Cost-plus pricing (also known as markup pricing) is a method to determine the selling price of a product in which a fixed percentage is added to the unit cost of a product. The unit cost of a product is defined as the cost of manufacturing one unit of a product.
Despite the popularity of the cost-plus pricing model, it might not be the best way to determine the selling price of all kinds of products. This pricing method takes only the unit cost of the product and your desired profit margin into account. Unlike the value-based pricing model, it does not emphasize other external factors such as the product’s perceived value, market conditions, or competitor prices.‍
A cost-plus pricing strategy is a method where you add a fixed markup percentage to the unit cost of a product to obtain its selling price.
Many different types of industries use the cost-plus pricing strategy.  Ideally, this method works best when the products are utilitarian in nature. For example, retailers, such as grocery stores, clothing shops, etc., use this method of setting prices. These stores offer a range of products to their customers. Hence, the seller can fix different markup percentages for other products. This pricing strategy is unsuitable for Software as a service (SaaS) businesses because it doesn’t consider the product's perceived value. Generally, the added value of SaaS products is much more significant than the production cost of the product.
This strategy works well for businesses trying to establish a cost-leadership strategy. A business can share its pricing strategy as a unique value proposition (UVP) with its customers. ‍
To determine the selling price of a product using the cost-plus pricing formula, you need to follow the steps mentioned below:
Selling Price = Total Cost (1 + Markup percentage)
Let us understand the cost-plus pricing formula with an example. Suppose you are the owner of a business that sells mattresses, and you are tasked to determine the selling price for one mattress.
First, you need to note down all the costs associated with the production of one mattress:
Let’s assume that the markup percentage is fixed at 40%; then the selling price can be determined using the formula:
Selling Price = $100 (1 + 0.40)
Selling Price = $100 (1.40)
Selling Price = $140
Therefore, the selling price of one mattress is $140.‍
The advantages of using the cost-plus model are as follows:
The disadvantages of using the cost-plus model are as follows:
Below is an example industry that relies on the cost-based pricing strategy to determine the selling price of their products:
Saas products
A cost-plus pricing strategy could be an easy method to set a price for your SaaS product. However, this method is not exactly compatible with the subscription-based SaaS business model. Generally, SaaS products are priced depending on the value it provides to their customers and the competitor's price. The cost-plus model doesn’t take both these factors into account.