or $2 each time, but they do so consistently. Who knows what the fees will be in five or ten years?

4. Premium Pricing: AWAY

There are lots of examples of premium pricing strategies … Rolex, Tesla, Nike — you name it. One that I thought of immediately was AWAY luggage .

Does luggage need to be almost $500? I’d say no, especially since I recently purchased a two-piece Samsonite set for one-third the cost. However, AWAY has still been very successful even though they charge a high price for their luggage. This is because when you purchase AWAY, you’re purchasing an experience. The unique branding and the image AWAY portrays for customers make the value of the luggage match the purchase price.

5. Competitive Pricing Strategy: Shopify

Shopify is an ecommerce platform that helps businesses manage their stores and sell their products online. Shopify — which integrates with HubSpot — has a competitive pricing strategy.

There are a number of ecommerce software options on the market today — Shopify differentiates itself by the features they provide users and the price at which they offer them. They have three thoughtfully-priced versions of their product for customers to choose from with a number of customizable and flexible features.

With these extensive options tailored to any ecommerce business' needs, the cost of Shopify is highly competitive and is often the same as or lower than other ecommerce platforms on the market today.

6. Project-Based Pricing Strategy: Courtney Samuel Events

Anyone who's planned a wedding knows how costly they can be. I'm in the midst of planning my own, and I've found that the bundled, project-based fees are the easiest to manage. For example, my wedding coordinator Courtney charges one flat fee for her services. This pricing approach focuses on the value of the outcome (e.g., an organized and stressless wedding day) instead of the value of the time spent on calls, projects, or meetings.

Because vendors like Courtney typically deliver a variety of services — wedding planning, day-of coordination, physical meetings, etc. — in addition to spending time answering questions and providing thoughtful suggestions, a project-based fee better captures the value of her work. Project-based pricing is also helpful for clients and companies who'd rather pay a flat fee or monthly retainer than deal with tracked hours or weekly invoices.

7. Value-Based Pricing Strategy: INBOUND

While INBOUND doesn't leave the ultimate ticket price up to its attendees, it does provide a range of tickets from which customers can choose. By offering multiple ticket "levels," customers can choose what experience they want to have based on how they value the event.

INBOUND tickets change with time, however, meaning this pricing strategy could also be considered dynamic (like the Cubs example above). As the INBOUND event gets closer, tickets tend to rise in price.

8. Bundle Pricing: State Farm

State Farm is known for its tongue-in-cheek advertisements and its bundle deals for home and auto insurance. You can receive a quote on one or the other, but getting a quote on both can save you money on your premiums.

State Farm benefits from bundle pricing by selling more policies, and consumers benefit by paying less than they normally would if they used two different insurance providers for home and auto coverage.

9. Geographic Pricing: Gasoline

Gasoline is notorious for having a wide range of prices around the world, but even within the United States, prices can vary by several dollars depending on the state you live in. In California for example, gas prices have consistently hovered around $3 in the summer months for the past 10 years. On the other hand, gas prices in Indiana have been in the $2 range during the same time period. Laws, environmental factors, and production cost all influence the price of gasoline in California which causes the geographic disparity in the cost of the fuel.

Get Your Pricing Strategy Right

Thinking about everything that goes into pricing can make your head spin: competitors, production costs, customer demand, industry needs, profit margins … the list is endless. Thankfully, you don’t have to master all of these factors at once.

Simply sit down, calculate some numbers (like your COGS and profit goals), and figure out what’s most important for your business. Start with what you need, and this will help you pinpoint the right kind of pricing strategy to use.

More than anything, though, remember pricing is an iterative process. It’s highly unlikely that you’ll set the right prices right away — it might take a couple of tries (and lots of research), and that’s OK.

Editor's note: This post was originally published in March 2019 and has been updated for comprehensiveness.

Don't forget to share this post!

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Pricing Strategy in a Business Plan: Deep Dive

• March 21, 2024
• Business Plan , How to Write

In this blog post, we’re diving into how to choose and explain your pricing strategy in your business plan. We’ll cover different pricing models like penetration, premium, and value-based. We’ll also dive into how to present your pricing strategy in your business plan.

Whether you’re starting a new business or preparing a business plan for an existing company, getting your pricing right is key to attracting customers and making a profit. Let’s break down how to make your pricing strategy clear and effective. Let’s dive in!

What are the different pricing strategies?

Different pricing strategies can significantly influence demand, profitability, and market positioning for businesses. Here’s an overview of some common pricing strategies:

• Cost-Plus Pricing: Adds a markup percentage to the cost of producing a product or delivering a service. It’s simple to calculate and ensures a profit margin.
• Value-Based Pricing: Sets prices based on the perceived value to the customer rather than the cost of production. This strategy focuses on the benefits and value the product or service brings to the customer.
• Competitive Pricing: Prices are set based on competitors’ pricing structures. Businesses might price their products slightly lower than competitors to gain market share or at a similar level to match the market rate.
• Penetration Pricing: Involves setting lower prices to enter a competitive market and attract customers quickly. The goal is to gain market share and then gradually increase prices.
• Premium Pricing: Setting the price of a product or service higher than the competitors. This strategy is used to signal superior quality or exclusivity to justify the higher cost.
• Dynamic Pricing: Adjusting prices in real-time based on market demand, competition, and other factors. Common in industries like hospitality and airlines.
• Freemium Pricing: Offering a basic product or service for free while charging for premium features. This strategy is often used by software and service companies to attract users.
• Bundle Pricing: Combining several products or services and selling them at a single price, often lower than the total cost of buying each item separately. This can increase the perceived value and encourage sales.

How to choose a pricing strategy

Here’s how to come up with an efficient pricing strategy:

Align Pricing with Market Strategy

Begin by articulating how your pricing strategy complements your overall market strategy. If you’re aiming for market penetration, explain how your pricing is designed to attract a large volume of customers by being more affordable than competitors.

For a premium pricing strategy, discuss the exceptional quality, exclusivity, or unique value your offerings bring, justifying higher price points.

If you’re adopting a value-based pricing model instead, illustrate how your pricing directly correlates with the perceived value to the customer, possibly through superior benefits or cost savings they provide.

Relate Pricing to the Target Market

Your pricing strategy should be closely tied to your understanding of your target market .

For instance, if your target market highly values sustainability and is willing to pay more for eco-friendly products, your pricing should reflect this. Similarly, if you’re targeting a price-sensitive segment, explain how your pricing strategy enables you to offer competitive value while maintaining profitability.

Consider the Competitive Landscape

A comprehensive pricing strategy also considers the competitive landscape . Analyze your competitors’ pricing and how your strategy positions you within this context.

Are you offering a more affordable alternative to premium products, or are you introducing a higher-quality option in a market segment dominated by low-cost competitors?

Discuss how your pricing strategy gives you a competitive edge, whether it’s by filling a gap in the market, offering better value, or challenging the status quo with innovative pricing models.

Where to include your prices in your business plan?

In your business plan, prices should be detailed under “Products or Services” within the Business Overview section of your business.

This part of the plan not only describes what you are offering but also provides an ideal opportunity to outline your pricing strategy and the specific prices or price ranges of your products or services.

Here, you can explain how your pricing fits into the market and aligns with your overall business strategy, giving potential investors or lenders a clear understanding of your approach to generating revenue.

Remember your pricing strategy should align with your financial projections (projected income statement, cash flow statement, and balance sheet). Indeed, you will need to give some high-level explanation of how you came up with these financial projections, based on your pricing strategy too.

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Cost-Based Pricing Strategy: Definition, Formula, Examples

Key Takeaway: One pricing strategy that has stood the test of time is cost-based pricing. It's a method that's as straightforward as it is essential, allowing business owners to navigate the intricate landscape of setting prices with confidence.

Imagine setting a price that not only covers what it costs to produce your offering but also ensures you make a profit – that's the essence of cost-based pricing. So, what is cost-based pricing?

Let's say you own a cozy neighborhood restaurant business known for its delectable wholesale pasta and spaghetti Bolognese. To determine the price for this beloved dish, you must first tally up all the costs involved. 

This includes the cost of ingredients like the different types of pasta , tomatoes, ground beef, and wholesale spices , as well as expenses for the chef's time, wholesale restaurant supplies , and any overhead costs like the rent of your brick-and-mortar space and utilities.

Suppose the cost to produce a serving of spaghetti Bolognese amounts to $5. To ensure a reasonable profit margin, the restaurant might apply a 50% markup, making the final menu price $10. 

In this article, we will discuss cost-based pricing strategies, formulas, and various examples. Let’s get started!

Cost-Based Pricing Definition

Cost-based pricing is when a business owner decides how much to charge for something by figuring out how much it costs to make or provide. They add a bit extra (called a "markup") to make a profit. 

To do this, you need to calculate all the expenses for making the product or delivering the service, like ingredients or materials, workers' pay, and other bills. Then, you'll add a bit extra, which is your profit, and that's the wholesale vs. retail price your customers will pay. It's a simple way to make sure you cover your production costs and make some money too.

One of the downsides of the cost-based strategy is that it doesn’t consider other factors like what competitors charge, what customers are willing to pay for the products, or if there's a special value your business provides that might justify a higher price. 

9 Cost-Based Pricing Types

Here are some common types of cost-based pricing:

• Full-Cost Pricing: Full-cost pricing involves considering both fixed and variable costs associated with producing a product or delivering a service. In full-cost pricing, the business calculates the total of both fixed and variable costs and then adds a desired profit margin or markup percentage to set the final selling price.
• Direct-Cost Pricing: Direct-cost pricing focuses primarily on variable costs associated with producing a product or service. Fixed costs are not included in the pricing calculation. The selling price is determined by adding a markup or profit margin only to the variable costs, providing a simpler and more flexible pricing model.
• Margin Pricing: Margin pricing is the reverse of markup pricing. Instead of adding a markup percentage, a desired profit margin percentage is applied to the total cost. If the desired margin is 30%, and the product cost is $100, the selling price would be $130.
• Target Return Pricing: With this method, a business sets prices to achieve a specific target return on investment or profit margin. It calculates the necessary selling price based on the desired return and the total cost.
• Cost-Plus Pricing: Cost-plus pricing is a broader term that encompasses various cost-based pricing strategies. It involves adding a markup or margin to the cost to determine the selling price.
• Absorption Cost Pricing: In manufacturing, this approach considers all production costs, including variable and fixed costs, as well as allocated overhead costs. It ensures that the selling price covers the total cost per unit.
• Activity-Based Costing (ABC) Pricing: ABC pricing allocates costs to specific activities or processes and then assigns these costs to products or services based on their usage of those activities. It offers a more accurate way to determine product costs.
• Standard Cost Pricing: This method uses predetermined standard costs for materials, labor, and overhead. The selling price is set based on these standards, allowing for better cost control and performance evaluation.
• Marginal Cost Pricing: Marginal cost pricing focuses on covering only the variable costs associated with producing one additional unit of a product. It's often used in situations where maximizing short-term profit is essential.

