Among B2B pricing practitioners and pundits alike, cost-plus pricing has been a professional punching bag for quite some time now. It’s the thing we’re supposed to “grow out of” when we finally “mature.” It’s the approach we’re supposed to “leave behind” when we finally become more “sophisticated.”
Cost-plus pricing is almost always portrayed as being simplistic, lazy, internally-focused, and woefully naïve. It’s characterized as something only rank amateurs…or accountants…would still be relying upon.
So…everyone agrees that cost-plus pricing is terrible, right?
Well…not exactly.
In the More Effective Cost-Plus Pricing training session, we spend a bit of time deconstructing why the popular narrative actually misses the mark. And the first thing we point out is something that tends to get overlooked in all the trash talk…
The problems associated with cost-plus pricing have nothing to do with the math.
Adding a markup over cost to arrive at a price point is not some kind of intellectual crime or mathematical heresy. In fact, many highly sophisticated price optimization systems will use that same basic structure under the hood—i.e. a base cost, multiplied by some factor, to generate a pricing recommendation.
The mathematical equation itself is simple, intuitive, and frankly, unassailable.
So…if the math isn’t the problem, what is?
As we discuss in the session, what people are usually bashing when they denigrate cost-plus pricing is not the idea of adding a markup over cost. No, what they’re really bashing is the way in which that markup is usually determined and applied.
Specifically, they’re taking issue with the application of a single, internally-focused markup across all customers, all situations, and all deal circumstances, with no consideration whatsoever for the relative differences in willingness-to-pay and sensitivity that exist in any given marketplace.
That’s the “inside-out and across-the-board” version of cost-plus pricing. And as we illustrate in the session, it’s an approach that’s virtually guaranteed to leave a lot of money on the table at both ends of the willingness-to-pay spectrum. This approach can’t help but underprice many deals that are won, while at the same time, losing profitable deals through overpricing.
At this point, I’ll stipulate that this version of cost-plus pricing deserves a good thrashing. But again, there’s nothing inherently wrong with the math involved. We just need use the math much more effectively.
As we detail in the training session, the more effective approach to cost-plus pricing involves:
- Breaking free from the internal myopia and historical precedents to develop an outside-in perspective and cultivate a market-oriented mindset.
- Leveraging price segmentation to identify and codify the deal circumstances under which different markups are warranted and advantageous.
- Being more thoughtful, analytical, and data-driven about the magnitude of the relative markups being applied and the resulting price levels.
- Developing models that are easy to explain, responsive to cost fluctuations, and deliverable through existing selling systems and quoting tools.
Simply put, instead of treating our product markups as across-the-board constants, based on arbitrary or internal criteria, we need to transform them into market-based variables that reflect meaningful differences in perceived value and willingness-to-pay across various customers and deal circumstances.
Cost-plus pricing doesn’t get a bad rap because the math is too simplistic. It gets a bad rap because the application of the math is too simplistic.
We need to stop pretending that our marketplace is homogeneous. We need to stop acting as though differences in value perception and willingness-to-pay don’t really matter. And we need to stop kidding ourselves that one markup across-the-board can…”on average”…fit every situation.
Once we do that, cost-plus becomes a perfectly serviceable, flexible, explainable, responsive, and scalable way to generate differentiated price points.
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