Earlier in 2024, Netflix shook things up with their new subscription plans, sparking widespread panic among subscribers worried about their binge-watching budgets. However, these concerns didn’t quite reflect in the company’s valuation or revenue. 

What does this say about pricing strategies? 

Pricing is more than just numbers; Netflix understands the necessity of understanding its audience, competitor prices, and the potential ramifications of every price adjustment. And so should you, as a product manager, while you choose your product pricing strategy.

Among the various options you may come across, the cost-plus pricing strategy stands out. You calculate the costs of production and then add a profit margin. And you don’t even have to look far for an example — your local grocery store employs this strategy every day.

But how do you apply this strategy in B2B SaaS? In this blog, we’re breaking down the ins and outs of the cost-plus pricing strategy.

What is Cost-Plus Pricing?

Cost-plus pricing, or markup pricing, is a strategy where businesses set their prices by adding a specific markup to the total cost of producing a product or service. This approach ensures that all expenses are covered and guarantees a consistent profit margin.

It’s commonly used in industries where costs are relatively stable and predictable, such as manufacturing, construction, and some service-based businesses.

Think about how a local bakery operates: they calculate the total cost of ingredients, labor, and overhead, then add a markup to determine the price of a loaf of bread. If the total cost comes to $2, they might sell it for $3, pocketing a $1 profit.

If you’re looking for a larger-scale example, think about construction. Contractors often use cost-plus pricing to bid on projects. If a project costs $100,000 to complete, they might charge the client $120,000, with the extra $20,000 being their markup price or profit.

How Does Cost-Plus Pricing Work?

Understanding how the cost-plus pricing formula operates is essential for effectively implementing this strategy. Here’s a streamlined process to guide you through it:

1. Calculate total costs: Begin by determining the total costs associated with producing or delivering your product or service. This should include direct costs like materials and labor, as well as indirect costs such as overhead.
2. Establish profit margin: Next, decide on your desired profit margin. This figure is critical as it directly influences your pricing strategy and overall profitability.
3. Determine selling price: Finally, combine your total costs with the profit margin to arrive at your final selling price.

The formula for this pricing strategy can be summarized as follows:

Selling Price = Total Cost + (Total Cost × Markup Percentage)

To illustrate this, consider a hypothetical SaaS company that has developed a project management tool. The total cost of developing, maintaining, and supporting the software for one user per year is $100. If the company aims for a 50% profit margin, the calculation would proceed as follows:

Selling Price = $100 + ($100 × 50%) = $150 per user per year

In this example, the company would set the price of its project management tool at $150 per user per year. This approach ensures that the company covers its costs while achieving its desired profit margin. 

Understanding this pricing formula is crucial for product managers aiming to balance cost recovery and profitability.

Components of Total Cost

Let’s get into the nitty-gritty of cost-plus pricing. Here’s what’s in the mix:

1. Direct costs: Think of these as the expenses tied directly to creating or delivering your product or service. In the SaaS world, this could mean:some text
   • Development costs spread out over the product's expected lifespan
   • Hosting and infrastructure fees
   • Direct labor costs for customer support and maintenance
2. Overhead costs: These are the behind-the-scenes expenses that keep your business running but don’t link to a specific product. Examples include:some text
   • Office rent and utilities
   • Salaries for admin staff
   • Marketing and sales expenses
   • Legal and accounting fees
3. Variable costs: These costs fluctuate with your production or sales volume. For a SaaS biz, that might include:some text
   • Transaction fees from payment processing
   • Extra hosting costs as your user base grows
   • Commissions for sales reps
4. Fixed costs: These stay the same, no matter how much you produce or sell. Think of:some text
   • Base salaries for full-time employees
   • Software licenses for development tools
   • Insurance premiums

Accurately calculating these costs, will help you nail down your total cost base — which is crucial for effectively applying a cost-plus pricing strategy.

Advantages of Cost-Plus Pricing

Cost-plus pricing is a go-to strategy for many businesses, offering a range of benefits that can simplify the pricing process:

1. Simplicity and ease of implementation: The standout feature of cost-plus pricing is its straightforwardness. The calculations involved are uncomplicated, requiring minimal market analysis or competitive intelligence.
2. Predictable profit margins: Applying a fixed markup to production costs enables companies to maintain consistent profit margins across their product lines. This predictability helps in financial planning and management.
3. Cost recovery: This pricing strategy guarantees that all costs associated with production are covered, significantly reducing the risk of selling products at a loss. 
4. Justifiable price increases: When production costs rise, explaining price hikes to customers becomes much easier. Since the cost-plus model is transparent and directly linked to costs, customers can easily understand the rationale behind price adjustments.
5. Stability: Cost-plus pricing can contribute to price stability in markets where costs remain relatively constant. This stability can enhance customer trust and loyalty, as they come to expect consistent pricing.
6. Clear communication with stakeholders: The simplicity of this model makes it easy to communicate pricing structures to stakeholders—be it investors, employees, or business partners. This transparency makes way for stronger relationships and trust.
7. Reduction of pricing decisions: Once a markup percentage is established, pricing becomes a more automated process. This reduction in constant pricing decisions allows businesses to focus on other strategic areas.

