Advantages and Disadvantages of Using Cost Based Pricing
Pricing strategies are an important part of generating revenue for your company. They can be used as tactics to help drive sales growth. Earlier, we wrote about the importance of dynamic pricing for business. Today we want to talk about a more popular cost-based pricing strategy. Implementing it with strategic foresight will lead to customer trust and profit, which will allow you to grow your business.
Cost-based pricing, as the name suggests, is a method of pricing goods or services based on production and distribution costs. In doing so, companies add a percentage of the total cost to the price to offset the risk and effort.
Let's start by looking at some well-known examples of companies using cost-based pricing. Ryanair is committed to providing the cheapest service in its industry. By continually cutting costs where possible, it strives to charge lower prices. Of course, this leads to a lower margin, but, on the other hand, it allows you to increase sales and, accordingly, profits. But even higher-priced companies can use cost-based pricing. However, these companies usually deliberately create higher costs to demand higher prices and higher profits.
Cost-based pricing is the most popular way of setting a price because it is easy to calculate. This type of pricing provides predictable margins and does not require too much effort to establish a price.
Sometimes you may need to raise the prices of your products and services. Most customers would resent the price hike, but if you cite the increased production costs as the reason, it will be much easier to explain this to the customer. If it costs X monetary units to produce a product, then the manufacturer must charge X plus a margin to generate a profit.
Also, this method allows you to ensure a stable rate of return.
Can be applied to a variety of products and services such as customized products and even new and innovative products. This is one of the few pricing strategies that can guarantee a profit. Regardless of the state of the industry, if you value your goods and services to their production costs, you will generate income.
However, cost-based pricing has some disadvantages. The most obvious of these is that this method is targeted at the domestic market. Thus, only internal cost issues are analyzed, and external factors such as the customer's willingness to pay more are not taken into account.
Another major disadvantage is the accuracy of the cost at which the price is calculated. Fixed costs are often difficult to attribute to specific products or services within an organization. Input costs change, fixed costs are allocated differently. This can lead to a violation of the desired standard margin.
To overcome the above disadvantages, a company can use market pricing. At the same time, the company sets the price based on the cost of similar goods and services.
Companies need to keep a close eye on their costs, especially in a highly competitive environment. If it costs a company more to produce and sell a similar product than its competitors, it will end up with a higher price or lower profit.
It can be concluded that cost-based pricing has positive aspects for the business, such a method is understandable and justified for customers, is easy to use, and allows you to control income. But it is worth remembering that there are drawbacks that can be reduced to achieve maximum work efficiency results.
The correct use of cost-based pricing through strategic implementation will undoubtedly benefit businesses that choose this pricing method.