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Why cost-based pricing sucks
Financial Post ^ | April 19, 2012 | Paul Hunt

Posted on 01/18/2014 2:24:50 PM PST by rickmichaels

Cost based pricing is relatively simple; you figure out your cost of goods, set a desired margin for each unit, add that margin onto your costs and you have your price. Cost based pricing doesn’t require the detailed level of analysis and value measurement necessary to employ a value-based pricing strategy. Because it’s simple, many companies fall into a trap of cost-based pricing. But as far as smart pricing goes, cost-based pricing strategies are anything but. So if it’s simple, why does it suck? Here are three reasons why:

(Excerpt) Read more at business.financialpost.com ...


TOPICS: Business/Economy
KEYWORDS: capitalism; costbasedpricing; pricing

1 posted on 01/18/2014 2:24:50 PM PST by rickmichaels
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To: rickmichaels

Sounds like a rationalization right out of “Atlas Shrugged”.


2 posted on 01/18/2014 2:26:39 PM PST by gorush (History repeats itself because human nature is static)
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To: rickmichaels

It’s not pricing that matters. It’s what people are willing to pay that matters. An entirely different calculation.


3 posted on 01/18/2014 2:27:35 PM PST by P.O.E. (Pray for America)
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To: gorush

The politicians and groups that support cost-based pricing think people are too stupid to make a value decision without the governments help.


4 posted on 01/18/2014 2:32:27 PM PST by Zeneta
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To: rickmichaels

Just more suppression and/or control of capitalism.


5 posted on 01/18/2014 2:35:39 PM PST by EagleUSA
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To: rickmichaels

The author was never a product manager.


6 posted on 01/18/2014 2:42:01 PM PST by Conspiracy Guy (Did the ancients know they were ancients? Or did they see themselves as presents?)
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To: rickmichaels
Rather simplistic look at cost pricing...

Every product I sell is set at a minimum cost plus price for that particular segment or type of product...

A item that needs special consideration in the sell price like being keep frozen automatically is set at a higher margin to off set the cost of keeping it frozen...

The biggest factor in pricing a product is what the COMPETITION IS SELLING IT FOR...

I have many items as an example in my dry goods category that is priced at what the market will bear because there are few competitors that sell it... typically it will only be a few margin points higher than normal...

An item or similar item 50 other companies sell will be priced accordingly...

7 posted on 01/18/2014 2:42:16 PM PST by Popman ("Resistance to Tyrants is Obedience to God" - Thomas Jefferson)
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To: rickmichaels

Is the min-max method out of date or too advanced?
I never heard of any of these pricing strategies- except for cost-based which is used for utilities.


8 posted on 01/18/2014 2:45:37 PM PST by mrsmith (Dumb sluts: Lifeblood of the Media, Backbone of the Democrat Party!)
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To: rickmichaels

Cost based pricing does not work in the government. They overtax the systems and the more money they take in the more they waste.


9 posted on 01/18/2014 2:49:08 PM PST by mountainlion (Live well for those that did not make it back.)
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To: rickmichaels

No respectable publication would use “sucks” in the title


10 posted on 01/18/2014 2:50:37 PM PST by GeronL (Extra Large Cheesy Over-Stuffed Hobbit)
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To: EagleUSA

They just won’t leave it alone. Poverty and low growth all come from government interference in the marketplace.


11 posted on 01/18/2014 2:59:31 PM PST by 1010RD (First, Do No Harm)
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To: rickmichaels

I like to buy things below the marginal costs and let the manufacturer make a profit on volume.


12 posted on 01/18/2014 3:00:10 PM PST by Paladin2
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To: P.O.E.
Most prices fall between the cast of marginal manufacturing and the value to the buyer.

Maximizing profit would indicate selling to everyone at their individual price on the demand curve (limited by marginal costs on the low end).

13 posted on 01/18/2014 3:04:03 PM PST by Paladin2
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To: Zeneta

I’d like to only purchase the gov’t services I want.


14 posted on 01/18/2014 3:04:50 PM PST by Paladin2
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To: Paladin2

Why should they be government services?


15 posted on 01/18/2014 3:06:37 PM PST by GeronL (Extra Large Cheesy Over-Stuffed Hobbit)
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To: rickmichaels

Well it kind of depends on what you sell. Luxury designer goods are usually value priced rather than cost priced.

