Why cost-plus strategy is insufficient now and how to make it better?
- 16 October 2018
Pricing matters! Especially if you’re running an online business.
Neil Patel states that 54% of shoppers will purchase products left in shopping carts if those products are offered at a lower price. Another survey, carried out by PwC, showed that 61% of respondents compare product prices. That’s why e-commerce companies should embrace pricing strategies and approach them in a serious manner. With thoughtfully developed and properly maintained pricing strategies, online businesses of all sizes would actually see a great impact on conversion rates and improvements in their revenue. Basically, a pricing strategy can be used as an effective marketing weapon.
There are plenty of approaches to build online pricing strategies for your business. Every business has unique market dynamics and its own internal circumstances. That’s why not all strategies may fit with your requirements and some may damage the brand value or harm the health of your revenue. It is necessary to analyze the data, including the external factors and the possible outcome of the pricing strategy that you are planning to apply for the sake of profit-maximization.
Of all the different online pricing strategies, we want to start with a cost-plus strategy, which is one of the simplest approaches. To gain a better understanding, let’s take a look at what cost-plus pricing means for online businesses and uncover the secret of the methodology by exploring why it is often not enough for today’s e-commerce world.
What is an online cost-plus pricing strategy?
Cost-plus pricing strategy is a cost-oriented method for deciding product prices. Basically, the company adds all the costs, including materials, labor, and overheads, and applies the profit margin that the company wants to achieve in order to arrive at the optimal price for a product. That way, if the cost of product ABC is 100 and the mark-up you desire is 25%, you have to price it at 125. Sounds simple, right?
However, many e-commerce companies make mistakes when calculating their costs and setting the right price because they may not be aware of extra overhead costs and ignore related operational costs that an e-commerce company has.
Any e-commerce company should at least have enough adequate information on its costs as they are directly related to the financial health of the business. As the main goal of any type of business is making profit from each sale, miscalculating the costs can reduce revenue. So, cost-plus pricing should be at the base of any other pricing strategy. However, solely sticking to cost-plus pricing strategy is not sufficient in today’s e-commerce competition as there are many external factors that may cause problems. Now let’s go deeper and learn why cost-plus should not be your ultimate strategy!
The risk of ignoring the competition
The cost-plus pricing strategy alone does not let brands take into consideration their competitors’ price actions and fluctuations. A company focusing too much on internal issues may lead to inadequate market research, and eventually to the shock of discovering that the competitors are frequently setting different prices. This has a negative effect on the brand’s market share and the expected profits. The cost-plus approach ends up either pricing too low or too high. In both scenarios, sales volume or profit will be affected negatively. Let me give you an example.
Today, online shoppers are armed with various facilities to enable them to check prices and they are extremely eager to find the best deals. The most apparent example, comparison shopping engines, produce many results for a product in seconds. So, your customers can see the price list including your products next to the competitor’s products and prices on the same page.
So, in order to be the most favored choice in the current e-commerce world, you should be aware of the competitors’ methods for calculating their prices because this can affect your own marketing and pricing strategies both in the short and long run.
Monitoring your prices automatically will enable you to gain great visibility on the market. Such market intelligence and analysis, which can be gathered using price monitoring tools, do not mean you need to drop your prices all the time and eat into your margins but allows you to optimize your pricing decisions to be competitive while maintaining your profitability.
Ignoring the customer’s willingness to pay
Regardless of the business, your customers should come first and you need to be very aware of their needs, behavior and perceptions. In every decision process, especially in pricing, the customer must be involved if you want to make money.
However, the most important drawback of cost-plus pricing is that it completely ignores customers’ perceptions and their willingness to pay. These factors are undeniably the most crucial components of the sales process, so any pricing strategy that doesn’t take customer value into consideration creates a huge risk. Also, your customers do not care about your costs.
Actually, they care about how your product helps them, how it makes them feel unique and ultimately, these factors determine the price perception of your product. The way to satisfy customer needs and not lose money is to apply consumer-oriented pricing. With that approach, your pricing decisions will place customers’ value first. You’ll also enhance your brand value, establish customer loyalty, and ultimately, improve your bottom line.
How to apply the consumer-oriented pricing strategy?
Before setting product prices that reflect customer value, you should follow some specific procedures to carry out market and customer analysis.
We have prepared a quick checklist for applying value-first pricing strategy.
- Once you understand who your customers are, create “ideal buyer personas” or “customer avatars” that will help you clearly picture your target customers.
- Carry out demographic market research about your customers.
- Conduct product analysis from the perspective of the customer by asking both about the product features and their preferences.
- Carry out a price sensitivity analysis to detect the critical price points.
- Once you get answers about price sensitivity, look again at the buyer personas to find the best prices for specific buyer-persona groups.
- Analyze the results and continuously optimize your pricing strategy.
Missing the opportunity to capture different segments
By varying prices for different customer segments, you can increase the chance of capturing the attention of diverse audiences, which will help you to maximize revenue and improve the bottom-line. This is called price segmentation!
Very basically, price segmentation is the approach of setting different prices for the same product. For example, you can offer a discounted price for students during the Back-to-the-School period. Or, for example, applying a great deal on chair prices for online shoppers who have recently purchased a table from your online store would definitely boost your conversion rates.
Similar examples can be found in everyday life, such as student prices for movie or football tickets, special bus ticket prices for veterans… The list goes on.
Customers can be segmented by volume, demographics, locations, purchasing behavior, financial status, purchase frequency. You can also carry out segmentation based on their attributes.
However, cost-plus pricing limits your ability to adjust prices for different market segments as you’ll just focus on your costs when deciding product prices. So, don’t just stick with one price, experiment with the amount different segments are willing to pay.
The risk of missing the real value of the product
Solely focusing on costs may not reflect the real value of a product – there is a risk of leaving money on the table. Think of a scenario; for instance how a brand sells a product with great quality in terms of its durability, innovation or better service when compared to its competitors. That brand implements the cost-plus strategy and only aims to get a 10% margin from each sale. Such decision would result in the brand losing thousands of dollars in profit, because the price could be set much higher due to the product’s quality. As you can see the brand can miss the real value of the product.
LED light bulbs are a perfect example. These bulbs can be produced at a low cost; approximately for $1. However, they are sold at the minimum of $10, as compared to traditional light bulbs. The reason is the additional benefits and value for customers that LEDs provide.
Summary: don’t ignore your costs but solely sticking to cost-plus will be never sufficient
Your costs are crucial for your financial health. That’s for sure. But, just applying a cost-plus pricing strategy is not sufficient any longer. This is because we are now living in a customer-oriented world and ignoring the customers would be a huge mistake. Look for customer segments willing to pay more and charge a higher margin to those customers. If you sell basic or premium products raise the margin on the “premium” product.
You will quickly see that there is a lot of potential additional revenue and money to be gained by pricing based on customer-orientation rather than just costs. Cost-plus pricing is also not acceptable for determining the price of a product to be sold in a competitive market, primarily because it does not factor in the prices charged by competitors. Once you start monitoring your competitor’s prices, you will have the ability to respond to them quickly.
Interested in price monitoring? Contact us – we can help you! -> Click and fill the form.
Dealavo Smart Prices is a tech company specializing in web scraping, data cleansing, data analysis and delivering powerful and actionable e-commerce insights to brands and e-shops. For more than five years we have been delivering services for many clients from 30 different countries. We have gained the trust of global brands including Samsung, DeLonghi, MSI, Xiaomi, Acer, Epson, and many more, including one of the top 10 biggest pure play e-shops in Europe.