Cost-plus pricing: What is it and when to use it

Cost-plus pricing (also known as markup pricing) is a straightforward method to ensure your business stays profitable from day one. Unlike competitive pricing or dynamic pricing, which rely on external market shifts, this approach focuses entirely on factors within your control.

This is especially important as a new wave of entrepreneurs enters the market. Recent QuickBooks data shows that 47% of aspiring small business owners cite cost as their biggest barrier to starting up.

The best part is that you can calculate your rates using the data already sitting in your accounting software. Here’s how to use cost-plus pricing to protect your margins and grow your business.

Jump to:

• How to calculate cost-plus pricing
• Cost-plus pricing example
• Pros of cost-plus pricing
• Cons of cost-plus pricing
• Should you use cost-plus pricing? 3 considerations
• Cost-plus pricing best practices
• Modern cost factors: Remote work and data privacy
• Streamline your accounting and save time

Cost-plus pricing looks at all the costs to produce a single unit of product. You then add a markup percentage to arrive at the final selling price. The exact markup percentage varies, depending on what the company considers a reasonable profit.

Compared to pricing other production processes, cost-plus pricing is one of the easiest to calculate. It doesn’t require any competitive analysis or research. Most of the information you’re likely already tracking.

The cost-plus pricing formula is:

([Direct material costs + direct labor costs + overhead] / number of units) x (1 + markup percentage)

Note that direct material and direct labor costs are also known as variable costs, while overhead expenses are the fixed costs. To calculate cost-plus pricing, follow the three steps below:

How to calculate cost-plus pricing

1. Find your total costs

The first step is to determine how much it costs to produce a certain quantity of products. To get your total cost, add together:

• Direct material cost: These are the costs of materials you use to produce a product.
• Direct labor cost: This is the cost of ‌labor to create the product
• Overhead costs: These are operational costs that aren’t directly tied to the final product, such as rent and utilities.

To get your total cost, add together your direct materials, direct labor, and overhead. This sum represents your unit cost (the total expenditure required to produce one single item or service).

2. Divide costs by units

Take the total production cost and divide it by the number of units in the given batch. This results in the cost per unit. For example, if your costs were $1,000 and you made 100 units, your cost per unit would be $100 ($1000 / 100).

3. Multiply by your markup

This last step requires some consideration. While there are suggested industry markups, the exact markup percentage is up to you. A markup (versus margin) is the difference between the cost of your product and its selling price (aka your profit).

Markups are typically a percentage. The higher the markup percentage, the greater your profit for every product you sell. You’ll multiply the cost per product (calculated in the previous step) by your markup percentage. The result is the product’s cost-plus price.

Cost-plus pricing example

The following cost-plus pricing examples show how to apply the cost price formula in two different instances:

Manufacturer example

Say a manufacturer makes 100,000 picture frames for sale. The entire production incurs $150,000 in direct material costs, $250,000 in direct labor costs, and $100,000 in overhead costs.

Here’s how the manufacturer calculates ‌cost-plus pricing:

• $150,000 + $250,000 + $100,000 = $500,000
• $500,000 / 100,000 = $5
• $5 * (1 + 1.00) = $10

The resulting cost-plus price for one picture frame is $10, which includes a profit of $5.

Retailer example

Now consider a small grocery store that uses variable cost-plus pricing to profit from selling wholesale goods. It purchases 1,000 bottles of juice at wholesale for $4,500. It expects to sell the water within a week.

Here’s how it calculates its cost-plus pricing:

1. The total cost of the water is $4,500.

• $4,500 / 1,000 = $4.50
• $4.50 * (1 + 0.15) = $5.18 per bottle

For the grocery store, the variable cost-plus pricing for a bottle of juice is about $5.18 (with a profit of $0.68).

Choosing your approach: Total vs. variable cost

While most businesses factor in all expenses, some use variable cost-plus pricing. This method only factors in costs that fluctuate with production, like raw materials and packaging. If you choose this route, your markup percentage should be high enough to cover your fixed costs (like rent) and still leave room for profit.

Pros of cost-plus pricing

Cost-plus pricing offers several advantages for both businesses and customers. Here are the three most common benefits.

Simple to use

Many business owners choose cost-plus pricing because it requires minimal effort. You don't need to conduct deep competitor analysis or customer research to get started. Your existing financial data, paired with a few basic calculations, can help you set your prices to start.

Covers costs

The cost-plus formula relies on two main factors: total cost and your desired markup. This structure ensures you cover the expenses for every product you sell. As long as your cost data is accurate and your markup percentage is reasonable, this strategy helps maintain a consistent, positive rate of return.

Easy to explain

This pricing model is inherently clear. Customers can easily see the relationship between price and quality. Transparency also helps when you need to adjust your rates. You can justify price increases by pointing to a direct rise in production or material costs. Being upfront about your fixed margin builds market trust and simplifies your value proposition.

