A guide to cost-based pricing: When to use it as a small business owner

One of the major challenges small business owners face is pricing their products and services adequately, not to overprice and lose potential customers, and not to underprice and jeopardize their profitability. Various pricing models are available, and cost-based pricing is one of the oldest but most popular pricing strategies, particularly for small businesses. In this blog post, we will discuss what cost-based pricing means and when it's ideal for small business owners.

Cost-Based pricing model

Cost-based pricing, also known as cost-plus pricing, is a pricing strategy used by small business owners to determine their product or service cost by adding up all the costs. The costs may include direct and indirect expenses, such as overhead costs, materials, production costs, transportation costs, and labor. The costs can be added up based on the percentage mark-up rate, which is added to the total cost of the product or service to arrive at the final selling price.

When to use cost-based pricing

Cost-based pricing is ideal for small businesses that have a cost-intensive production process, such as manufacturing. When small business owners use cost-based pricing, they ensure that they cover all costs and remain profitable, as the pricing is based on the cost of production. It's especially useful when there’s a limited demand for one's product or service, and the market is highly competitive.

Advantages of cost-based pricing

One of the significant advantages of cost-based pricing is that a small business owner can determine the cost of production and mark-up the price to make a profit. It's also easy to manage and monitor as the cost of production is accurately calculated in advance. Cost-based pricing ensures a small business owner doesn’t sell a product at a loss and can always determine the minimum selling price.

Disadvantages of cost-based pricing

Cost-based pricing may not always be suitable for a small business owner as it does not factor in the customer's perceived value of the product or service in question. The pricing model may not be able to compete against rivals with a more desirable product or service, or one with a lower production cost. Cost-based pricing may also be disadvantageous for a start-up or a small business introducing a new product to the market since the pricing may not allow for proper market penetration.

Cost-based pricing is a reliable pricing model for small business owners to determine the selling price for their product or service easily. It's ideal for small businesses with complex logistics, unique competitive advantages, and a deep understanding of their production costs. However, it may not be appropriate for small businesses that enter highly competitive markets or those introducing new products. We hope this blog post has been informative and will help small business owners know when to use cost-based pricing. As always, be flexible with your pricing strategy but prioritize the profitability of your business.