Cost-Based Pricing Strategy Advantages

Here are a few advantages of cost-based pricing strategies:

• Transparency and Credibility: Cost-based pricing brings transparency to the table. When you can break down the price for your clients, showing them it's based on the actual production and operational costs, it builds trust. 
• Simplicity and Ease of Use: It's like having a trusty tool in your toolkit. Cost-based pricing is straightforward and easy to understand. You calculate your costs, add a reasonable markup for profit, and voila! You've got a price. 
• Financial Security and Risk Management : Picture a safety net. You know you're covering all your costs and making a profit. It minimizes the risks of unexpected financial surprises and helps in making informed business decisions.
• Baseline for Vendor Negotiations : Think of cost-based pricing as your starting line in a negotiation race. You know your bottom dollar, the minimum you can accept while still ensuring your costs are covered. 
• Consistent Profitability: Cost-based pricing is like having a steady income stream. Once you’ve factored in your costs and profit margin, it is easier to ensure that every eCommerce sale contributes positively to your bottom line. It's a reliable way to maintain consistent profitability in your business.

Cost-Based Pricing Strategy Examples

Let’s look at some examples of cost-based strategies:

• Food and Beverage Industry : Imagine a small-scale wholesale craft beer production company that specializes in creating different types of craft beer . To employ a cost-based pricing strategy, they meticulously calculate the cost of wholesale grains , labor, bottling, eCommerce packaging , wholesale food packaging , and overhead expenses. Let's say the total cost per bottle of craft beer amounts to $2. To ensure profitability, they decide on a 40% markup. Consequently, the final selling price per bottle is set at $2.80, covering all production expenses and generating a satisfactory profit margin.
• Restaurant Industry : In the bustling restaurant industry, cost-based pricing is a fundamental approach to setting menu prices. Let's take a classic Italian restaurant offering a popular pasta and seafood dish . The restaurant calculates the cost of ingredients (pasta, sauce, vegetables, wholesale seafood , wholesale meat ), cooking time, and the portion size, which totals to $6. Applying a 60% markup to account for overheads, staff wages, and profit, the pasta dish is priced at $9.60. This ensures the restaurant covers its costs while making a profit with each serving.
• Wholesale Distribution Industry: Within the wholesale distribution industry, consider a company specializing in providing wholesale restaurant supplies such as wholesale pasta, wholesale flour , organic spices, wholesale herbs, wholesale microgreens , and wholesale ice cream to local eateries. The company analyzes the expenses related to sourcing these items, storage, shipping and handling , and operating costs. After calculating all costs, they add a 20% markup to ensure profitability. For instance, if the cost of a package of pasta is $4, the selling price to restaurants becomes $4.80, allowing the wholesale distributor to maintain a healthy margin while supplying essential products to restaurants.

Cost-Based Pricing Formula

So, how do you calculate cost-based pricing? Let’s see!

• Calculate Total Production Costs

The first step in the cost-based pricing formula involves calculating all the expenses associated with producing a product or delivering a service. 

• Determine Variable and Fixed Costs 

Once all the costs are identified, it's essential to distinguish between variable and fixed costs.

• Calculate Total Cost Per Unit

After categorizing costs, calculate the total cost per unit by summing up both variable and fixed costs. This provides a clear picture of the overall expense incurred to produce each unit of the product or service. 

The formula for total cost per unit is:

Total Cost per Unit = (Total Fixed Costs + Total Variable Costs) / Total Number of Units Produced

• Add Desired Profit Margin (Markup)

The next step is to decide on the profit margin, typically expressed as a percentage, that you want to add to the total cost per unit. This profit margin accounts for desired profitability and business sustainability. 

The formula to add the profit margin is:

Selling Price per Unit = Total Cost per Unit + (Total Cost per Unit × Markup Percentage)

• Set the Final Selling Price

Once you've calculated the selling price using the desired markup, this becomes the final selling price of your product or service. It's the price you will present to customers, covering all your costs and allowing for a profit margin that aligns with your business goals and market positioning.

Cost-Based Pricing Calculator

Step 1: Calculate Total Production Costs

Step 2: Determine Variable and Fixed Costs

Total Cost per Unit: $

Step 3: Add Desired Profit Margin (Markup)

Selling Price: $

Frequently asked questions about cost-based pricing strategy.

In highly competitive markets, relying solely on cost-based pricing might mean you're missing out on potential profits or market share. It is important to consider other factors when setting your price - competitor’s pricing, customer willingness to pay, and even the demand for the product.

Let’s answer a few questions about cost-based pricing:

What is Price-Based Costing?

Price-based costing is a pricing analysis strategy in which the selling price of a product or service is determined by calculating the total cost of production and adding a desired profit margin.  

What are the 3 Benefits of Cost-Based Pricing?

The three benefits of cost-based pricing are:

• Profitability Control
• Cost Recovery
• Simplicity and ease of use

What are the Two Types of Cost-Based Pricing?

The two types of cost-based pricing are:

• Full-cost pricing
• Direct-cost pricing

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Business tips

15 pricing strategies and how to set yours

Hopefully, you enjoy what you do, and that's why you do it. But unfortunately, business isn't just about doing what you love—it's also about making money. And of course, making money means pricing your products or services correctly.

For your business to be sustainable, you'll need a pricing strategy that generates adequate income while also being attractive to customers.

Here's a guide to creating a pricing strategy that will keep your profits moving up and to the right.

What is a pricing strategy?

A pricing strategy is a plan for setting the best price for your products or services. The goal is to set a price that will entice customers to buy, but that isn't so low that you're not making a profit. 

Sure, you could just trial-and-error a bunch of prices until you find the price that maximizes profit without deterring potential customers—and there will probably still be some of that even after you choose a pricing strategy for your business. But you'll spend a lot less time and money starting with a pricing analysis than you will taking a complete shot in the dark.

15 common pricing methods and examples

Your core pricing strategy has to do with what you're selling: a luxury, a bargain, or just a good product for a good price. Once you have that figured out, you'll move on to choosing a pricing method, which is the how of your pricing strategy.

Pricing methods are sort of like plays in a playbook. Your product probably isn't going to switch from being a luxury to a bargain and back again, but you can (and, in some cases, should) switch up the pricing method you're using to better meet your market demands.

Here, we'll look at 15 of the most common pricing methods, plus how and when to use them.

1. Value-based pricing

The first pricing method is probably the one you're most familiar with: value-based pricing. You might think of it as the "default" pricing method since it consists of finding what the customer is willing to pay (the WTP price), making sure it's higher than the cost of production, and setting your price somewhere in between.

If you need to make a price adjustment, you can do so as long as the new price falls within the WTP range. If the new price surpasses this range, you'll need to explore avenues to expand the WTP range. You can do this by incorporating additional value into your product or service to increase the customer's willingness to pay the new price.

Takeaway: Charge what you can without turning off the customer to your product. 

2. Cost-plus pricing

A very similar method to value-based pricing is cost-plus pricing. Instead of basing prices on what the customer is willing to pay, businesses set prices by determining the cost of production and their ideal profit margin. For example, if a product costs $100 to make and a company's target margin is 15%, then the product will sell for $115. 

Cost-plus prices still need to fall within the WTP range, but they're not chosen based specifically on what the customer is willing to pay. If the cost-plus price falls outside the WTP range, the company either needs to adjust its target margin or find a way to lower production costs.

Takeaway: Ensure all costs are covered and don't keep you from reaching your desired profit margin.

3. Competitive pricing

When Norm McLaughlin formulated the pricing model for his business, Norm's Computer Services , he decided that he wanted to be considered competitive but not cheap. That meant his pricing was on par with his peers, but he avoided the use of any terminology like "budget," "cheap," or "cheapest" in his small business's marketing .

One of the things he tried early on was offering the first 15 minutes of work free of charge—if he solved the issue within that first quarter of an hour, the job would be completely free. It worked. Clients told him they wanted to pay even if he solved the issue in under 15 minutes because they didn't feel good about paying nothing for a service that involved someone coming to their home. It was an attractive offer that increased his competitive edge without negatively impacting his bottom line.

Takeaway: Maintain or gain market share from your competitors.  

4. Economy pricing

Similar to competitive pricing, economy pricing involves setting the lowest prices among your competitors to attract bargain buyers. But unlike competitive pricing, economy pricing specifically targets people who will consciously sacrifice quality in exchange for a cheaper price. Knowing this, you can source cheaper supplies, eliminate extra features, and make other changes to lower your production costs so that you can offer extremely low prices while continuing to make a profit. 

The fast fashion industry is infamous for its reliance on economy pricing. Clothes are created quickly using cheap (and often ethically questionable) labor, and they wear out quickly. This allows stores to sell highly trend-conscious clothing, since customers need to replace their clothes more frequently. Unfortunately, it also causes major environmental damage —and usually doesn't even save customers money compared to buying more expensive but longer-lasting clothing.

Takeaway: Attract price-sensitive customers while achieving high sales volume and cost efficiencies.

5. Penetration pricing

As a new business , you may find that you need to set your prices toward the lower end of the spectrum. Penetration pricing is when a business sets the price of a product or service low at the beginning, then raises the price once the company is more established.

Businesses that provide a service can draw customers in with low pricing, then win their loyalty with great service. Introductory offers can be a great way to entice new clients or customers. For example, you could offer a fixed price or percentage off the first job, or a portion of free labor. At least one of Norm's competitors offered a 10% reduction on labor for returning customers. In Norm's view, a better approach to customer retention was to offer them that 10% off the first job—and then do such good work that they wouldn't mind paying the full price for subsequent jobs.

Takeaway: Gain market share and attract customers quickly with low initial prices, then raise prices once you've established a strong customer base. 

6. Dynamic pricing

Have you ever pulled out your phone intending to grab a rideshare on a busy weekend night or (I wince just thinking about it) a holiday? Those jaw-dropping price surges are the result of what's called dynamic pricing, or pricing that changes fluidly according to availability and demand.

Truly dynamic pricing requires an algorithm that can automatically adjust prices according to purchasing activity. Uber's CEO isn't sitting behind a Wizard of Oz curtain declaring price surges; the app automatically increases prices when demand is higher than the number of drivers on the road. A less immediate version of dynamic pricing can be seen at the gas pump, where prices change frequently in response to demand but aren't automatic (in some states, like New Jersey, they can't change more than once per day). 

For small businesses, dynamic pricing works best with services or custom products that require a price quote, since customers expect prices to be different depending on the project and circumstances. If your prices are listed on your site and you change them constantly, you'll drive away potential customers who perceive you as unpredictable or unreliable.

Takeaway: Maximize revenue while adjusting for real-time factors like demand, competition, and market conditions. 

7. Price skimming

Price skimming is the opposite of penetration pricing, where you start by setting the maximum price and gradually lower it over time. This strategy works best with products that have major releases, like laptops or cars. By price skimming, you'll be able to capture early buyers willing to pay top dollar for the latest and greatest; then, as you gradually lower the price, you'll be able to sell the maximum number of products at each price before dropping it again. 

One of the most well-known price skimmers is Apple, which has made its product launches into full events with tickets and fans to build as much hype as humanly possible. Mega-fans buy the newly unveiled products the moment they're available, even waiting in lines overnight outside Apple Stores to do so. As each new product is released, the older models get shunted down the pricing ladder to capture buyers with lower WTP points. 

Takeaway: Capture early adopters and maximize revenue with high initial prices before gradually reducing prices to attract more price-sensitive customers.

8. Hourly pricing

Often used in service-based industries, hourly pricing establishes prices based on the time spent on a particular task or service. This aligns the price directly with the effort or resources dedicated to the project. It's a straightforward method for you and the client to understand and agree upon the service's value.