Disadvantages of Cost-Plus Pricing

While cost-plus pricing may seem like the golden ticket, it’s not without its share of pitfalls:

1. Ignoring market dynamics: This method often overlooks the bigger picture—like market demand, how customers perceive value, and what competitors are charging. This blind spot can lead to lost sales and missed opportunities.
2. Risk of mispricing: If your costs are running high compared to the competition, you might end up overpricing your product. On the flip side, if your product offers way more value than your pricing suggests, you could be leaving cash on the table.
3. No motivation for cost efficiency: Since prices are based purely on costs, there’s little incentive to streamline operations or cut expenses. Sort of like running a marathon but never trying to improve your time.
4. Ignoring willingness to pay: Cost-plus pricing doesn’t factor in what customers are actually willing to fork over for your product or service. This could lead to pricing yourself out of the market — or worse — missing out on potential revenue.
5. Value discrepancy: Especially in the SaaS realm, where serving another customer often comes at a minimal cost, this strategy may fail to capture the true value delivered to users.
6. Complex cost allocation: In industries with complicated production processes or shared resources, pinpointing accurate costs, and hence, arriving at a consistent cost-plus pricing model can be difficult.
7. Rigid approach: The inflexibility of cost-plus pricing can make it tough to adjust quickly in the face of changing market conditions or competitive pressures.

Cost-Plus Pricing in SaaS

When it comes to SaaS products, cost-plus pricing isn’t always a straightforward application of the formula. It requires some serious thought. 

Unlike your average product, SaaS often carries hefty upfront development costs but low ongoing expenses for serving extra customers. This makes nailing down a pure cost-plus pricing strategy a bit of a head-scratcher.

So, what should you keep in mind when applying cost-plus pricing in the SaaS landscape?

1. Cover all the bases: It’s not just development costs. Think broader — include ongoing expenses like:some text
   • Hosting and infrastructure
   • Customer support
   • Sales and marketing efforts
   • Regular updates and maintenance
   • Customer acquisition costs (CAC)
2. Spread out the development costs: Those initial development bills can hit hard, so it's smart to amortize them over the product's expected lifetime or across a specific customer base. This way, you won’t feel the financial pinch all at once, allowing for more sustainable pricing strategies in the long run.
3. Embrace scalability: As your SaaS business scales, your cost per user typically decreases thanks to those economies of scale. Your pricing model should be flexible enough to adapt to this shift, ensuring that you maximize profit without scaring away new customers.
4. Dabble in tiers: If your SaaS product has various service levels, consider applying cost-plus pricing to each tier based on its unique costs. This can help you create more tailored pricing structures that reflect the value offered at each level, making it easier to attract a wider range of customers.
5. Know your customer's worth: Factor in the expected lifetime value of a customer when you’re setting your profit margins. This insight allows you to strike a balance between competitive pricing and profitability, ensuring that you get the most out of your customer relationships over time.
6. Stay competitive: Sure, you want to cover costs but don't forget to factor in the market. Keeping an eye on competitors' pricing and industry standards is crucial. It may require adjusting your markup or mixing in other pricing strategies, or you risk affecting your net revenue retention.
7. Think freemium: If you offer a free tier to attract users, make sure to include the costs of supporting those users in your pricing for the paid tiers. Balancing the cost of free users with the revenue from paid customers is key to maintaining profitability while still expanding your user base.

While cost-plus pricing is a great starting point, it’s often more effective when combined with other strategies, like value-based or competitive pricing.

Alternative Pricing Strategies

Before you dive headfirst into the cost-plus model, it’s smart to explore other pricing strategies that might better suit your SaaS business:

1. Value-based pricing: This one’s all about how much your customers think your product is worth, rather than how much it costs to make. If product-led growth is your game, value based pricing could be your golden ticket.
2. Competitive pricing: In a cutthroat market, setting your prices based on what your competitors charge can help you stay in the game. This approach keeps you aligned with industry standards.
3. Penetration pricing: Think of this as your initial low-price strategy to grab market share quickly from competitors, then slowly bumping up the price as you gain traction. Perfect for new SaaS products trying to break into a packed marketplace.
4. Price skimming: Start with high prices to snag those eager early adopters who want the latest tech, then lower your prices over time to attract the more budget-conscious crowd. It’s a classic move for maximizing profits.
5. Freemium: This popular model offers a basic version of your product for free while charging for premium features. It’s great for building a user base fast and upselling later.
6. Tiered pricing: Offering different service levels at various price points lets customers choose what fits their needs and budget best. Tiered pricing is all about flexibility.
7. Usage-based pricing: Here, you charge customers based on how much they actually use your product. This can work wonders for SaaS offerings with variable usage patterns.