Cons of cost-plus pricing

Like any business strategy, cost-plus pricing has its share of drawbacks.

Might not cover all costs

Your profit depends entirely on the accuracy of your cost estimates and sales projections. If you face unexpected expenses, like equipment repairs or high volumes of unsold inventory, your business could end up operating at a loss. It’s important to revisit your pricing regularly as your business scales.

Can lead to inefficient operations

When you pass every expense directly to the consumer, there’s less incentive to streamline your workflow. This can lead to a lack of innovation in materials or methods, which often results in overpriced products that struggle to compete.

A QuickBooks AI agent counters this by automatically flagging unusual expense spikes and identifying cost-saving patterns that human eyes might miss. By providing real-time efficiency scores, it forces a focus on lean operations even when margins feel comfortable.

Ignores profit maximization

This inside-out approach ignores external factors like consumer demand and market trends. If you only look at your own costs, your prices might be too high to attract buyers or too low to capture the full value of your product.

Should you use cost-plus pricing? 3 considerations

Pricing strategies are critical to your success as a small business owner. While cost-plus pricing is a popular choice, it isn’t always the right fit for every business model. Consider these three factors before you commit:

Are you creating a new product or service?

When you introduce something new to the market, it can be difficult to predict demand or pinpoint exact production costs. Setting a fixed markup is a challenge if your overhead is still fluctuating. If demand starts lower than expected, you may need the flexibility to drop your prices below your standard markup to move inventory or gain traction.

What is your competition charging?

Cost-plus pricing focuses on your internal numbers, but it ignores the rest of the market. It’s vital to research what competitors charge for similar offerings. If your calculated price is significantly higher than the market average, you may need to adjust your strategy to stay competitive and attract customers.

Do you need to generate a set profit?

Some industries require more pricing agility than others. In retail, for example, customers are often highly price-conscious. If you strictly follow a cost-plus model in a sensitive market, you risk pricing yourself out of a sale. In these cases, a value-based or market-based approach might be more effective for reaching your profit goals.

Cost-plus pricing best practices

To get the most out of cost-plus pricing, you need to look beyond a simple formula. Success with this model requires a balance of internal accuracy and external market awareness to ensure your margins remain healthy as your business grows.

Understand your production costs

You must have a clear understanding of your total production costs, including both variable and fixed expenses. Determining the true cost per unit is the only way to calculate a markup percentage that covers your bills and generates a real profit.

If you overlook hidden costs like shipping materials or small administrative fees, your markup might actually result in a net loss.

Monitor the competition

It’s vital to keep your eyes on the competition when setting your product prices. Even though cost-plus pricing is an "inside-out" strategy, understanding what others charge helps you set a markup percentage in line with industry standards.

If your prices are significantly higher than the market average without a clear value-add, you may need to find ways to lower your internal costs to remain competitive.

Listen to customer feedback

Regularly check in with your customers to ensure your pricing meets their expectations and needs. Customer feedback can signal whether your perceived value matches your price point or if your markup is pushing products out of their budget.

Balancing your financial requirements with customer satisfaction is the key to building long-term loyalty and repeat business.

Choose the right contract type

For long-term projects or service-based work, you must decide between cost-plus and fixed pricing. Cost-plus contracts offer more flexibility because the final price can change based on actual project expenses.

In contrast, fixed pricing sets a total cost before the work begins, which provides more certainty for the customer but more risk for you if costs rise unexpectedly.

Account for external factors

Don’t forget to consider external factors like economic changes, new regulations, and the availability of raw materials. These outside forces can suddenly drive up your production costs, making your existing markup obsolete overnight.

Reviewing your pricing strategy quarterly helps you stay ahead of inflation and supply chain shifts that could otherwise eat into your profits.

Modern cost factors: Remote work and data privacy

As the traditional office shifts, your pricing model must adapt to new types of overhead and risk-related expenses.

Impact of hybrid and remote work

Transitioning to a remote or hybrid model changes the "overhead" portion of the cost-plus formula. While you might save on physical rent, you may see an increase in costs for cloud software subscriptions, home office stipends, and decentralized shipping. If you fail to re-calculate these shifting operational costs, your fixed markup may no longer cover your actual bottom line.

Privacy and data security costs

Implementing a bring your own device policy or using employee monitoring software introduces new financial variables. To protect your business, you must factor in the costs of cybersecurity insurance, encrypted hardware, and compliance audits into your overhead.

A QuickBooks AI agent can help here by tracking these specific technical expenses in real-time, ensuring your markup accounts for the high price of data protection and regulatory compliance.

Streamline your accounting and save time

Out of the many pricing strategies available, cost-plus pricing is a popular option and remains one of the easiest to use. It offers a quick approach to determining a final sales price. Even without industry know-how, companies of all sizes can use it for nearly any product.

Cost-plus pricing is especially helpful if you’re job costing or projecting profitability, which you can do with accounting software like QuickBooks.