Having said that, if your projects' complexity or required resources vary quite a bit, a flat hourly rate may not be best for your business.

Takeaway:   Ensure customers are billed fairly based on the actual hours worked.

9. Project-based pricing

Project-based pricing is also common in service-based industries. This method determines prices based on the scope, complexity, and resources required for each project. Rather than charging a fixed or hourly rate, companies assess the unique needs of each project and provide a tailored quote. That way, businesses are accounting for factors like resources, expertise, and time commitment required to complete the project successfully.

This pricing model is common for architects. When a client approaches an architecture firm with a request to design and construct a building, the firm will assess the project's scale, complexity, materials, and other specific requirements to provide a project-based quote. Obviously, the process and requirements for designing a public bathroom vs. a skyscraper will be very different, beyond just time discrepancies. 

Takeaway: Make sure profitability and effort are accounted for in your pricing structure.  

10. High-low pricing

I've taught all my loved ones that we don't walk into Michael's without a coupon or buy anything at JOANN that hasn't been marked down to at least 40% off.

These stores use high-low pricing, where they offer products or services at a higher price initially and periodically discount them. This approach attracts price-sensitive customers who are motivated by discounts (me) while also maximizing revenue from customers willing to pay higher prices to get their hands on the product before it starts flying off the shelves once it's been discounted.

Companies can maintain a balance between profitability and reaching a larger range of customers by driving traffic to their stores or websites during promotional periods.

Takeaway: Create a perception of value to encourage customer purchases. 

11. Bundle pricing

You've probably seen the Progressive commercials practically begging you to bundle your car and home insurance for a better deal. Or maybe you bundled your cable and phone services back in the day. 

Bundle pricing is when a company combines multiple products or services and offers them at a lower overall price than what each item would individually cost. This creates a perception of added value, convenience, and savings for customers. If you sell a lot of small items or are trying to spread the love to an overlooked service, this pricing strategy may help you increase your sales.

Takeaway: Sell items together in a package deal that's slightly cheaper than if you were to sell the items individually to increase sales and customer satisfaction.

12. Geographic pricing

I follow a candy shop on TikTok with the most delicious-looking candy I've ever seen. They're located in the U.K. and I'm in the U.S., which means I'd have to pay outrageous prices to account for the shipping costs.

Geographic pricing involves setting prices based on different geographic regions or markets, considering factors like local market conditions, competitive landscape, and transportation costs like shipping. While this strategy makes it harder for a candy lover like me to get their hands on some delectable sweets, if you want to expand outside of your own geographic region, this strategy may be inevitable to keep your profits stable.

Takeaway: Maintain profitability across all your geographic markets by adjusting for variable factors.

13. Psychological pricing

A book priced at $20? I'll pass. A book for $19.99? I'll take 10. This common phenomenon that we all fall for time and time again is called psychological pricing. Also known as charm pricing, this strategy leverages consumers' perceptions and emotions to make them think they're getting a better deal than they actually are. 

Making the price seem more appealing or affordable to customers effectively influences customer behavior and increases sales, even if the price difference is negligible (and even if the customer knows in their heart of hearts that it's negligible). You can combine this strategy with another method since it's a common standard in many industries.

Takeaway: Create the illusion of a lower price so customers perceive your price as fairer.  

14. Freemium pricing

If you're like me, you started out with the free version of Spotify until the ads were so grating on your soul that you gave in and shelled out the cash for the paid ad-free version. This method of offering a basic version of a product or service for free and charging for additional premium features or advanced functionality is called freemium pricing. 

By offering a free version, companies can give customers a taste of the value their product or service offers, build brand awareness, and create a larger user base. They then monetize their user base with an enhanced experience for a subscription fee or one-time purchase. If you're new to the market, this is a great way to get buy-in from people who would otherwise be unwilling to convert.

Takeaway: Attract a large user base and convert some into paying customers. 

15. Premium pricing

Some people enjoy the prestigious vibe and social appearance of luxury brands. For example, luxury car companies, like BMW or Mercedes-Benz, position their vehicles as high-end, offering advanced technology, luxurious interiors, and superior performance. (Although I'd love to see what they have that my Honda CR-V doesn't.) 

With those high-end features comes a high-end price tag, otherwise known as premium pricing. This strategy positions the company as exclusive and superior in value in comparison to lower-priced competitors. It appeals to a target market willing to pay a premium for the perceived benefits. If that's your target market, then this is your ticket.

Takeaway: Target affluent customers and generate higher profit margins. 

Factors to consider when pricing a product

You likely know off the bat that you'll need to consider your own business costs and competitor prices so that you can find a price that earns a profit but isn't so high that it drives potential customers to other businesses with better deals. But unfortunately, it's not that simple: there are a lot of factors you'll need to consider in order to determine the best pricing strategy for you.

I know I just said cost wasn't the only factor to consider, but it is the most important one to start with. If your prices aren't higher than your costs, you'll be out of business before you even get your company off the ground.

When calculating costs, make sure you include:

Product materials

Employee wages (that includes what you pay yourself!)

Overhead costs (rent, insurance, utilities, taxes, etc.)

Software and services for things like accounting, marketing, and legal

Shipping and transportation

Economic factors

When costs change, your prices will have to change in order to stay competitive and keep making a profit. Businesses that rely directly on commodities as supplies—so things like lumber, oil, and metals—will be most vulnerable to economic fluctuations , but all industries are affected in some way or another by global, political, and social changes. 

Conduct thorough research to identify what economic conditions your business thrives in, and recession-proof your business . Be proactive about anticipating events that could affect your supply and demand . You especially need to incorporate a safety net into your profit margins to ensure you have enough funds to stay in business during slow periods if you're in a more temperamental industry.

Competitor pricing

Your prices don't always need to be lower than your competitors', but if they're higher, you need to be able to justify it with added quality. Your products don't always need to be quality, but if they're low-quality, you'll need to be able to justify it with lower prices. Where you fall on either side of this trade-off determines your value position , which we'll discuss in a bit. But no matter how you decide to position your product, you'll need to stay up-to-date on what your competitors charge, pricing trends in your industry, and what pricing models work best for your market.

It's usually not difficult to find out what your competitors charge—either by visiting their websites or by calling them to ask. As you gather information for your competitor analysis , keep a spreadsheet where you can record prices and note things like introductory offers, loyalty programs, and discounts.

Positioning

It's a common misconception that businesses have to sell good-quality products to be successful. There are buyers at every price and quality level; what matters is how your product quality and price are positioned with respect to each other.

One of the easiest industries for demonstrating this concept is the airline industry, because there's no way to mistake the difference between a high- and low-quality purchase when there's a literal curtain dividing them. Normally, price and quality will align with one another. First-class tickets offer high quality at a high price, economy tickets offer low quality at a low price, and everyone else gets piled into coach. 

Value prices occur when quality is higher than price—when you fly during off-peak times or get upgraded to first class for free. When demand is high and seats are limited, the airlines can afford to charge higher prices for lower-quality seats, counting on the fact that you'll pay full price for a terrible seat if it's your only option.

When you apply this to your own pricing, ask yourself what kind of value your product or service offers. Are you solving an urgent problem , or is your product more for comfort and enjoyment? If you sell a first-class product, you'll lose money by selling it at economy prices. If you sell an economy product, you'll need to sell it for a bargain price.

As you start off in business, it's important to remember that you can change your pricing strategy as you go along. This is a marathon, not a sprint, so it's more about building a client base of satisfied customers who will come back to you again and again than it is to make as much money as possible as quickly as possible. 

And the good news is that you don't have to get everything right from the very beginning. You can try different approaches and make adjustments as you go until you're achieving the outcomes you want. To continue optimizing for success, learn how you can automate your small business .

Related reading:

The best eCommerce website building platforms for online stores

Optimizing your small business product mix

The best CRMs for small businesses

The best project management software for small businesses

This article was originally published in December 2020 by Norm Mclaughlin. It was most recently updated in July 2023.

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Cecilia Gillen

Cecilia is a content marketer with a degree in Media and Journalism from the University of South Dakota. After graduating, Cecilia moved to Omaha, Nebraska where she enjoys reading (almost as much as book buying), decor hunting at garage sales, and spending time with her two cats.

• Small business
• Sales & business development

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Cost Based Pricing: A Guide To Understanding

Cost based pricing is a tried and tested approach that considers the costs involved in producing, marketing, and selling your offerings, allowing you to determine a fair and competitive price point.

From understanding fixed and variable costs to calculating profit margins, in this guide, we walk you through the step-by-step process of implementing cost based pricing in your business.

What is Cost Based Pricing?

The definition of cost based pricing includes: a method for setting prices based on cost of goods or services sold, plus a markup (profit).

“Cost Based pricing sets a floor price for desired margins” [1] University of Oregon. " Consumer-Based Pricing ."   -University of Oregon

Methods of Cost Based Pricing

Cost based pricing is a strategy that recognizes the costs involved in producing, marketing, and selling an end product. Recognizing these costs allows you to identify fair and competitive pricing for your products or services. Furthermore, cost based pricing assumes that all costs are covered. Different versions of this method exist, each with its own distinct advantages and disadvantages.

Formula: Calculate Cost-Plus Pricing

Material+Labor+Overhead Costs Multiplied by (1 + markup amount)

Formula: Calculate Break-Even Pricing

Divide (fixed costs) by (price-variable cost)

Although each method has pros and cons, you must consider your business’s specific needs and goals when selecting a strategy. Understanding these methods better enables you to make more informed pricing decisions.

Advantages & Disadvantages of Cost Based Pricing

This pricing strategy offers several advantages for a business. A main advantage is it ensures all costs are covered, ensuring a consistent profit margin. This is especially important for companies with large fixed costs or variable costs that change with production volume.

Another advantage is a clear and transparent pricing structure. When prices are based on cost, customers can more easily understand how pricing was determined and feel confident they’re receiving a fair deal. This helps foster trust and loyalty, resulting in repeat business and positive word-of-mouth dialogue.

Cost based pricing can also be time-intensive and difficult to implement and oversee. This is especially true if your company has many different product or service offerings.

It’s important to contemplate these advantages and disadvantages within the context of your company. This pricing strategy may not be the best fit for every situation, however, it can provide a solid foundation when setting up a profitable and fair pricing structure.

Factors to Consider with Cost Based Pricing

If implementing this pricing strategy within your business, several factors must be considered to ensure prices accurately reflect the true costs involved.

The first factor is understanding fixed costs. These costs are expenses that remain the same regardless of production or sales volume. Examples of these costs may include rent, utilities, or salaries.

Understanding your fixed costs will allow you to allocate a portion of them to each unit of your product or service when calculating the cost-based pricing formula.       

Variable costs are another important factor to consider, sometimes referred to as step variable costs . These costs are expenses that change with the volume of production or sales. They may include raw materials, direct labor, or shipping costs.

Calculating variable costs involved with each unit of your product or service allows you to determine the direct cost of producing or delivering that unit.

In addition to fixed and variable costs, it’s important to include overhead costs as well. Overhead costs are indirect costs necessary for your company’s operation, even though they don’t directly relate to your product or service. These costs typically include administrative expenses, marketing costs, and depreciation.

Allocating a portion of fixed, variable, and overhead costs to each unit of production ensures your pricing includes all required costs to run your company.