Implementing Cost-Plus Pricing: Your Step-by-Step Playbook

1. Calculate your total costs:some text
   • Direct costs: Start by listing all the direct production costs tied to your product, such as materials, labor, and any other expenses directly involved in production.
   • Overhead costs: Don’t forget overhead costs like utilities and rent. Make sure to allocate everything appropriately to your product or service to get a clear picture of your total expenses in cost based pricing.
2. Determine your desired profit margin:

Look at what’s standard in your industry to understand the competitive landscape. Keep your business goals and growth plans in mind as you set your profit margin. If you’ve got investors, factor in their expectations too, as this can influence your pricing strategy.

3. Set your markup percentage:

Based on your desired profit margin, calculate the markup percentage you’ll need to apply to those costs.

This percentage is crucial as it will help ensure your business remains profitable while covering all your expenses. Consider industry benchmarks to gauge a reasonable markup that aligns with your market positioning.

4. Calculate your selling price:

It’s simple math—take your total costs and apply that markup percentage to find your selling price.

This price should not only cover your costs and desired profit but also be appealing to your target customers. Make sure the final price feels justified by the value you provide, as this will enhance customer satisfaction and loyalty.

5. Compare with market rates:

Research what competitors are charging and check out market rates to ensure your price is competitive. It’s essential to strike a balance between being attractive to customers and maintaining your profit goals, so consider how your offering stands out in the market.

6. Test and adjust:

Once your cost based pricing is live, keep a close eye on its performance by monitoring sales, customer feedback, and market trends.

Be ready to tweak your markup or your entire pricing strategy if you notice any negative impact on sales or customer acquisition. Regular testing helps you stay agile and responsive to market changes.

7. Regularly review and update:

Costs aren’t static, and neither should be your pricing. Make it a habit to regularly tally your product adoption curve with pricing strategies. This helps you adjust pricing based on the product’s position in its lifecycle and how different segments of customers are adopting it. For example:

• You can price higher for early adopters and innovators who have a strong need for your product due to the absence or obsoleteness of alternatives.
• But as adoption increases, pricing may need to be adjusted to make the product more attractive to mainstream customers and stay competitive in the market.

This constant adjustment helps ensure that your pricing reflects current demand, market conditions, and costs.

Implement a smart system for automatic price adjustments based on cost changes. This can save you a lot of headaches and keep your pricing strategy in line with your business goals.

Key Considerations Before You Make the Call

If you’re thinking about adopting a cost-plus pricing strategy, here are some key considerations to keep in mind:

1. Your target market: Understanding your customers is crucial. Dive deep into their preferences and willingness to pay to determine the value they associate with your product. This insight will help you tailor your pricing strategy effectively.
2. Competitive landscape: Analyzing your competition is essential for setting your prices. Look at what similar products are charging and identify how your features and value proposition compare to theirs.
3. Unique value proposition: What makes your product stand out from the crowd? Articulating your unique selling points will not only help in value based pricing but also resonate with your target audience.
4. Long-term strategy: Your pricing strategy should align with your overall business goals. Consider how it supports your growth trajectory and whether it positions you for future market opportunities.

5. Flexibility: A rigid pricing model can hinder your ability to adapt to market changes. Ensure your strategy allows for adjustments based on customer feedback and evolving industry trends.
6. Cost structure: Thoroughly understanding your cost structure is essential for accurate pricing. Keep in mind that costs can fluctuate, especially as you scale, so regularly review your expenses to maintain profitability.
7. Customer segmentation: Different customer segments often have varying needs and price sensitivities. Tailoring your pricing approach for distinct segments can enhance customer satisfaction and boost sales.
8. Market positioning: Where do you want your product to be in the marketplace? Defining your desired market position—be it premium, mid-range, or budget—will guide your pricing decisions and marketing efforts.

Regularly Review and Adjust Your Pricing Strategy

While understanding your costs is crucial for any business, SaaS companies often benefit from a more nuanced approach that combines elements of cost-plus pricing with competitive and value based pricing strategies. This hybrid approach allows you to ensure cost recovery while also capturing the full value your product provides to customers.

In the end, the best pricing strategy for your SaaS business will depend on your cost structure, market position, competitive landscape, and customer base. Carefully consider these factors and combine different pricing approaches to develop a pricing strategy that works for your business.

Want to ensure your customers see the value in your pricing? 

Userflow allows you to create seamless onboarding experiences that showcase the value of your product, helping users recognize why your pricing is worth every penny.