Price your product or service

Cost-plus versus value-based pricing

There are two basic methods of pricing your products and services: cost-plus and value-based pricing. The best choice depends on your type of business, what influences your customers to buy and the nature of your competition.

Cost-plus pricing

This takes the cost of producing your product or service and adds an amount that you need to make a profit. This is usually expressed as a percentage of the cost.

It is generally more suited to businesses that deal with large volumes or which operate in markets dominated by competition on price.

But cost-plus pricing ignores your image and market positioning. And hidden costs are easily forgotten, so your true profit per sale is often lower than you realise.

Value-based pricing

This focuses on the price you believe customers are willing to pay, based on the benefits your business offers them.

Value-based pricing depends on the strength of the benefits you can prove you offer to customers. See our guide on planning to sell.

If you have clearly-defined benefits that give you an advantage over your competitors, you can charge according to the value you offer customers. While this approach can prove very profitable, it can alienate potential customers who are driven only by price and can also draw in new competitors.

Price your product or service

The difference between cost and value

Knowing the difference between cost and value can increase profitability:

the cost of your product or service is the amount you spend to produce it
the price is your financial reward for providing the product or service
the value is what your customer believes the product or service is worth to them

For example, the cost for a plumber to fix a burst pipe at a customer's home may be £5 for travel, materials costing £2.50 and an hour's labour at £10. However, the value of the service to the customer - who may have water leaking all over their house - is far greater than the £17.50 cost, so the plumber may decide to charge a total of £50.

Pricing should be in line with the value of the benefits that your business provides for its customers, while also bearing in mind the prices your competitors charge.

To maximise your profitability, find out:

what benefits your customers gain from using your product or service
the criteria your customers use for buying decisions - for example, speed of delivery, convenience or reliability
what value your customers place on receiving the benefits you provide

Wherever possible, set prices that reflect the value you provide - not just the cost.

http://webarchive.nationalarchives.gov.uk/20120823131012/http://www.businesslink.gov.uk/bdotg/action/detail?type=RESOURCES&itemId=1073790695

http://content.healthaffairs.org/content/28/5/1418.full.pdf+html