After clearly understanding your costs, you can calculate a desired profit margin. This identifies the amount of profit you intend to make on each sold unit. When determining profit margin, it’s also important to consider factors like market competition and customer demand.

The profit margin should align with these factors and ensure your pricing is competitive in the long run.

Implementing Cost Based Pricing

Implementing this pricing strategy within your business requires a systematic approach. Following these steps will help ensure your strategy is effective and aligns with your business objectives.

1. Identify Costs

Start with identifying all costs involved with producing, marketing, and selling your products or services. This includes fixed costs, variable costs, and overhead expenses.

2. Allocate Costs

After identifying all costs, distribute them amongst each unit of your product or service. This will provide a better understanding of direct costs associated with each unit of production.

3. Determine Profit Margin

Contemplate factors such as market competition, customer demand, and business goals when determining the profit margin. This will help you identify a price that is competitive and sustainable.

4. Set Your Price

Using the direct cost per unit and your desired profit margin, calculate the price for each unit of your product or service. This will ensure your prices cover all costs and generate the desired profit.

5. Test & Refine

Once you have set pricing, monitor the effectiveness and adjust as needed. This may require conducting market research, analyzing customer feedback, and evaluating the company’s financial performance.

Following these steps will help you implement and oversee pricing in a balanced manner.

Cost Based Pricing Example

To better illustrate this approach, let’s review a few hypothetical pricing examples demonstrating its potential usefulness.

Example 1: TRG Electronics

TRG Electronics is a leading manufacturer that implemented cost-based pricing to set prices for their range of smartphones. By carefully analyzing their fixed and variable costs, TRG could accurately determine the direct cost of producing each individual unit.

They then added a markup to cover overhead expenses and generate a desired profit margin. This approach allowed them to deploy competitive pricing that not only covered their costs but also acknowledges the value of their products.

As a result, TRG experienced a large increase in sales as well as profitability. This helped further solidify their position within the highly competitive electronics market.

Example 2: Max Consulting

Max Consulting is a management consulting firm that implemented cost-based pricing to set fees for their consulting services. By identifying their fixed costs, such as office rent and salaries, and their variable costs, such as travel expenses, Max was able to determine the direct cost of delivering each consulting engagement.

They then added a markup to cover overhead expenses and generate a desired profit margin. This approach allowed Max to set prices that accurately reflect the value of their services to clients. As a result, Max experienced increased client satisfaction and repeat business, establishing itself as a trusted advisor in the consulting industry.

These examples highlight the potential effectiveness this pricing method offers within different sectors.

Pitfalls to Avoid with Cost Based Pricing

Although this strategy can be an effective pricing mechanism, there are common pitfalls businesses should be aware of.

One common issue is relying too much on cost based pricing without considering all other factors like customer demand and market conditions. It’s important to fully understand the value customers place on products or services. Furthermore, neglecting demand and market conditions may result in additional missed revenue opportunities.

Another pitfall is failing to review and update your costs regularly. Costs change over time due to factors like inflation, changes in supplier pricing, and adjusting exchange rates. It’s important to review and update costs periodically to ensure they accurately represent your expenses.

Additionally, businesses should avoid setting prices based solely on competitors. While it’s important to be aware of competitors’ pricing strategies, blindly following their pricing can tremendously erode your profit margins.

It is better to focus on understanding the value your products or services provide and set pricing that accurately reflects such value.

Being aware of and avoiding these common pitfalls will help ensure your cost based pricing strategy is effective and sustainable in the long run.

Other Pricing Strategies to Consider

Even though cost based pricing is common and widely used, it’s important to also consider alternative options that may better suit your business needs. Here are several alternatives to consider:

Value Based Pricing

Competitive pricing, penetration pricing, premium pricing.

These alternative pricing strategies offer additional approaches worth considering that may align well with your business and profitability objectives.

Tools for Cost Based Pricing

Implementing this pricing method throughout your company may be easier with the help of several tools and resources. Here are some worth considering:

• Cost Accounting Software: Accounting tools can help you accurately track cost based activity. Many software programs allow you to input your fixed and variable costs, allocate overhead expenses, and calculate your profit margin.
• Competitor Analysis Tools: Competitor analysis tools can help you gather competitive intelligence, allowing you to make better pricing decisions. Seek out and utilize tools providing competitor pricing, market trends, and customer preferences.
• Market Research: Market research provides insight into customer demand, preferences, and willingness to pay. Consider utilizing surveys, focus groups, or interviews to gather data that will aid you in pricing decisions.
• Industry Publications: Industry publications and websites can provide valuable information on pricing trends, industry benchmarks, and best practices. Stay current with your industry’s latest news and developments to ensure your pricing strategy remains competitive.

Leveraging these tools and resources will enable you to implement cost based pricing more effectively.

Implementing cost based pricing requires careful analysis, regular reviews, and periodic adjustments to ensure its effectiveness and sustainability.

Weighing the pros and cons of this pricing method along with other strategies allows you to pick an option that best aligns with your business needs.

Additional Resources

Other helpful articles may include:

Understanding Material Costs Stockout Cost: How to Avoid Cost of Nonconformance 

Published by John Henry, MBA

How to Choose the Right Pricing Strategy for Your Business

Pricing a product or service is a delicate art, there are many options to choose and the optimal one is never set in stone. In this tutorial, we run down some of the popular methods and how you can select the most appropriate strategy for your business.

By Toptal Research

A correct pricing strategy is key for a company. Setting your pricing strategy and price levels appropriately can make the difference between profitability, breaking even, or failing. There are many examples of companies that were able to find sustainable business models thanks to specialized pricing strategies, such as eBay’s promoted posts or LinkedIn’s premium package .

Before we define the different pricing strategies that are available, it is first very important for the founder to understand what market they are actually entering and what their clients are demanding. Furthermore, a founder needs to be aware of how their business model could support different pricing levels. There are many ways to reach $100 million dollars in revenue , but keep in mind that the pricing strategy you choose will greatly affect how your business will be run.

In this post, we will outline the main pricing strategies, walk through a process that you can follow to reach your appropriate pricing option, and detail the main pitfalls. To fully understand the pros and cons of each of these variables, you should also tap your network for entrepreneurs with experience in pricing strategy or get help from professional experts such as the pricing finance experts at Toptal .

Define Your Type of Business

Before choosing the pricing strategy, your first must define what type of business you’re pricing for. It is very different to sell to businesses (business to business, or B2B) than it is to sell to final consumers (business to consumer, or B2C). Depending on which type of client a company has, there are different implications that have to be thought out before choosing the pricing strategy.

Although for many readers the difference between both types of companies is clear, it is worth defining them:

B2B: A company with a business-to-business model is a company that sells to other businesses. The ticket size per transaction is usually large, but the sales cycle is also usually longer than selling directly to consumers, depending on the size of the companies involved. Furthermore, a sales process within the B2B sector can usually involve several bidders that compete with each other (request for proposal). Finally, a B2B transaction tends to have recurrent customers that buy frequently from the seller, which helps with cash flow. Some could argue that B2B is a more quantifiable business model to price towards, as business owners largely are drawn to products that either help them sell more and/or spend less.

B2C: A company with a business-to-consumer model is a company that sells directly to the individual consumer. The ticket size per transaction is usually smaller than B2B sales, but the purchaser usually decides to make the transaction immediately. The stickiness of a B2C customer is frequently lower than a B2B client.

Recently, there have been a few additions to this simple classification, such as business to business to consumer ( B2B2C ) or direct to consumer ( D2C ). For the purposes of pricing implications, most of these additions can be grouped into B2B or B2C.

Types of Pricing Strategies

Once you have defined what type of clients your business caters toward, you can review the different pricing options available and the implications that they might have on your growth. It is important to note that this is just an overview of each pricing strategy, and the application of different pricing strategies will have different effects depending on the business.

SaaS Pricing: SaaS means software as a service, which is a software distribution model in which another company hosts an application or product for the customer and that the customer can access it through an internet connection. SaaS pricing is usually periodical, where the customer pays for the right to use the software for a specific time period. Unlike traditional software models, where a lump license is bought outright for one version of a product, SaaS business models charge customers into perpetuity for new iterations of the service.

Freemium Pricing: Freemium pricing means offering your customers some product features for free, with the expectation that they get hooked on the service and eventually demand more features that will be charged. Spotify is a great example of freemium pricing: At first, you sign up for free streaming, accepting ads every once in a while. After a few months of this, you get tired of hearing the same ad again and again and you finally pay up the monthly fee. Dropbox is another notorious example: You use the limited free space for your family photos, but once you reach the limit, you are hooked and decide to pay for the premium version.

Tiered or Goldilocks Pricing: Tiered or goldilocks pricing offers several pricing options to the customer, usually going from basic all the way to enterprise. Businesses structure them in ways such that a customer eventually increases their knowledge and use of the service, hits a roadblock in their current service plan, and then upgrades. By way of example, once again look at Dropbox , which as you can see offers three different business plans for customers depending on customer needs.

When considering the goldilocks pricing option, it is important to know what objectives you have for your company. There are two different goals that can be pursued:

Being able to offer different options to different clients (customer segmentation)

Nudging the customer to choose a specific option, which is usually the middle price between the extremes. This strategy is also called the anchoring effect. In the Dropbox example, it seems the company is pushing customers to buy the Advanced model, with unlimited space versus “only” 2TB.

This Ted Talk from MIT professor Dan Ariely provides one of the best examples available (starting at 12:25), where he speaks about a specific case. In this real-life example, The Economist provided its readers with three subscription options: online subscription for $59, print-only subscription for $125 and finally a third option of print plus online, also for $125.

Ariely showed his MIT students all three options to see what options they would choose, and the results can be seen in the following table:

As the table shows, 84% of students chose the print and online option. After this first survey, Ariely removed the “print only” option and gave a separate group of MIT students the same survey with the two remaining options. These were the results:

The difference in results is clear: Only 32% of students chose the print and online option. If these were real results for The Economist, offering all three options with the “print only” anchor would have increased revenue by 42.8%. Clearly, anchoring through Goldilocks pricing can be a highly effective strategy for getting the maximum value from your products and services.

One-time Licensing Fee: In a one-time licensing fee, the customer buys the software or product one time and it is owned by the customer without any more payments. One clear disadvantage is that this pricing strategy does not make the customer sticky, as the transaction is made only once. Another disadvantage is that there are no immediate incentives for software updates and maintenance. From a cash flow perspective, this pricing model also results in irregular periods of high cash inflow, around times such as a new release, new budget years, or even Christmas.

This option was popular before the rise of the internet (remember buying Microsoft Encarta every year?) and the resulting ability to upgrade and maintain software online.

Per User/Seat Pricing: Per user/seat pricing means pricing in conjunction with how many users per customer will use the product. This option is also called per license pricing.

Enterprise Pricing: Enterprise pricing is an ad-hoc pricing that a company prepares for a large client that cannot fit into a standard option plan. Usually enterprise contracts are closed for at least a year, as the amount of development and setup work is significant for both parties.

Cost-based Pricing: Cost-based pricing first analyzes what the actual product costs are, and then based on that cost level the business increases the pricing a certain percentage. For example, a physical store retailer can decide that it will sell all items at a 100% markup: Therefore, if it buys a product wholesale for $10, it will sell the product at $20. This option is very common among retail companies.

