Cost-plus pricing, n. gerund, delusional.

Going beyond Nagle & Holden … cost-plus prices:

– miss psychological price points

– effectively destabilize the business because they’re set with no perception of customer value in mind (if the prices are set irrationally, customer behavior will be irrational)

– assume that all the costs are cost-competitive, right? Wrong.

– temporarily shield uncompetitive procurement/costing/product management

– prevent the necessary and creative tension between pricing (“these products are not cost competitive!â€) and costing/procurement (“oh yes they are!”) to help improve the business as whole

– are very apparent to professional purchasers & purchasing depts. and can be exploited accordingly

– would be severely lagged and ineffective when used for life-cycle and X-rate management

– can be easily gamed by the competition: it’s very obvious when a company doesn’t set its price competitively

– wait, don’t tell me that with cost-plus pricing you don’t even bother with competitive analysis either ….?

Any more?

Cost-plus pricing, n. gerund, delusional.

1. From “The Strategy & Tactics of Pricing” Nagle & Holden, 2nd edition (1987 & 1995):

Cost-plus Pricing:

– “carries an aura of financial prudenceâ€

– “blueprint for mediocre financial performanceâ€

– “impossible to determine product’s cost before a price has been setâ€

cost = Æ’(volume) = Æ’(price) but if price = Æ’(cost) then you create an infinite loop which can will lead to the wrong solution (“flawed circularity†or – speaking in engineering rather than tabloid terms – catastrophic)

– creates a catastrophic cycle of a decline when competition increases: volumes decline, then overheads allocated to the products will increase leading to increased prices, which in turn will drive volumes down, increases overheads …. etc

2. Cost-plus pricing assumes costs are accurate, which is rarely the case, and, in reality, there is no good way of defining – let alone allocating – overheads:

cost = Æ’(allocations) = Æ’(volume) = Æ’(price), and again, if price = Æ’(cost) then you create an infinite loop which can will lead to the wrong solution (“flawed circularity†or – again, speaking in engineering rather than tabloid terms – catastrophic)

3. Sub-optimized pricing. Every price created by cost-plus pricing is either too high or too low. Every price could and should be improved.