Cost plus pricing advantages

Written by emily beach
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Cost plus pricing advantages
Select the right pricing strategy to maximise profits and keep costs in check. (Medioimages/Photodisc/Photodisc/Getty Images)

Cost plus pricing represents one of the simplest pricing strategies available to businesses. Using this method, prices are determined by adding up all costs associated with a project then adding a specific profit margin on top to determine the final price. Cost plus pricing offers a number of advantages to both sellers and buyers.

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Transparency

Unlike traditional lump-sum price structures, cost plus pricing offers a high degree of transparency. Both the buyer and seller agree on a specific profit figure ahead of time, resulting in clear expectations between the two parties. In addition to the clear profit expectations, all cost information is readily available to both parties. The seller typically supplies not only an invoice but clear backup information to support each cost associated with the project. This ensures buyers only pay for the costs incurred and also makes it difficult for sellers to inject hidden fees into project invoices.

Flexibility

Cost plus pricing offers the greatest advantage and is often the only appropriate pricing strategy in situations where total costs are unclear at the start of the project. For example, on a custom production run that involves a highly specialised project, sellers may not be able to provide accurate pricing or estimates before production. In this situation, cost plus pricing allows the seller to buy all equipment and materials required to complete the job and then bill the buyer for these costs, plus an agreed profit add-on. Cost plus pricing also works for service contracts where the scope of the work is unknown. For example, an electrician who is hired to upgrade electrical wiring in a building may run into unseen difficulties during the course of his work. Cost plus pricing allows him to complete the work while ensuring he will make a specific level of profit.

Price protection

For sellers, one of the most important advantages associated with cost plus pricing is the protection it offers from unexpected cost increases. In a typical lump-sum pricing agreement, a seller is subject to significant risk. If material prices rise during the project, the seller is often forced to absorb those costs and may even lose money on the job. Under cost plus pricing, sellers are charge the buyer for all costs associated with the project as they are incurred. All risks associated with price increases are borne by the buyer.

Easy to administer

For buyers, one of the biggest advantages of cost plus pricing is simplicity and administrative ease. Almost anyone can review invoices and easily approve them for payment based on cost documentation and profit information. With a traditional lump-sum contract, it's easy to get confused over which portion of the contract sum is allocated to which costs. This makes administration more difficult and often requires that the seller has some understanding of the production process involved. Cost plus pricing is a simpler arrangement, resulting in less time and money devoted to administration.

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