Value-based Pricing: Value based pricing first looks at what value a specific product provides to the customer and then calculates the pricing as a function of that value. A generally accepted rule of thumb for setting the final price is to set it at 10 times less than the value provided to the customer. For example, if for the customer, the perceived value is $1,000, the retailers would sell it for $100. This pricing strategy can only be sustained if the product sold is unique, without many competitors undercutting the price.

Competitive Positioning: With a strategy that pursues competitive positioning, the company analyzes how it wants to be perceived vis-a-vis other competitors. The company could try to slightly undercut its competitors, with the risk that the competitors would match this pricing and start a downward pricing spiral. Alternatively, the company could try a more premium approach and set its price above competitors.

Razor Blade Model: A razor blade model consists of providing an initial product that hooks the customer and then later selling them a second product that is essential to the use of the first product. There are two clear examples of this strategy: first, the actual razor blade company Gillette, which sells its razor handles relatively cheap and then sells the actual razor blades at a premium. Secondly, printers. While actual printers sell at a low price, continuous purchasing of ink toners will eventually by far exceed the initial hardware cost. You can see further examples of this pricing within the industries of video game consoles and pod-based coffee machines.

Free Products (Revenue Is Earned from Critical Mass and Ads): This pricing is currently very popular with the success of companies such as Facebook and Google—They do not charge their customers for the use of their products, making customers’ data the actual product to sell to third-party businesses. There are clearly some very successful examples of this strategy. However, a founder must be aware that success with this strategy is very difficult to achieve, as the company needs to become very large and reach critical mass while being unable to obtain significant income during the ramp-up phase.

How to Set Up Your Pricing Strategy

After having gone through all of the different options and creating a shortlist of feasible routes for your company, you must do the hard work of executing and setting the final pricing strategy.

The first thing you should know is that whatever pricing strategy you choose, this option will define the business entirely, from how revenue will grow to how the actual business and team will be built. It is very different to set up a company that sells through a SaaS model compared to one that sells through a one-time purchase strategy.

The second thing to keep in mind is that the choice of a pricing strategy and pricing level is actually a process, and this process must be repeated periodically during the lifetime of the business, as we will see in the last section of this article.

During the process of selecting a strategy, you must first conduct deep customer research. However, be very careful when gathering feedback from non-paying customers. The only feedback that is worthwhile comes from customers that have actually bought your product. Anyone else will probably not have thought through the problem as much as a real customer that has a real need and has paid money for the service.

To obtain these first customers in this beta phase, try to tell a story through your pricing. For example, if you go with the option of value-based pricing, make it clear how valuable your product is and why your initial pricing really makes buying your product worth it. To increase the chances of obtaining these first customers, the founder should hit the road and help to tell the story.

Also, keep it very simple for these first customers. Do not overcomplicate the options. If you want to test different price points, you should create different subsets of clients that will each see a different price point. You can then test the rate of adoption at each price point. For example, it might not be a good idea at this stage to try goldilocks pricing, or at least to show it to the customers.

In addition to all of the above, make sure to research your main competitors, both direct and indirect, and understand why they chose their price levels and strategies. Use this information as another reference point for your decision making process while keeping in mind that your competitors could actually be wrong with the pricing that they chose. Always test out pricing for yourself.

After the initial pricing is set, the iteration process starts. Increase the price slightly and see where the limit is, depending on the level of pushback the customers start to give. Do this with different pricing levels with different customers, and you will have great insight into different customer segments.

Common Pitfalls in Pricing Strategies

There are a few common pitfalls that entrepreneurs make regarding their pricing strategy:

Not Changing Your Price: Even after full launch, a company should periodically review its pricing. At least once a year is good practice. This exercise will allow you not only to stay abreast of what your customers demand, but also what the competition is doing, and be able to adjust accordingly.

Underselling Your Company: Some entrepreneurs, when facing initial resistance from potential customers, tend to reduce their pricing to close sales. This can lead to a situation where they are selling themselves and their product short. Also, thinking that this client resistance is only due to high pricing can be a distraction from other key problems that are the real reason, such as a flawed product-market fit.

Thinking That Non-paying Customers Have Value: As said in the previous section, a founder should be wary of incorporating feedback from non-paying customers. This applies for both initial pricing testing and ongoing sales to a customer, where sometimes a client demands specific changes to your product before buying it.

Providing Too Much Choice: When customers have to choose between too many options, it makes the decision harder for them . Psychologist Barry Schwartz proved in his book the Paradox of Choice that customers can defer decisions for a long time or never actually make the decision. A company should avoid putting their potential clients in a similar situation.

Making Negative Connotations: When selling a product or service, an entrepreneur should avoid using arguments that are negative. For example, it is preferable to not mention that your product will reduce the number of employees your customer needs. It is better to be positive—say, for instance, that your employees will be significantly more productive.

Not Giving Special Treatment to Loyal Customers: For subscription-based businesses, you can push customers toward annual or quarterly payments instead of monthly payments by offering a better price if you pay annually or quarterly. This will will help you with cash flow and the customer will perceive a direct benefit thanks to his loyalty to your product.

Conclusions

Clearly a significant amount of analysis, customer research, and iterative testing is required for proper pricing strategy. There is no one-size-fits-all approach: Each company within each market is different. The key is to fine-tune your pricing until you reach the sweet spot that you are looking for, testing different strategies and price points until you find the perfect combination for your product or service

Start testing!

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Pricing Strategy Examples and Guide: Cost-Based Pricing

• March 10, 2020

Working in the field of pricing and revenue management, one of the most common questions I get is, “Where should I set my price?” Although it might seem like a relatively straight forward question, the underlying answer is anything but. There are three common pricing strategies and pricing models typically employed when setting a price.

The 3 Most Common Pricing Strategies

When it comes to pricing anything (B2B, B2C, product or service), there are three key strategies to achieve  price optimization :

1. Cost-based or cost-plus pricing 2. Market-based pricing 3. Value-based pricing

While there are claims of other strategies, most are offshoots or variations of these three.

1. What is a Cost-Based or Cost-Plus Pricing Strategy Example:

What is cost-based or cost-plus pricing? Surprisingly, cost-based pricing is what it sounds like: calculating the cost of a product or service and adding a standard margin to the cost. For example, if it costs $2.50 to make a widget, then a 50% standard margin would mean the widget’s price is $5.00.

2. What is a Market-Based Pricing Strategy Example:

Unlike cost-based pricing, market-based pricing takes into account competitors. Market-based pricing is when the price of a product or service is set based on its competitive market position and product market fit—essentially pricing on par with or near your competition. For example, commodities (raw materials, basic resources, agricultural, or mining products, such as iron ore, sugar, or grains like rice and wheat) often fall in this category as pricing is defined by what the market is willing to pay. Another typical example of market-based pricing is companies whose pricing strategy is to be “fast-followers.” A fast-follower is a company that adjusts their prices shortly after their competitors change their prices (quickly following suit, aka fast-following).

3. What is a Value-Based Pricing Strategy Example:

Value-based pricing is the final approach and usually the most difficult to execute. This pricing strategy seeks to estimate the determined “value” of a good or service based on the buyer’s point of view and then price based on that perceived value.

A prime example of value-based pricing is business-class airline tickets. Business-class tickets offer significant value for a segment of customers—added comfort, early-boarding, meal service, arriving at destination well-rested (perceived as especially valuable on long-flights)—and airlines price these tickets accordingly.

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The Pros and Cons of Cost-Based Pricing & Other Pricing Strategies

Now that we’ve reviewed the three most used pricing strategies let’s outline the benefits and drawbacks of each in more detail.

What are the Benefits and Drawbacks of a Cost-Based Pricing Strategy?

Cost-based and cost-plus pricing is often the most popular way to set a price because it is easy to calculate, is generally objective, brings predictable margins, and doesn’t require too much effort to put in place.

Cost-based and cost-plus pricing is also readily justifiable to customers as it’s a very straightforward way of approaching price:

If a product costs x to produce, then the producer must charge x plus a margin to secure a profit.

In the consumer goods space, for example, manufacturers will often exploit this by telling tales of an increase in the cost of an essential commodity used in the production of their goods. As the good now costs more to produce, the manufacturer has found a way of passing off that price increase—real or otherwise—to the consumer.

There are, however, some critical drawbacks to cost-based/cost-plus pricing. The most glaring of which is that it is inward-focused—only taking into consideration internal cost concerns and not considering external factors like a customer’s willingness to pay a premium. For example, when you renew a passport in Canada, a five-year renewal costs $120, and the 10-year passport renewal costs $160. The customer’s perceived value and convenience of not having to return to the passport office after only five years (which can be quite high depending on individual experience) are potentially worth more than the $40 markup Service Canada charges for the 10-year passport. Service Canada could surely price higher for this convenience.

Another major drawback is the accuracy of the “cost” used to calculate the price. Often fixed costs are difficult to attribute to specific products or services within an organization. Input costs change, fixed costs get allocated differently. There are multiple reasons why cost can change within an organization, leading to:

• Customers not believing production cost to be true, and consequently not purchasing the product
• Cost estimates that are subsequently determined inaccurate, potentially leading to a miss in the desired standard margin

What are the Benefits and Drawbacks of a Market-Based Pricing Strategy?

Market-based pricing moves beyond the navel-gazing of cost-based pricing and looks externally to incorporate a pricing analysis of market conditions to set prices.

The most common use of market-based pricing is in the commodity market. For those industries which are not commodities, the reality is that market-based pricing is key competitor pricing. Key competitor pricing is when companies benchmark their price to their key competitors, either market leaders or those similar in terms of size and geography.

In the food services industry, for example, the market price is essential for the suppliers selling restaurants raw ingredients. Because the ingredients are a part of and not the sole focus of the meal, restaurants will often opt for the cheapest. This factor makes the market/competitor price of goods (for example, ingredients like vegetables, fruit, meat, etc.) critical to the pricing strategy.

Market-based pricing is especially beneficial to companies that have a cost advantage in the market, for example, Walmart. Due to Walmart’s cost-advantage—ability to sell products at a lower cost than their competition—they can offer prices at a  market discount  compared to other retailers.

But, market-based pricing does have drawbacks. Like cost-plus pricing, the market-based approach does not consider the buyer’s willingness to pay, meaning money is likely to be left on the table.

It is also of note that getting competitive market data in some industries can be complicated and unreliable, making it hard to set prices in line with your competitors. While there are services that track the competitive market price, these are often expensive and unreliable as prices are aggregated to protect privacy.

While market-based pricing gives a good outward view when compared to cost-plus pricing, it still misses the input of the buyer/customer and, consequently, the potential for additional profit.

What are the Benefits and Drawbacks of a Value-Based Pricing Strategy?

Value-based pricing moves the pricing strategy approach forward by considering the customer’s willingness to pay when setting the price of a good or service.

This approach has become very popular over the last few years, but it is also one of the most difficult to execute. Marketing departments favour this approach as it quantifies and charges for the value a product or service delivers.

The reason for its notoriety is that profitability can be maximized by extracting the most value from customers by pricing exactly what they are willing to pay. But, to be able to price based on value, one must be able to calculate the perceived value and, thus the customer’s willingness to pay. There are a few ways to do this:

• Traditional market research such as a conjoint analysis
• Statistical modelling using choice-based methodologies
• Other quantitative and qualitative methods and workshops (for example, price value mapping exercises)

The difficulty is that most companies don’t have the internal capacity to execute these activities as they require specialized skills and time. Not only is value-based pricing harder to implement than the two other pricing strategies, it is also costlier. However, the higher payoff makes value-based pricing a worthy endeavour.

