Product Pricing Strategies – Cost-Plus Pricing and its Problems
Product Pricing is a tricky business. When you have a product at hand and you have a market to serve, you need to have a pricing strategy that would make your product appealing to the consumer. How to go about pricing your product? You may have to be an economist if you are to calculate your product’s price elasticity and diminishing marginal utility of your product. However, marketers are not really expected to be economists; and that makes pricing that much simpler.
The Cost-based approach to pricing: Most companies resort to a cost-based pricing strategy. The cost-plus pricing strategy goes exclusively by the costs incurred by the organization in production and tends to place a margin on the costs incurred. Cost plus margin leads to product pricing. While this simplistic approach to product pricing may be appealing to many organizations, in reality, pricing is a much more dynamic affair – and cost-plus approach to pricing may not be the best way to price your product.
The problem with cost-plus pricing strategy is that it discounts the value added to the product with knowledge capital. In a knowledge economy, knowledge pays – and it is the expertise and specialized skills that needs to be charged for, when you price your product. Going by a cost-plus pricing would discount the effect that knowledge has on the product and wouldn’t really consider the value derived by the customer from your product. For instance, products that do not just deliver need-satisfaction but go on to deliver values in addition to what the product per se offers; this makes the product command a premium in the market. It is this reason that makes iPhones charge a premium and enjoy a higher margin than, say, a traditional cordless phone. Going by the cost-plus approach to pricing would rob the iPhone of its image and, despite all its utility, may not have a market to serve!
Premium Pricing Strategy before market saturation: Yet another problem with the cost-plus approach to pricing is that you tend to lose out on saving for the rainy day. It is conventional for pioneers of new technology to charge a premium for products that are just being introduced in the market. While businesses may blame the concept of economies of scale for their premium pricing strategy, it is also a tactic to milk the market before it gets crowded with heavy competition. Mobile phone organizations that were pioneers in the market enjoyed hefty premiums before competition forced their margins wafer thin.
While the cost-plus approach to pricing of products may have accounting utility and may be simplistic, it doesn’t serve the marketing purpose or the financial acumen.
