How is This For Cost Based Pricing?

[tweetmeme source=”pricingright”] Cost based pricing is tacking on a % margin to the cost of the unit instead of pricing your product/service based on the value it adds to your customers. Costs does not matter to your customers and nor should it matter to pricing your product. Costs matter only to the extent that it makes no economic sense to sell a product below its marginal cost. I am dismayed to see the extent to which people go to compute costs, allocating a share of every cost incurred to every unit sold.

Let me try to explain how ridiculous cost based pricing is by taking it to the extreme.

Suppose you ran a coffee shop that sold just one SKU (as I said I am taking this to the extreme to prove the point). As your customers buy their cup of coffee they see a row of jars in front of them. Each neatly labeled with

  1. a short definition of what it is for
  2. a dollar value

There is a jar for

  • mortgage
  • insurance
  • delivery
  • coffee beans
  • milk
  • utilities
  • bathroom cleaners
  • interest
  • depreciation on coffee machine
  • salary for employee 1 &2
  • childcare (for your child while you work)
  • profit

Each jar is also marked with a respective dollar amount.

You ask your customers to drop exact amount marked on every one of those jars.

Every time the price of coffee beans, milk etc goes up you re-lable your jars.

What do you think your customers will do?

Ask your self what your customer is paying for? Did they walk into your store to get their daily caffeine fix, experience the great ambiance you provide or to help you offset your costs?

Do you practice effective price management?