Still, value-based pricing is not without its drawbacks. After all, different customers have different willingness to pay. In a perfect world, a company would be able to charge each customer a price based on their willingness to pay, (but in reality), that isn’t possible.

Segmentation is a crucial component of value-based pricing—understanding what groups of customers exist and what each specific group perceived values are when compared to others. If companies can differentiate products (for example, through versioning—version A offers three features for x price, and version B offers five features for x price), it allows them to capture a greater portion of the market, increase sales and profitability through product differentiation for different customer segments without leading to cannibalization of overall sales.

Ultimately, however, value is subjective, and in many cases, when utilizing value-based pricing, companies are estimating the hypothetical value customers will benefit from.   For example, a particular car engine oil might decrease repairs by up to 20%. However, if the manufacturer sets the price based on the 20% decrease and customers only realize 5% fewer repairs, the price might not reflect the value delivered, and the company stands to lose customers.

Ultimately, however, value is subjective, and in many cases, when utilizing value-based pricing, companies are estimating the hypothetical value customers will benefit from.

Despite its benefits, value-based pricing is tough to execute, especially if other competitors are not pricing based on value. If a company pricing on value is in a competitive situation with a company pricing based on cost, it often leads to the degradation of the value equation.

While value-based pricing is a step in the right direction for most organizations, it is not an all-encompassing solution.

Balancing Cost-Based Pricing and Market-Based Pricing Strategies

As you can see, the three most common pricing strategies all have benefits and drawbacks, and different groups in an organization prefer one over another. Ultimately, the best way to set prices is to use a balanced RM framework, which incorporates all three methodologies and takes a unified approach to price across the organization.

This balanced approach invites all key stakeholders to be part of the pricing process—finance, sales, and marketing. In doing so, companies can consider internal costs/profitability (financials), external market pressures (competition), as well as willingness to pay (customer value) in their decision-making process.

A balanced approach to pricing strategy, aided by a pricing consultant, allows your company to be more flexible with pricing and provides the opportunity to micro-optimize. For example, a company might price two very similar product lines differently based on geography/market. In one market, there may be multiple competitors (need to set price more in line with competition), while in another market, the company may hold a monopoly (can price higher).

The Balanced RM approach for pricing can deliver superior profit results for companies. In our experience, companies outperform individual pricing strategies (cost plus, value-based and market-based) by as much as 70% when using a balanced approach.

How to Choose The Right Pricing Strategy

Ultimately it is essential to remember that pricing is a journey and not a destination. Landscapes are continually evolving, so adaptability is vital regardless of your current pricing strategy.

Typically, organizations grow from market-based pricing to cost-plus and then, finally, as they mature, towards value-based pricing. As your organization grows, ensure that your pricing strategy is evolving along with that growth. Be nimble and opportunistic – evolve, adapt and take advantage of your ever-changing environment.

If you’re considering a more strategic approach to pricing for your organization, I encourage you to work with a pricing consultant who will ensure your strategy is capturing as much value as possible, in addition to helping you build your internal capabilities for sustainable profitability.

ABOUT THE AUTHOR  Michael Stanisz is a Partner at Revenue Management Labs. Revenue Management Labs help companies develop and execute practical solutions to maximize long-term revenue and profitability. Connect with Michael at  [email protected].

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Cost-Based Pricing

Table of Contents

What is cost-based pricing.

Cost-based pricing is a pricing strategy where businesses set a selling price based on a product’s production, manufacturing, and distribution costs. Typically, they arrive at this figure by adding a markup percentage to the total cost of making and delivering the product.

Several expenses go into the costs of production and distribution, including raw materials, piece-rate labor costs, packaging, production supplies, overhead expenses (like rent and utilities), and shipping. Depending on which expenses a company factors into their calculation, their cost-based pricing strategy is either full-cost or direct-cost pricing.

• Full-cost pricing considers fixed and variable costs, plus a percentage markup. It’s more accurate because it accounts for everything, but calculating it is more complicated.
• Direct-cost pricing only considers the direct (variable) costs of producing and distributing a product, such as materials and labor. This approach is more straightforward but may leave businesses with a lower profit margin.

The concept behind the cost-based pricing model is relatively simple: calculate all the costs of bringing a product to market. Then, add a margin to determine the selling price. Plenty of businesses, big or small, use cost-based strategies (at least partially) because they’re relatively easy to implement and lead to predictable (and guaranteed) profit margins.

• Cost-plus pricing
• Markup pricing
• Break-even pricing

Why Companies Use Cost-Based Pricing

Although it doesn’t account for external factors like demand and competition, cost-based pricing is useful in many situations.

• Ensuring profitability when selling high-cost items. By considering all costs involved, companies can guarantee a profit margin with each sale. Products that are expensive to manufacture (such as engineer-to-order items) are often sold using this method.
• Covering production costs. In industries where fixed costs (like rent and equipment) make up a significant part of production expenses, cost-based pricing methods allow companies to recover those costs quickly and efficiently.
• Simplifying pricing decisions. Unlike value-based pricing , which requires extensive market research and analysis, the cost-based approach uses internal data, making it easier for businesses to set prices without external input.
• Setting a baseline price for a new product. Since cost-based models don’t require any external data/input, there are fewer variables involved. This makes it a useful starting point for companies launching new products and trying to determine the right price for them.

That said, it doesn’t account for demand. Setting prices based solely on costs might mean your product doesn’t reflect its true value in the market, leading to missed opportunities and lost profits.

Cost-based pricing also ignores what your competitors are charging for similar products. If they offer lower prices, you may have a harder time selling your product at your target profit margin.

And, it doesn’t incentivize efficiency and innovation. If a company relies solely on cost-based pricing, they have little incentive to focus on improving efficiency and reducing production costs.

So, cost-based pricing is best used in conjunction with other pricing strategies , such as value-based or competitor-based pricing. Companies that use a combination of these methods can ensure they are factoring in both internal and external factors when setting prices for their products.

Types of Cost-Based Pricing Strategies

Cost-plus pricing .

Cost-plus pricing is the most common cost-based method. It involves adding a predetermined percentage markup to a product’s total per-unit cost. This method is useful when other costs, such as marketing or research and development, are difficult to calculate.

Cost Plus Pricing = Break-Even Price x Desired Profit Margin (%)

For example, if a company’s break-even price is $50 per unit and they want to make a 20% profit margin, the calculation would look like this:

Cost Plus Pricing = $50 x 1.20 = $60

So, according to the cost-plus pricing strategy, the selling price for this product would be $60 per unit.

Break-Even Pricing

The break-even pricing strategy is a cost-based method that aims to determine the price at which a company will break even — they neither make nor lose money. It’s used most often when launching new products or for one-time item production, like events or services.

Break-Even Price = (Total Fixed Costs / Number of Units Produced) + Variable Costs

For example, if a company has $10,000 in fixed costs and plans to produce 500 units, with variable production costs of $20 per unit, the calculation would look like this:

Break-Even Price = ($10,000 / 500) + $20 = $40

To determine the sub of fixed and variable costs, businesses conduct a break-even analysis beforehand to determine the point where revenue equals expenses and, after that point, how much profit they can make. This information helps them set prices to cover their costs and make a profit.

Markup Pricing

Ecommerce and retail businesses commonly use markup pricing. It’s a simple cost-based method where the selling price of a product is calculated by adding a predetermined markup to the cost of goods sold.

Mark-up Price = Cost of Goods Sold x Markup Percentage

For example, if a product costs $50 and has a 50% markup, the calculation would look like this:

Mark-up Price = $50 x 1.5 = $75

The markup pricing method is useful for businesses that sell commodities with no differentiation, like grocery items or raw materials.

Target Profit Pricing

Businesses use target profit pricing when they want to set reasonable, competitive prices while still accounting for profitability . It’s slightly different from cost-plus pricing in that businesses consider both the desired profit margin and the target price.

Target Profit Price = (Total Costs + Total Desired Profit) / Number of Units Produced

For example, if a company has $10,000 in total costs and wants to make a 30% profit, and they plan to produce 1,000 units, the calculation would look like this:

Target Profit Price = ($10,000 + ($10,000 x 0.30)) / 1000 = ($10,000 + $3,000) / 1000 = $13

In the above case, the target profit price for each unit is $13.

Advantages and Disadvantages of Cost-Based Pricing

Advantages of a cost-based pricing strategy.

• Easy to calculate and understand. Companies with limited resources, very little data, and small teams can use cost-based methods without extensive market research. You’d need large amounts of data to implement competitive pricing or a value-based model, which generally requires time and/or significant resources.
• Simplifies product launches. Since cost-based pricing doesn’t rely on external data or inputs, it’s perfect for when your organization launches a new product. They can use the cost-plus pricing method to set a baseline price and adjust as needed once they gather more data or learn more about their target market.
• Allows for a guaranteed profit margin. Accounting for production costs means you’re making a profit on every sale. Overreliance on competitive and value-based models may mean you’re selling at a loss due to external factors, like changes in the market or competitor pricing.
• Protects against volatility. In industries with high levels of volatility, such as commodities or technology, cost-based pricing can provide a buffer against sudden changes and help businesses maintain profitability.
• Good baseline for testing. Price optimization is a tricky equation to get right. You can use market reactions to your cost-based price to generate data and insights to eventually develop more intricate pricing strategies.

Disadvantages of a Cost-Based Pricing Strategy

• Ignores market demand. An entirely cost-based strategy assumes that the price a product sells for is based on its production costs, disregarding consumer behavior and market forces.
• No guarantee of sales. Just because each sale is profitable for you doesn’t mean your customers will pay that price. A cost-based strategy can lead to overpricing or underpricing a product, resulting in lost sales and revenue.
• Does not consider perceived value. A cost-based model assumes the only factors customers consider are production costs, ignoring how a customer may perceive value in relation to the price of a product. So, while it works well in industries like bespoke manufacturing, DTC ecommerce often requires a more nuanced approach to pricing. Otherwise, a massive company like Amazon will take your customers.

Examples of Cost-Based Pricing

Manufacturing.

B2B manufacturing is one of the best examples of cost-based pricing in practice. Since it’s mostly contract-based, the cost-plus pricing model makes it easy for businesses to understand their manufacturing expenses and set a profit margin. This way, they can fulfill orders while remaining profitable.

It works so well in contract manufacturing because B2B buyers expect that the manufacturer will receive a percentage of the cost. And, since the organization is customizing an order for the buyer, the buyer also expects to pay any additional costs for customization.

Commodity-Based Industries

In industries like oil and gas, cost-based pricing is the norm. The price of a barrel of crude oil depends on its production costs, which includes extraction, refining, and transportation.

Since there’s a direct correlation between the cost of producing a commodity and its selling price on the market, companies use cost-based pricing to maintain profitability. Even when prices fluctuate due to market forces, they can adjust production and costs accordingly.

When organizing events, companies use break-even pricing to ensure they don’t lose money on ticket sales. With this method, businesses determine the total cost of hosting an event, including venue rental, catering, and marketing expenses. They then divide that number by the expected number of attendees to calculate the ticket price.

Retail companies can use cost-based pricing if the customer generally understands manufacturing costs. With massive ecommerce platforms like Amazon and retailers like Walmart, this doesn’t work for every type of product.