It also depends on how many competitors you have and whether the product is unique and exclusive.

Value pricing attracts competition because they will quickly realize that the cost is low and the profit margin high and they will rather quickly undercut your pricing PDQ and the resulting price war result in a downward spiral to cost pricing.

Sometimes, keeping your value pricing modest will delay the entry of competitors into your market, because there might be other value priced products that have more tempting margins.

There is no one best system for everything.


16 posted on 01/18/2014 3:11:09 PM PST by Valpal1 (If the police can t solve a problem with violence, they ll find a way to fix it with brute force)
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To: GeronL; Paladin2

Interestingly enough, the Government seems to use a “Cost-based” taxing model. With absolutely no controls on cost.


17 posted on 01/18/2014 3:16:39 PM PST by Zeneta
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To: Paladin2

That would involve keeping the prices secret from other buyers. The free market requires instant, open and public pricing info.

Which is why advertisers and politicians spend so much time obscuring the facts.


18 posted on 01/18/2014 3:25:22 PM PST by P.O.E. (Pray for America)
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To: gorush
Sounds like a rationalization right out of “Atlas Shrugged”.

Oh, pray tell why is it any sort of "rationalization".

And then, if you have the time, please let us know how Ayn Rand figures into it.

19 posted on 01/18/2014 3:33:12 PM PST by BfloGuy ( Even the opponents of Socialism are dominated by socialist ideas.)
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To: P.O.E.

I’m sure Dingy has the Senator price list in his pocket.


20 posted on 01/18/2014 3:38:31 PM PST by Paladin2
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To: Paladin2

It’s amazing how many of them go in all piss & vinegar, and in time all start singing the same tune as everyone else.

Guess the price must be pretty attractive.


21 posted on 01/18/2014 3:50:30 PM PST by P.O.E. (Pray for America)
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To: rickmichaels
This way the big-government/big-corporate crony-fascist complex can slather on as many phony "costs" as they desire and we are required to eat them.
22 posted on 01/18/2014 3:50:54 PM PST by E. Pluribus Unum (Who knew that one day professional wrestling would be less fake than professional journalism?)
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To: gorush

Sounds like Harvard Business School - “screw the customer for as much as you can, maximize profit, maximize personal year-end bonus.” However, what it also does is to allow your competitor to undercut your price, steal your market, and perhaps put you out of business.


23 posted on 01/18/2014 3:58:25 PM PST by I am Richard Brandon (center)
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To: rickmichaels

my old boss set our prices based on margins that would allow the company to pay off all of its debt in a set period of time, given wildly optimistic sales projections. The market did not agree with him. Interestingly, as he raised prices, sales dropped. He felt that this was because our sales reps weren’t working hard enough, and our service was lacking. His proposed solution was to raise prices a little bit more to make up for the revenue shortfall. There are costs to being stupid.


24 posted on 01/18/2014 4:11:25 PM PST by cdcdawg (Be seeing you...)
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To: BfloGuy

I sense that we disagree. My statement was intuitively obvious to the most casual observer...My happiness is unaffected by your position on the matter. :{)


25 posted on 01/18/2014 4:15:18 PM PST by gorush (History repeats itself because human nature is static)
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To: rickmichaels

He only focuses on cost not value. Comparing seats at an arena.

Obviously the seats cost the seller the same but differ greatly in value to the consumer. If not for price, who should get the front row seats? He gets to decide?


26 posted on 01/18/2014 4:20:26 PM PST by crusher2013
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To: I am Richard Brandon

You can compete on value or on price or a combination of the two.

Screwing your customers is like eating your seed corn. It’s amazing how fast customers will drop a business that is treating them badly.

Hard enough to stay in business long term without getting a bad reputation.


27 posted on 01/18/2014 4:23:19 PM PST by crusher2013
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To: cdcdawg

What is even more fun is the guy who prices to lose money on every job planning on making it up in volume.


28 posted on 01/18/2014 4:25:13 PM PST by scottteng (Tax government employees til they quit and find something useful to do)
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To: BfloGuy

This article does sound like one of the anointed, big government types in Atlas Shrugged lecturing the benighted on why and how to conduct business. What consumers are willing to pay doesn’t seem to enter into the calculus. The real world seems to dictate that prices generally must be high enough to cover costs, and low enough that people will pay them.

