Disadvantages of Cost-plus Pricing Method

Drawbacks of Cost-plus Pricing

• IGNORES COMPETITION. A company may set a product price based on the cost plus formula and then be surprised when it finds that competitors are charging substantially different prices. The company might end up pricing either too low and giving away potential profits, or pricing too high and achieving low revenues.
• CONTRACT COST OVERRUNS. Suppliers under a cost plus pricing arrangement have little or no incentive to curtail their expenditures. On the contrary, it will likely include as many costs as possible in the contract so that it can be reimbursed. To avoid this, such contractual arrangement could include cost-reduction incentives for the suppliers.
• IGNORES REPLACEMENT COSTS. The method is normally based on historical costs. However these may change over time. The most immediate replacement cost is a better representative of the costs incurred by the entity.
• IGNORES VALUE. Cost-plus basically ignores the value a product or service provides to the customer. If a cost plus approach is used, you are not able to charge a higher price in case the added value for a customer of customer group is very high.