When Should You Use the Cost Plus Pricing Model?

Among the multiple pricing models employed by the small and medium business, the Cost Plus is like an old pose. Everybody hates it, yet many still feel that they need that. It's the same with cost plus: many dislike it, but behind the scenes they use it as well. We have seen numerous professionals using it: wedding photographers, videographers, planners, officiants, DJs, photo booths, etc. Even bakers use cost plus pricing because it is so straightforward.

What is Cost-Plus Pricing?

The easiest way to describe the cost plus method is this: the business calculates the costs related to the production of a good or service. The costs can be fixed and variable. Once all the cost have been accounted for, the professional adds his profit margin and obtains the price. In our pricing travels we have seen markups from 10% to 900%. In other words, don't get stuck trying to determine the perfect markup figure.

Pros of Cost-Plus Pricing

As with everything in life, there are pros and cons of this pricing method. First, when a bride asks how you came up with the numbers, it is easy to explain how you calculated your collections. Second, assuming the couples pay your price you can forecast your revenue and profits for the year. Next, you know what is the maximum discount you can offer (not that we endorse that, but just in case). The cost-plus method leads to a fair price and fair packages. Other methods, such as percentage of wedding budget (used by many wedding planners) are unfair and can cause couples' backlash. There are many cases when customers protested (with their wallets) to different pricing methods.

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Simple to Calculate and Implement

The best part of this pricing method is that it is very easy to calculate and implement a certain price. For small businesses that lack a pricing team, simplicity and speed are key.

Efficiency is Rewarded and Passed to Couples

Because the final price a bride pays is directly related to costs, the most efficient professionals will have the lowest cost structure, hence, the lowest prices. Such a vendor with a lean cost structure can easily undercut competitors and gain market share while passing the savings to the clients.

Cons of Cost-Plus Pricing

This pricing method could sometimes drive inefficiencies. For example, to chase higher revenues and profits, if you are only considering a wedding, you might be tempted to increase the variable costs so that the % of total cost is higher.

Because this method makes sure the company recovers costs, there is no incentive to find new efficiencies so the owners can become complacent.

Compared to other pricing methods, this is a silo method. Cost plus ignores competitors' prices and the couples ability and willingness to pay so there is money left on the table. The duty of all business is to provide value for their clients and maximize profits. While cost plus only looks at the costs at the other extreme is value pricing ignores costs.

In our opinion, there should be different methods employed depending on the market situation, financial position and pricing power of the company. The cost plus method does not capture all the profits and 1% price increase results on average in 8% profit growth.

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Dynamic Pricing

For example, Coca Cola introduced a price model that increased the Coke pricing sold through vending machines when temperature increased. Uber is notorious for surge prices while airlines, hotels, hydro companies and car rentals have been employing dynamic pricing for so long that we are used to it and generally accept it as a normal business practice. Dynamic pricing

The beauty of Cost-Plus pricing is that such price can be easily defended and won't ever create controversy or boycott of the products and services of a particular vendor.

If you wanted to be super transparent, you could list your costs and the way you calculated your package.

Cost-Plus Pricing Example for Wedding Photographers

Let's analyze a New York wedding photographer for example. Why we picked New York City you might ask. Well, it is simply because New York wedding photography market is very closed to an efficient marketplace. There are many weddings in town, many photo professionals and the market is deregulated.

We will assume a photographer shoots 4 weddings per month on average. If that is the case, here is a simple calculation of the price.

Calculate Fixed Costs

First, we need to calculate the fixed costs per wedding.

Rent = $500 ($2,000/month divided by 4 weddings per month)

Utilities =$100

Insurance = $50

Equipment Depreciation = $450

Office costs = $50

Advertising costs = 250

Other costs = 100

Total fixed costs = $1,400

Calculate Variable Costs

Here are the variable costs per wedding

Wages lead shooter = $50/hr X 10 hrs = $500

Wages second shooter = $30/hr x 10 hrs = $300

Post Processing = $20/hr * 30 hours = $600 (yes, it is that expensive to process images)

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Parking = $20

Food = $30

Other expenses = $50

Total Variable Costs=$1,500

Determine the Total Cost and Package Pricing

Total Costs = Total Fixed Costs + Total Variable Costs

Total Costs = $2,900

Markup = 20%

It follows that the Package price will be $2900 x (1+20%) = $3,480

It always puzzles us when we see photographers who charge $1,500 for a 12 hour wedding. Our assumption is that they do not take into account all costs and they only capture the variable costs directly related to the wedding. In other words, the artists only think about how much it costs to document the day and take the photos, without considering depreciation, advertising, overheads, etc.

Please note that for simplicity purposes, we did not consider taxes in this scenario.

Conclusion

While the cost-plus pricing method is imperfect it is a good start. Still, in our opinion it should be used in conjunction with the market price and value based pricing.

References

When Cost Plus is a Good Idea, Harvard Business Review, July 12, 2018

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