For products with a well-defined market price for a certain level of quality, there’s no reason for a cost-based strategy. For example, there would be no reason to sell a regular graphic t-shirt for less than $25, even if you found a way to produce and deliver it at a cost per unit of $2.

But, for unique products (say, a t-shirt with patented moisture-wicking technology), a method like cost-plus pricing is reasonable. The unique feature of the product gives it a distinct perceived value (especially if you market it well), so a higher price doesn’t seem unreasonable to consumers.

Service-Based Industries

Professional services need to take a cut off the top to pay their employees, contractors, and fixed costs (if they have any). Like manufacturing, it’s quote- and contract-based. So, .

It also helps them understand how many projects they need annually, quarterly, or monthly to maintain profitability. For example, you may have a firm charging $3,000/month for a marketing retainer. The retainer pays for 1 X $75/hour copywriter, 1 X $100/hour graphic designer, and some overhead costs. This establishes a baseline cost you can tweak as needed.

Leveraging Technology to Execute Cost-Based Pricing

Business analytics.

Although it’s a simple equation, you’ll still want to strike the right balance of profit vs. customers’ willingness to pay. As you acquire new subscribers, sell through your inventory, or render your services, you’ll need business analytics tools to help you gauge how effectively your current price reflects customers’ perceived value.

Optimized pricing results in more sales. Even if the ‘perfect’ price is below your target margin, it could be worth it if it helps you sell significantly more or find ways to operate more efficiently. Using this information will help you find that number and work toward it.

Enterprise Resource Planning (ERP)

ERP software helps you calculate your costs in real time. Since it shows you your expenses and projected overhead margin, you can use it to determine your costs both in total and per unit. ERP can also track inventory, reflect dynamic production costs, and display historical data on expenses and sales. So, you can also use it to refine your cost-based strategy over time.

Configure, Price, Quote (CPQ)

As mentioned above, most businesses that find success with cost-based pricing are quote-based. CPQ software uses preset pricing rules and artificial intelligence to streamline the pricing process. Sales teams use it to generate itemized quotes, which, assuming you’ve programmed the system correctly, reflect profitable sales prices for your company.

On an ongoing basis, you’ll have to bill for the services rendered or products sold to your customers. Depending on how you bill and what type of payment processing system you use, billing can lead to more costs (like transaction fees).

But, you’ll need it to manage your revenue. And, it’s not just about billing for the products and services you sell; you’ll also need to charge customers for additional costs like customization and shipping.

People Also Ask

What is the difference between value-based pricing and cost-based pricing.

Value-based pricing is a pricing strategy that considers a product’s perceived value (according to customers), rather than just the cost of production. This means companies can set prices that represent customers’ willingness to pay, instead of just covering costs. Cost-based pricing is the opposite — it focuses primarily on covering production costs and adding a markup for profit.

What is usually the first step in cost-based pricing?

The first step in cost-based pricing is always to figure out the baseline pricing. This requires a detailed analysis of the fixed and variable costs associated with producing and selling the product. Once the pricing team establishes a baseline, they can add a markup to determine the final price.

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What is Cost-Based Pricing? The Pros and Cons

October 24, 2022 May 25, 2022

The last thing any business wants is to fizzle out due to a lack of customers and revenue. And for many businesses, this happens because they’re not charging enough for their products or services. 

This is where cost-based pricing comes in.

As a home service business, you must be strategic when it comes to pricing your products and services. When you do, it will be easier to not only attract new customers but also keep the ones you’ve already got.

So, what exactly is cost-based pricing, and how do you know if it’s the right pricing strategy for your business?

In this article, we’ll explore this type of pricing strategy in detail, including its advantages and disadvantages, so that you can make an informed decision about whether or not it’s the right pricing strategy for your business.

What Exactly is Cost-Based Pricing?

Cost-based pricing , otherwise known as the cost-plus method, is a pricing strategy for goods and services that takes into account the cost of producing and delivering them. Businesses use cost-based pricing to calculate a price that will cover their costs and allow them to make a profit.

This allows businesses to stay ahead of the competition by making sure they are not selling their products or services at a loss. Many businesses use cost-based pricing in conjunction with other pricing strategies to come up with a final price for their goods and services.

There are several different methods of cost-based pricing, but all of them involve considering the cost of making and selling a product or service before setting the price. This ensures that prices are fair and reasonable and that businesses can stay in operation.

Are you seeking a more optimized pricing strategy for your business?

At Wizard of Sales® , we help businesses in the home service industry find a more efficient and effective approach to pricing and negotiation. Our Hybrid Pricing Model™ allows you to implement authentic and persuasive pricing that enhances profitability.

Book a demo with us today to get started!

The Two Methods of Cost-Based pricing

Cost-based pricing can be broken down into two main types: cost-plus pricing and break-even pricing.

Cost-plus pricing

In the cost-plus method, businesses add a markup to the cost of their goods or services to make a profit. The cost-plus method is often used by businesses when they are trying to price new products. 

To calculate cost-plus pricing, businesses first need to determine all the costs associated with producing their goods or services. These costs can include: 

• Raw materials
• Manufacturing overhead 

After all the costs have been tallied up, a markup is added to the total cost. The markup can be a percentage of the cost or a flat fee. Once the cost-plus markup has been determined, that is the price charged to the customer.

Break-even pricing

Break-even pricing is a method in which the company sets the price of its product or service so that it covers all of its costs and makes a profit. 

To calculate break-even pricing, businesses need to determine their fixed costs, variable costs, and desired profit. Fixed costs are expenses that stay the same regardless of how many products or services are sold, such as rent and utilities. Variable costs are expenses that change based on how many products or services are sold, such as the cost of materials. 

Once businesses have determined their fixed and variable costs, they can calculate their break-even point — the number of products or services they need to sell to make a profit. From there, they can add their desired profit to their break-even point to determine their cost-based price.

Pros of Cost-Based Pricing

Cost-based pricing has several great advantages. Here are the top three to consider when deciding if cost-based pricing is the best method for your business: 

Easy to Calculate

One of the main advantages of cost-based pricing is that it is relatively easy to calculate. You simply take your total costs and add the desired profit margin. This makes cost-based pricing ideal for businesses with low margins or high fixed costs.

Ensures a Steady Rate of Profit

Another big advantage of cost-based pricing is that it ensures a steady rate of profit. Because you are always aiming to cover your costs plus make a profit, cost-based pricing helps to ensure that your business remains profitable, even if sales volume fluctuates. 

Customers Find it Rather Simple to Understand

Cost-based pricing can be easy for customers to understand. If they know how much it cost you to produce the product, then they can better understand why you charge what you do. In some cases, cost-based pricing may even help increase customer loyalty because they feel that they are being charged a fair price.

Cons of Cost-based Pricing

Just as cost-based pricing has its advantages, it also has its fair share of disadvantages that should be considered before implementing this type of pricing strategy. 

Demand or Competition Are Not Considered in Cost-Based Pricing

In cost-based pricing, the selling price is set based on the cost of producing the good or service, without considering demand-based pricing or competition. This can sometimes lead to prices that are too high or too low, depending on the market conditions. 

Variation in Prices in Comparison to the Target Market

If the cost of producing a good or service varies widely, cost-based pricing can result in prices that are all over the map. This can be confusing for customers and make it difficult to establish a consistent brand identity because prices are constantly changing. 

Could Lead to an Inefficient and Unethical Production Process

If cost-based pricing is the only thing considered when setting prices, there’s no incentive to find ways to produce goods or services more efficiently. This could lead to an unethical production process that is wasteful and harmful to the environment or takes advantage of workers.

Cost-Plus Pricing Strategy Example

To paint a better picture, let’s do a cost-based pricing example for an HVAC company. Let’s say this company offers installation, repair, and maintenance services for air conditioning and heating units. They have a team of highly trained technicians that are available 24/7. 

The company’s cost-plus pricing strategy takes into account all the costs associated with providing its services. This includes the cost of labor, materials, overhead, and any other expenses incurred in running the business. The company then adds a markup to this cost to generate a price for its services. 

For example, let’s say it costs the HVAC company $100 to provide a service. They may then add a 20 percent profit markup to this cost, resulting in a price of $120 for the customer. The final price may also be affected by discounts, special offers, or other factors such as competition. 

Now, that this HVAC company has a cost-plus pricing strategy in place, it can be sure that it is always covering its costs and making a profit. This type of pricing can be helpful for businesses that have high overhead costs or that need to price their services quickly and without much market research.

Cost-Plus Price Formula

The cost-plus pricing formula is as follows:

cost-plus price = cost [(mark up/100) X cost]

To use the formula, you need to know your cost and the desired markup percentage. The markup is the gross profit you want to earn on the product or service and is expressed as a percentage of the cost. 

For example, if your cost is $100 and you want to earn a 50 percent gross profit, your markup would be 50. Once you have those numbers, you simply plug them into the formula like this:

$ cost-plus price = cost [(mark up/100) X cost]

$ 100 cost-plus price = 100 [(50/100) X 100]

$ cost-plus price = $150

As you can see, the cost-plus price would be $150.

With this formula, it’s easy to calculate a cost-plus price for any product or service. Just remember to use the right cost figure. For manufactured products, that would be the cost of direct materials, direct labor, and overhead. For services, it would be the cost of direct labor and overhead.

Is Cost-Based Pricing Right for You?

Cost-based pricing can be a useful tool for setting prices, but it’s not the only option. Other methods such as value-based pricing or market-based pricing may be more suitable for your business. So how do you know which approach is best for you?

Start by evaluating your business’s unique selling proposition (USP). What is it that makes your product or service special? What value do you provide that your competitors don’t? Answering these questions can help you determine the perceived value pricing of your offering and decide which method works best.

If your product is truly unique and there’s no market for it, then cost-based pricing may be the best option. However, if other businesses are offering similar products or services, market-based pricing is likely a better approach.

Deciding your pricing strategy is a big deal. After all, it will have a direct impact on your bottom line. But don’t let that intimidate you. By taking the time to understand the different options and evaluate what makes sense for your business, you can develop a pricing strategy that works for you.

At Wizard of Sales® , we can make your pricing strategy development process easy. Our Hybrid Pricing Model™ fits perfectly with a consultive style of selling, discounting, and negotiation that resonates at the kitchen table, helping make it easier for your sellers to sell, and your buyers to buy on the first sit.

Want to know more? Book a demo with us today!

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New York Takes Crucial Step Toward Making Congestion Pricing a Reality

The board of the Metropolitan Transportation Authority voted to approve a new $15 toll to drive into Manhattan. The plan still faces challenges from six lawsuits before it can begin in June.

By Winnie Hu and Ana Ley

New York City completed a crucial final step on Wednesday in a decades-long effort to become the first American city to roll out a comprehensive congestion pricing program, one that aims to push motorists out of their cars and onto mass transit by charging new tolls to drive into Midtown and Lower Manhattan.

The program could start as early as mid-June after the board of the Metropolitan Transportation Authority, the state agency that will install and manage the program, voted 11-to-1 to approve the final tolling rates, which will charge most passenger cars $15 a day to enter at 60th Street and below in Manhattan. The program is expected to reduce traffic and raise $1 billion annually for public transit improvements.

