Cost-based pricing

Cost-based pricing (also called cost-plus pricing) is a pricing strategy where a business calculates the cost of making or supplying one unit of a product, then adds a mark-up percentage to provide profit. The mark-up is a percentage of the unit cost, so it is added on top of the cost rather than taken out of the selling price.

How it works

For example, a small business makes scented candles. Wax, a jar, a wick and labour cost £6 per candle. The owner chooses a 50% mark-up. The mark-up is £6 × 50% = £3, so the selling price is £6 + £3 = £9. If costs rise to £7, the same 50% mark-up gives a price of £10.50, so the price still covers the higher cost and adds profit.

Advantages and drawbacks

Cost-based pricing can ensure the price covers costs and includes a profit margin, provided the costs are calculated accurately. It is simple to apply because the business starts from figures it already knows.

However, it ignores customers' willingness to pay and competitors' prices. A product with high costs may be given a high selling price, which could make it uncompetitive. Cost-based pricing therefore does not guarantee a profit: customers may refuse to buy if the price is too high, so the business may sell few units.