I have a friend who runs a small manufacturing company. When I asked him how he prices his products, he looked at me like I'd asked him how he ties his shoes. "I add up what it costs to make, then I add 30%. That's the price." No demand curves. No competitive analysis. No willingness-to-pay research. Just cost plus margin.
He's been in business for 22 years. So maybe the simplest approach isn't always the worst one.
Cost-plus pricing (also called markup pricing or cost-based pricing) is a pricing strategy where you determine your selling price by calculating the total cost of producing a product or service, then adding a fixed percentage markup to ensure profit.
The formula:
Selling Price = Total Cost per Unit + (Total Cost per Unit × Markup Percentage)
Or, equivalently:
Selling Price = Total Cost per Unit × (1 + Markup Percentage)
If it costs you $60 to produce a pair of shoes and you want a 30% markup, your selling price is $60 × 1.30 = $78. You make $18 profit per pair.
The approach is entirely inward-looking. You base the price on your internal cost structure, not on customer perception, competitive positioning, or market demand. That's its defining characteristic, for better and worse.
Cost-plus pricing is arguably the oldest formal pricing method in commerce. Merchants have been calculating "what it cost me plus what I want to earn" since before modern economics existed as a discipline.
But cost-plus pricing got its formal institutional backing during World War I, when the U.S. government adopted cost-plus contracts to encourage wartime production. The logic was straightforward: the government needed military goods fast, it couldn't predict costs in advance, so it told manufacturers "we'll cover your costs plus a guaranteed profit." This got factories producing quickly.
After World War II, cost-plus contracts played a major role in the technology boom. Companies like Hewlett-Packard and Fairchild Semiconductor used Department of Defense cost-plus contracts to fund R&D they couldn't have afforded on their own. The defense industry's cost-plus model essentially subsidized the early semiconductor revolution.
Today, cost-plus remains the default pricing method in government contracting, construction, professional services, and manufacturing.
The calculation seems simple, but the "cost" part requires more thought than most people realize.
| Cost Component | What It Includes | Example (T-shirt manufacturer) |
|---|---|---|
| Direct materials | Raw materials used in production | Fabric, thread, labels: $3.50 |
| Direct labor | Wages for production workers | Cutting, sewing, QC: $2.00 |
| Manufacturing overhead | Factory rent, utilities, equipment depreciation | Allocated per unit: $1.50 |
| Total manufacturing cost | $7.00 | |
| Administrative overhead | Office costs, management salaries | Allocated per unit: $1.00 |
| Selling expenses | Sales team, marketing, distribution | Allocated per unit: $1.50 |
| Total cost per unit | $9.50 | |
| Markup (40%) | $3.80 | |
| Selling price | $13.30 |
The tricky part is overhead allocation. How do you distribute your $50,000/month factory rent across 10,000 units? What happens when you produce 8,000 units instead? Your per-unit cost changes, which means your price changes, which means your volume might change again. This circular dependency is one of the fundamental weaknesses of cost-plus.