It was a historic moment for New York’s leaders and transportation advocates after decades of failed attempts to advance congestion pricing even as other gridlocked cities around the world, including London, Stockholm and Singapore, proved that similar programs could reduce traffic and pollution.

While other American cities have introduced related concepts by establishing toll roads or closing streets to traffic, the plan in New York is unmatched in ambition and scale.

Congestion pricing is expected to reduce the number of vehicles that enter Lower Manhattan by about 17 percent, according to a November study by an advisory committee reporting to the M.T.A. The report also said that the total number of miles driven in 28 counties across the region would be reduced.

“This was the right thing to do,” Janno Lieber, the authority’s chairman and chief executive, said after the vote. “New York has more traffic than any place in the United States, and now we’re doing something about it.”

Congestion pricing has long been a hard sell in New York, where many people commute by car from the boroughs outside of Manhattan and the suburbs, in part because some of them do not have access to public transit.

New York State legislators finally approved congestion pricing in 2019 after Gov. Andrew M. Cuomo helped push it through. A series of recent breakdowns in the city’s subway system had underscored the need for billions of dollars to update its aging infrastructure.

It has taken another five years to reach the starting line. Before the tolling program can begin, it must be reviewed by the Federal Highway Administration, which is expected to approve it.

Congestion pricing also faces legal challenges from six lawsuits that have been brought by elected officials and residents from across the New York region. Opponents have increasingly mobilized against the program in recent months, citing the cost of the tolls and the potential environmental effects from shifting traffic and pollution to other areas as drivers avoid the tolls.

A court hearing is scheduled for April 3 and 4 on a lawsuit brought by the State of New Jersey, which is seen as the most serious legal challenge. The mayor of Fort Lee, N.J., Mark J. Sokolich, has filed a related lawsuit.

Four more lawsuits have been brought in New York: by Ed Day, the Rockland County executive; by Vito Fossella, the Staten Island borough president, and the United Federation of Teachers; and by two separate groups of city residents.

Amid the litigation, M.T.A. officials have suspended some capital construction projects that were to be paid for by the program, and they said at a committee meeting on Monday that crucial work to modernize subway signals on the A and C lines had been delayed.

Nearly all the toll readers have been installed, and will automatically charge drivers for entering the designated congestion zone at 60th Street or below. There is no toll for leaving the zone or driving around in it. Through traffic on Franklin D. Roosevelt Drive and the West Side Highway will not be tolled.

Under the final tolling structure, which was based on recommendations by the advisory panel, most passenger vehicles will be charged $15 a day from 5 a.m. to 9 p.m. on weekdays, and from 9 a.m. to 9 p.m. on weekends. The toll will be $24 for small trucks and charter buses, and will rise to $36 for large trucks and tour buses. It will be $7.50 for motorcycles.

Those tolls will be discounted by 75 percent at night, dropping the cost for a passenger vehicle to $3.75.

Fares will go up by $1.25 for taxis and black car services, and by $2.50 for Uber and Lyft. Passengers will be responsible for paying the new fees, and they will be added to every ride that begins, ends or occurs within the congestion zone. There will be no nighttime discounts. (The new fees come on top of an existing congestion surcharge that was imposed on for-hire vehicles in 2019.)

The tolls will mostly be collected using the E-ZPass system. Electronic detection points have been placed at entrances and exits to the tolling zone. Drivers who do not use an E-ZPass will pay significantly higher fees — for instance, $22.50 instead of $15 during peak hours for passenger vehicles.

Emergency vehicles like fire trucks, ambulances and police cars, as well as vehicles carrying people with disabilities, were exempted from the new tolls under the state’s congestion pricing legislation .

As for discounts, low-income drivers who make less than $50,000 annually can apply to receive half off the daytime toll after their first 10 trips in a calendar month. In addition, low-income residents of the congestion zone who make less than $60,000 a year can apply for a state tax credit.

All drivers entering the zone directly from four tolled tunnels — the Lincoln, Holland, Hugh L. Carey and Queens-Midtown — will receive a “crossing credit” that will be applied against the daytime toll. The credit will be $5 round-trip for passenger vehicles, $12 for small trucks and intercity and charter buses, $20 for large trucks and tour buses, and $2.50 for motorcycles. No credits will be offered at night.

Grace Ashford contributed reporting.

Winnie Hu is a Times reporter covering the people and neighborhoods of New York City. More about Winnie Hu

Ana Ley is a Times reporter covering New York City’s mass transit system and the millions of passengers who use it. More about Ana Ley

Comparing Basic vs Premium Plans

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Note:  Access to some features depends on the user’s subscription. Visit Plans & Pricing to learn more about the different Planner subscriptions. 

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4 Viva Goals integration needs to be enabled see Enable Integrations in Viva Goals | Microsoft Learn  

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Rebates rise as carbon price increases to $80 per tonne

Starting today, a litre of gasoline will cost an extra 3.3 cents.

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The federal carbon tax and its associated rebates rise today as the national price on carbon emissions increases from $65 per tonne to $80.

While the national carbon price applies across the country, not everyone pays the federal carbon tax and receives money back.

Carbon pricing works differently in Quebec, the three territories and British Columbia — residents don't receive federal rebates. The remaining provinces are subject to the federal government's carbon tax or fuel levy, and families or residents receive rebates from Ottawa.

Canada also has a mix of federal, provincial and territorial carbon pricing systems for industrial emitters.

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• Industrial carbon pricing has three times the impact on emissions as consumer carbon tax: report

Starting today, the federal carbon tax increase will cost drivers an extra 3.3 cents per litre at the pump. Since Ottawa's fuel levy was introduced in 2019, the carbon tax has added 17.6 cents to the cost of a litre of gasoline. The levies for other fuels can be found online .

The rebates — recently rebranded as the Canadian Carbon Rebate — also have increased along with the carbon price, says Finance Canada. To receive the rebate, you need to file an income tax return. The rebate arrives through direct deposit in your bank account or through a cheque in the mail.

The payments come every three months; the next one is scheduled to arrive as early as April 15.

Here are the amounts a single adult person can expect to receive quarterly:

• $225 in Alberta.
• $150 in Manitoba.
• $140 in Ontario.
• $188 in Saskatchewan.
• $95 in New Brunswick.
• $103 in Nova Scotia.
• $110 in Prince Edward Island.
• $149 in Newfoundland and Labrador.

Here are the amounts a family of four can expect to receive quarterly:

• $450 in Alberta.
• $300 in Manitoba.
• $280 in Ontario.
• $376 in Saskatchewan.
• $190 in New Brunswick.
• $206 in Nova Scotia.
• $220 in Prince Edward Island.
• $298 in Newfoundland and Labrador.

Rural residents get a 10 per cent top-up on their rebates because they tend to drive more and consume more fuel. That rural top-up will double once a bill now before Parliament becomes law.

Nova Scotia, P.E.I, and Newfoundland and Labrador, however, will see their rebates decrease after Ottawa exempted home heating oil from the carbon tax. In October,  Prime Minister Justin Trudeau announced  the government will pause for three years the carbon pricing scheme on home heating oil in the provinces and territories where the carbon levy applies.

While New Brunswick is not seeing a drop in rebate amounts, other Atlantic provinces are because Ottawa is collecting less money from these provinces that tend to be more reliant on furnace oil than other parts of the country. 

All the money that's directly collected by the federal carbon pricing system, the federal government said, is returned to the province or territory where it's collected. About 90 per of the federal carbon tax goes towards rebates. The remainder goes to Indigenous communities, farmers and businesses.

National carbon pricing, a core federal Liberal climate policy, faces mounting opposition. Before Monday's rise, the opposition Conservatives and at least seven premiers called on the government to halt the increase. Conservative Leader Pierre Poilievre says if he forms government he will "axe the tax," because of the financial hardship the rising carbon price places on families and businesses. 

It's unclear if a future federal Conservative government would also get rid of carbon pricing for industrial emitters. Poilievre has not detailed how his proposal to use "technology not taxes" would ensure Canada achieves its emissions reduction targets.

The federal government says eight out of 10 families receive more in rebates than they pay under the carbon tax. The total amounts also can be found online .

A fiscal analysis by the independent parliamentary budget officer backs Ottawa's claim. The budget watchdog's often-cited report found wealthy families will lose money when the carbon price reaches its highest level in 2030-31 at $170 per tonne. Lower and middle-income families will make money from the rebates, said the Parliamentary Budget Officer (PBO).

Carbon tax crash course: How it works and what it will cost you

The PBO also concluded in a separate economic analysis that at $170 per tonne, the federal carbon tax will cut jobs and profits in the transport and oil and gas sectors. This means workers in the oilpatch could lose their jobs and Canadians who hold shares in oil companies like Suncor or Cenovus could see lower investment returns.

"When both fiscal and economic impacts of the federal fuel charge are considered, we estimate that most households will see a net loss," said the Parliamentary Budget Officer Yves Giroux. "Based on our analysis, most households will pay more in fuel charges and GST—as well as receiving slightly lower incomes—than they will receive in (rebates)."

Are emissions falling because of the carbon tax?

After several years of the national carbon price. Environment and Climate Change Canada said its modelling shows Canada's emissions would have been higher without carbon pricing.

The federal department said that in the latest year for emissions data (2021), emissions "would have been approximately 18 megatonnes higher in the absence of Canada's carbon pricing plan." That figure is almost equivalent to the annual emissions of Manitoba.

"Changing the energy system in an economy is a lot like sort of steering a cargo ship. It does take time," said Sara Hastings-Simon, an associate professor at the University of Calgary's faculty of science who studies carbon pricing and energy transitions.

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• Trudeau calls out 'short-term thinker' politicians as some premiers urge him to drop carbon price hike

"So we are just starting to see those, the results of those efforts and that ... if we can continue on that path, if we continue to have the suite of climate policies that we have in place, we will continue to see those emissions starting to fall from where they would have been and actually fall in an absolute sense."

The federal government has said that the price on carbon, including consumer and industrial carbon pricing, is expected to account for roughly one-third of Canada's emissions reductions.

Independent analysis from the Canadian Climate Institute, released in March, shows that the current suite of federal government climate policies is set to significantly reduce Canada's emissions.

The report found that carbon pricing — both the consumer and industrial versions — is projected to reduce emissions by as much as 50 per cent by 2030.

The report shows the pricing policy for large emitters accounts for most of the projected emissions cuts — driving three times the emissions reductions attributed to the consumer carbon price.

Parliamentary budget officer says carbon tax 'least disruptive' way to reduce emissions

The institute's report says industrial carbon pricing is projected to contribute "between 23 and 39 per cent (or 53 to 90 megatonnes) of avoided emissions from all policies implemented to date."

The report says the consumer carbon price accounts for between 8 and 9 per cent (or 19 to 22 megatonnes) of projected emissions reductions.

The Canadian Climate Institute conducts climate change policy research. It describes itself as a non-partisan and independent institute that receives financial support from Environment and Climate Change Canada and other private donors including the Ivey Foundation, Scotiabank and Loblaws. 

ABOUT THE AUTHOR

Senior reporter, Parliamentary Correspondent

David Thurton is a senior reporter in CBC's Parliamentary Bureau. He covers daily politics in the nation’s capital and specializes in environment and energy policy. Born in Canada but raised in Trinidad and Tobago, he’s moved around more times than he can count. He’s worked for CBC in several provinces and territories, including Alberta and the Northwest Territories. He can be reached at [email protected]

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