Cost-based pricing strategy:  why communication is a prerequisite for pricing leaders

 

 

At Taylor Wells, we often involved in the implementation of pricing teams and functions in businesses.  Where they were previously or where they have not been seen as core to the commercial proposition of the business. This can be when the dreaded adherence to a faulty cost-based pricing strategy or cost-plus can be very strongly defended.

Among pricing, experts revile the cost-plus pricing for some legitimate reasons. For stand-alone projects, in particular, cost-plus pricing discourages efficiency and cost containment. When lower costs quoted; the company earns lower revenue and total profit. A bloated cost structure, on the other hand, will raise prices and boost profit.

Another is the cost-based pricing formula ignores both the customer’s willingness to pay and the competitors’ prices. When these factors ignored, a pricing decision can be entirely off base.

In this short blog we do not intend to cover any of the well-known weaknesses of a cost-based pricing strategy but instead touch on some of the pitfalls that can happen when a new pricing lead or revenue manager seek to buy-in for a pricing optimisation programme or movement towards value-based pricing. At Taylor Wells, we are ardent believers that a pricing leader is also a business leader, i.e. not a segmented function such as purely finance, risk or legal. Do really transform pricing in a large corporate – you need to win buy-in from sales, marketing, finance, the C-suite, operations – in fact, all departments. To do this is certainly not easy. We feel underappreciated sometimes with the task at hand.

 

 

 

 

How to broach the elephant in the room – cost-based pricing strategy may not be the best way forward!

I was chatting to a friend the other day -from a company, I used to work at. I was asking about the commercial strategy and who is setting a pricing strategy now. He said, “how can they set prices when they do not even know the costs“. At that point I thought – I do not have enough time to go down the road of explaining value-based pricing and also, I do not want to criticise my friend who seems so committed to cost-based pricing strategy.

 

I think we have all been there when we realise that the person you are talking to is so committed to the apparent accounting and scientific rigour of cost-plus pricing, that do discuss anything different is seen as a form of heresy or lazy/shady marketing waffle.

 

It can be an exhausting experience – winning buy-in from multiple functions for a move to value-based pricing, but it is vital to build any pricing transformation. In fact, we view it as laying a solid foundation for the transformation; otherwise, you are sure to find the optimisation program will flounder as if on quick-sand.

 

 

There are sometimes strategic and tactical reasons to use cost-plus pricing. When implemented with forethought and prudence, cost-plus pricing can lead to powerful differentiation, greater customer trust, reduced risk of price wars, and steady, predictable profits for the company.

 

No pricing method is easier to communicate or to justify. Cost-plus pricing is considered to be inherently fair and nondiscriminatory to customers. That is if the business is 100% sure of its cost position. Most are not, however, and the cost base of products are often guesstimating rather than precision. 

 

Cost-plus pricing is the very antithesis of value-based pricing, which seeks to discover differences between customers’ economic valuations and to exploit them by customizing prices.

 

Providing useful and understandable explanation and evidence on Cost-based pricing strategy

 

Taylor Wells commits to an education-based form of marketing pricing and pricing recruitment. We strongly believe in the ability of pricing to deliver sustainable profit and revenue boosts to even the most established business. When you are a pricing professional, the benefit of value-based pricing are almost self-evident – but we sometimes need to remember how we discovered the profession in the first place.

Usually, a light-bulb moment when value-based pricing becomes clear to us. The challenge in spreading the word to others is helping them have their own light-bulb moment – and often the trick can be making them believe they thought of it themselves!

 

Implications

 

If the companies that use cost-based pricing, it stabilises price levels. Companies are less likely to engage in price wars if they base their prices mainly on costs instead of competitors’ prices.

 

Cost-plus pricing can encourage shoppers to use factors other than price in buying decisions. When consumers believe prices reflect cost, they are more likely to factor quality into their decision, instead of just buying whatever is cheapest.

 

When the company has unique competencies that allow for an advantageous cost structure relative to competitors. It can use cost-plus pricing to create and deliver the most enticing value proposition of all.

 

Conclusion

 

For companies with a cost advantage or an interest in using price transparency as a differentiator.  Cost-plus pricing is a powerful strategic tool.

 

Companies are less likely to engage in price wars if they base their prices; mainly on costs instead of competitors’ prices.

 

When implemented with forethought and prudence, cost-plus pricing can lead; to powerful differentiation, greater customer trust, reduced risk of price wars, and steady, predictable profits for the company.

 

 

If you would like more information, then download our free pricing guide or e-book now.

Or, feel free to call me on (2) 91994523

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