Cost-plus pricing is one of the strategies that businesses use to determine the price of their products. The strategy is also called the mark-up pricing. The strategy sets the prices of products/services as the cost of production plus a given percentage of profit margins. In most cases, the firm determines the amount of profit it wants from the sale of a product. The use of markup pricing helps a firm to estimate the amount of returns that it is likely to make. The strategy is considered as the most practical approach of maximizing profits, since it is easy to compute and does not need a lot of information. As opposed to competitive strategy, the cost-plus approach does not consider the competitors when setting prices. Further, the mark up strategy ignores the role of consumers in determining the price of products or/services. Also the strategy fails to consider the demand elasticity of products/services.
The cost-plus pricing strategy is suitable in markets with information asymmetry. In an imperfect market, it is possible to determine the price of products even if the demand curve of the product is unclear. The strategy is highly applicable in situations where managers just want to determine the production costs and do not care about competitors or consumers.
Despite, the practicability of the mark up strategy, it may give misleading perceptions regarding the profitability of a business. For example the price of furniture produced in China would be the cost of producing that furniture plus the desired profit margin. However, the returns will depend on the sales targets. If the sales are lower than expected, then this might lead to losses. Further, if the Chinese Company intends to sell its products internationally, it will have to consider the perceptions and behaviors of customers. Otherwise the global market will think that the Chinese products are of poor quality which explains their lower prices. The use of markup pricing strategy may, therefore, create a wrong perception about the product in the international market.