Trending
It’s common to hear complaints that a product isn’t meeting profitability targets due to high costs. However, this often stems from a fundamental misunderstanding of pricing strategies rather than actual cost issues.
A shift in perspective is crucial: instead of adhering to the traditional cost-plus pricing model, consider embracing the “BE DiFFERENT” approach to pricing.
The Traditional Cost-Plus Equation
Traditionally, businesses set prices based on the formula: Price = Cost + Margin. This means that a price is determined by adding a desired profit margin to the production or supply cost of the product or service.
While simple and straightforward, this method doesn’t account for market realities.
It assumes sales volume will meet company expectations, potentially leading to disappointing sales and reduced profits when the market finds the price unacceptable.
The Be Different Equation
Conversely, the “BE DiFFERENT” approach reworks this equation to Cost = Price - Margin. Here, the price is dictated by what the market is willing to pay.
The challenge is determining whether your costs can meet this market-driven price while achieving the desired margin.
In this scenario, both price and margin are constants, and cost becomes the variable to control.
Why Traditional Pricing Falls Short
The essential difference between the two pricing models lies in flexibility and market responsiveness.
The traditional model can often set prices that the market won’t bear if costs or expected margins are too high, leading to lower sales and profit margins.
In contrast, the BE DiFFERENT approach requires businesses to adapt their costs to meet market-driven prices and margin goals.
Maintaining margin targets is crucial. They should reflect the financial backbone of the business and not be sacrificed because of inefficiencies or misjudged market price potential.
With the BE DiFFERENT approach, businesses focus on supplying products efficiently, driven by market prices.
The Case for Market-Driven Cost Management
For example, if the market is willing to pay $10 for your product and your goal is a 30% gross margin, your maximum viable cost per unit should be $7.
If you can produce the item for less, your margins increase.
Critically, by allowing the market to set the price, businesses ensure they only invest resources in products capable of supporting those market prices.
If production or supply costs can’t meet market expectations, offering the product isn’t viable.
Incentives for Cost Efficiency
Cost-plus pricing can inadvertently promote inefficiency, as it incorporates costs without strict controls, potentially driving them higher.
In contrast, price-minus-margin strategies necessitate resource efficiency.
By prioritizing market-driven prices and expected margins, businesses pressure themselves to streamline operations and optimize costs.
Ultimately, adopting a market-driven approach requires a shift from focusing on cost and margin as mere financial measures to seeing them as strategic levers for resource allocation and efficiency.
Embracing this mindset helps businesses remain competitive and agile, ensuring they deliver value-driven products that meet both market demand and financial expectations.
Related: Achieve Remarkable Leadership by Focusing on ‘Line of Sight’