I agree that it doesn’t really rationalize anything. Rationality is usually lacking in articles that address why certain things “suck”.


29 posted on 01/18/2014 4:25:56 PM PST by cdcdawg (Be seeing you...)
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To: rickmichaels

FWIW, my understanding is that Costco sells everything at a fixed percentage markup. They seem to have been quite successful, and without screwing over their employees.


30 posted on 01/18/2014 4:35:17 PM PST by Sherman Logan
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To: Sherman Logan
FWIW, my understanding is that Costco sells everything at a fixed percentage markup.

That's true, but Costco and Wal-Mart tilt the playing field in their direction by forcing the manufacturers to be paid up front instead take their volume incentives and marketing funds when set goals are reached...

They are both big enough to guarantee volume and marketing objectives...

So they have a 2 or 5 % cost advantage over everybody else...

I am in direct competition with both and have seen copies of their invoices which are at the same cost presented to me...except my rebates, marketing funds have to earned after I achieve my volume objectives...

Legal ...Yes.. Fair ???

31 posted on 01/18/2014 4:54:34 PM PST by Popman ("Resistance to Tyrants is Obedience to God" - Thomas Jefferson)
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To: rickmichaels

We need a group of highly educated people appointed by politicians to dictate price and production. Somewhere they can be centrally located. if only such a system existed it would be super duper successful. I know, as a business owner, I’d welcome the relief of someone else deciding what to charge for my services.


32 posted on 01/18/2014 5:28:40 PM PST by Organic Panic
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To: P.O.E.

Read the article…it’s all about value based pricing, i.e., what people are willing to pay for perceptions of value received. Just as you say.


33 posted on 01/18/2014 6:56:06 PM PST by ProtectOurFreedom
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To: rickmichaels

This is a freshman level article. No one uses cost based pricing,


34 posted on 01/18/2014 7:38:52 PM PST by buffaloguy
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To: rickmichaels
This article could have been written by a Freshman taking an econ 101 class at any college. Such pap.

Value pricing is better than cost plus pricing, really, what a concept.

Good grief.

35 posted on 01/18/2014 7:58:24 PM PST by USS Alaska (If I could...I would.)
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To: rickmichaels

The author assumes costs are fixed. Over time costs can be reduced through purchasing scale, relocation of production, substitution of materials, automation, and improving labor productivity.

Pricing is one element of the marketing mix and the determination of actual prices is an element of corporate strategy. When setting the actual price of an item the company considers: competition (current and potential future), costs (current and projected future), requirements of the distribution chain (Tiffany has a different price expectations than Walmart), promotion strategies (high low or everyday low price), product positioning (some brands have higher perceived value and are able to price at a premium to similar products), internal financial/profitability goals, and an intuitive assessment of what the market will bear.

In my experience the only companies successful long term with pure cost based pricing are those who are able to maintain the low cost producer position in the industry and at the same time are willing to accept low margins to achieve high volume. The high volume requirement to cover fixed costs, and the advantages of production scale at high volumes, become significant barriers to competitive entry. However, high volume production scale typically requires undifferentiated commodity products to realize maximum production efficiency and lowest cost per unit. Commodity producers often lose market share to higher cost and higher priced products. An example is the beer industry where microbreweries are gaining share from the low cost producer (Anheuser Busch) even though their products are often priced higher.


36 posted on 01/19/2014 6:03:47 AM PST by Soul of the South (Yesterday is gone. Today will be what we make of it.)
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To: gorush
My statement was intuitively obvious to the most casual observer.

It most certainly is not, though your apparent faith in your ability to express yourself in writing is inspiring.

37 posted on 01/19/2014 3:41:04 PM PST by BfloGuy ( Even the opponents of Socialism are dominated by socialist ideas.)
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To: cdcdawg
This article does sound like one of the anointed, big government types in Atlas Shrugged lecturing the benighted on why and how to conduct business.

Well, that's a take I hadn't considered. But given the lack of any understanding of pricing [as you mentioned], I just considered it typical hack business journalism by someone who knows nothing of business and isn't much of a journalist.

38 posted on 01/19/2014 3:43:23 PM PST by BfloGuy ( Even the opponents of Socialism are dominated by socialist ideas.)
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