Disadvantages of cost-plus pricing
The simplicity of cost-plus pricing leads to a number of issues, especially for SaaS and subscription businesses:
1. Cost-plus pricing strategy can be horribly inefficient.
The guarantee of a target rate of return creates little incentive for cutting costs or increasing profitability. As the market and customers continue to change, stakeholders easily become passive towards pricing, creating laziness and atrophy of profits.
For perspective, the government uses this strategy of guaranteed profit margins on costs to make contracts with private businesses “easier.” The result is an incentive to maximize costs, which wastes billions of dollars and produces shoddy workmanship. A serious cost plus pricing disadvantage.
2. Cost-plus pricing method creates a culture of profit losing isolationism.
This inward-facing approach discourages market research. Although watching competitor prices isn’t the be all and end all, it is a pretty important element of pricing. You should know how much the competing good costs because it can affect your marketing and pricing strategies. With no research, you have little to no data on your customer's perceived product value (more in the last point).
3. Cost-plus pricing doesn’t take consumers into account.
Perhaps the biggest downfall of a cost-plus pricing model is that it completely disregards the customer’s willingness to pay.
To make money, a customer must be involved. Customers are essential to selling anything. Therefore, any pricing strategy that ignores customer value is detrimental to the business's profitability. This creates a vacuum that drains away all of the profit.
In summary, customers don't care about how much something costs you to make. They understand there are costs associated with doing business, but consumers care more about how much value you’re providing.
For example, making a bottle of Rogaine may cost $3, $10, or $50. Consumers only weigh price against the value of a husband with hair on his head. Depending on the customer, could be 2x, 10x, or 100x the cost depending on follicle effectiveness.
Simply barreling ahead with a desired rate of return can result in declining demand that is disregarded until substantial losses occur. Even if consumers buy your product, there could still be a better price for revenue optimization and price differentiation.