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RIP Cost-Plus Pricing, April 2020

There has never been a better reason to ditch cost-plus pricing than the health and economic crisis we are experiencing right now.

Cost-plus pricing is traditionally defined as the pricing methodology where you add up all your costs, throw on a desired profit margin to the sum of those costs, then cross your fingers and pray that customers will pay the resulting price you’ve set.

Once set, subsequent adjustments to cost-plus prices tend to be made because of increases in the price of the costs involved (materials, labour, etc.), or the lazy might just increase prices by the rate of inflation (the consumer price index). The ultra-lazy will just blend this exercise into the annual budgeting exercise the business undertakes prior to the start of a new financial year.

Cost-plus pricing is a sub-optimal method of setting prices at the best of times, but in the worst of times (like now), it is utterly useless.

It is an impossible task right now for so many reasons. The examples given below are based on what is happening amongst the 90% of Australia companies still actively trading (during the week commencing 30th March 2020), but no doubt these trends are being repeated and are equally applicable where ever you might be reading this post.

Fifty percent (50%) of Australian businesses have made changes to their workforce,  mainly a reduction in the hours staff work. Labour costs, in your cost-plus pricing model, need to be adjusted to reflect this, or perhaps the $1,500 per fortnight JobKeeper allowance, perhaps for six months, perhaps longer or shorter…who knows?

Thirty-eight percent (38%) of businesses are changing their methods of delivery. For some businesses, delivery will be a new service they offer, and therefore a new cost. For others, it may mean more costs associated with existing delivery options provided or, with the recent fall in oil prices, it may mean less costs….who knows?

Thirty-eight percent (38%) of Australian businesses have, or are in the process of,  renegotiating property rental or lease arrangements. The cost associated with the roof over your head will be changing one way or another, maybe for the next six months, maybe longer….who knows?

Twenty-nine percent (29%) of Australian businesses are reporting difficulty sourcing raw materials. Your output may be using higher priced raw materials, if you’ve managed to source them from elsewhere. If not, you’re output may be declining, and you don’t know if you should raise prices to reflect scarcity, or drop prices to maintain cash flow.

Twenty-four percent (24%) of Australian businesses have deferred loan repayments. Such loans could be for a huge range of investments you’ve made in your business (such as materials, vehicles, technology), but whatever you’ve spent them on, deferrals will have an impact on your cost base.

So in a nutshell, the foundation upon which cost-plus pricing is built has now crumbled. It is Useless. Dangerous. Finished. Kaput!

In the 1860’s, the Bon Marche Department store in Paris ended the era of price haggling, and welcomed in the era of fixed pricing, by introducing consumers to a thing called the price tag.

If businesses today want to survive, they will have to stop using fixed prices put on price tags, and calculated on a cost-plus basis. They will need to talk to their customers, understand the value their products & services provided to them, and price as close as possible to what their customers are willing to pay, utilising value-based pricing methodologies.

References: ABS, Business Impacts of COVID-19, Week Commencing 30th March 2020

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