Is Cost-Based Pricing Still Relevant in the Era of E-Commerce?
They say you get better prices online. What’s for sure is that consumers are more price sensitive and generally expect to score a better deal when shopping online. Big online retailers like Amazon know it well. They optimize prices on a daily (or hourly) basis according to product demand, price competition, seasonal sales and so on. It is now difficult for brands and manufacturers themselves to keep track of their e-tailer prices. With so much volatility, prices online seem to have become unrelated to what it actually costs to manufacture the products. What happened to pricing goods based on costs? Is cost-based pricing still relevant in the era of e-commerce?
1. What is cost-based pricing?
Cost-based pricing (also cost-plus pricing) is the easiest way to come up with a retail price for a product. There are two ways to determine it: full-cost pricing and direct-cost pricing. Full-cost pricing adds up both variable and fixed costs, plus a percentage (%) markup on top. Direct-cost pricing is just variable costs plus a % markup.
Fixed-costs are those that stay constant no matter the sales volume or other activity levels. In e-commerce, fixed-costs may include:
- Domain name or website hosting,
- Rent (office, warehouse),
- Salaries and utilities.
Variable costs are the opposite. They are purely linked to the number of products are services created. E-commerce specific examples are:
- Raw materials,
- Marketing activities,
- Externalized warehousing,
- Credit card fees,
- Retail margin (unless the goods are sold directly to the consumer)
2. What are the pros and cons of cost-based pricing?
Cost-based pricing is the most traditional strategy used by businesses and retailers to determine prices. The advantages are that it:
- is based on a simple formula,
- is optimized for market penetration,
- remains easy to adjust when costs change,
- makes sense from a marketing perspective and customer perception.
Cost-based pricing is not without some disadvantages:
- It does not account for the actual willingness to pay of the customer,
- It ignores competition and demand variations,
- Finally, it does not contribute to building a powerful brand over time.
3. Cost-based pricing applied to online retail
Here is one example to illustrate the application of the cost-based pricing strategy in online retail:
The sum of costs for this satchel is $24.58 including fixed and variable costs (based on our estimations). After considering the overall strategy, the manufacturer decided to add a $35.41 markup (+144%).
Amazon advertises this particular satchel as the best-seller in its category. It dominates this other basic satchel that retails for an extra $5. Both manufacturers offer the same perks such as free shipping, real leather, decent style, and different colors choices. The difference in price explains the increased sales volume.
Although cost-based pricing may seem outdated or arbitrary, it is relatively easy and predictable. It helps brands penetrate new markets and encourages manufacturers to keep costs reasonably low.
We read a lot about top brands and their value-based pricing strategies. Often though, we tend to forget that their approach to pricing was only made possible by years of relentless marketing efforts and brand building. For emerging brands trying to make a name for themselves, cost-based pricing is still a valid approach.
Value-Based Pricing – investopedia.com/
Pricing Methods – courses.lumenlearning.com/
COST-BASED PRICING – PRICING BASED ON COSTS – marketing-insider.eu/
Examples of fixed costs – accountingtools.com/
What are the Fixed and Variable costs involved for an E-commerce marketplace that Sells physical books and e-books? – quora.com/
3 Retail Pricing Strategies for eCommerce – practicalecommerce.com/
Cost-based pricing – slideshare.net/
Organizational and institutional barriers to value-based pricing in industrial relationships – Töytäri, P., Rajala, R. and Alejandro, T. (2015). Organizational and institutional barriers to value-based pricing in industrial relationships. Industrial Marketing Management, 47, pp.53-64.