Cost plus pricing method refers to that pricing strategy under which the company adds all costs which has gone into making a product like raw material, labor and then firm add some percentage of profit margin to arrive at a price for a product. Given below are some of the advantages and disadvantages of cost plus pricing –
Advantages of Cost plus Pricing
- Biggest advantage of this is that company knows exactly the amount of expenditure that has incurred on making a product and therefore they can add profit margin accordingly which helps in achieving the desired revenue for a firm. So for example if a company has incurred expenses of $100 and they want to earn profit margin of 10 % than the company will sell the product at $110
- It is the simplest method to decide the price for a product because one has just to add up all the cost and then add profit which you want to earn which will give the price for a product.
- Since company is using its own data for deciding cost which makes it easier for a company to evaluate the reasons for escalations in expenses and therefore it can take corrective action immediately
Disadvantages of Cost plus Pricing
- This method does not take into account the future demand for a product which should be the base before deciding the price of a product and therefore a serious limitation of this method.
- It also does not taken into account the competitor actions and its effects on pricing of the product, because in today competitive world if one solely depends on cost plus pricing it can lead to failure of company’s product in the market.
- It can result in company overestimating the price of a product because this method include sunk cost and ignores opportunity cost also while calculating cost and there is element of personal bias while deciding the profit margin which is to be added for a product