We Need to Know Costs to Set Prices! The Pricing Myth Debunked

“How can we set prices if we don’t even know our costs?” It’s one of the most common objections I hear from clients. That question always gets a smirk from me because the truth is, waiting to fully explore costs before setting prices holds businesses back. While understanding costs is essential to ensure profitability, it’s not the foundation of pricing. This article challenges the myth that pricing must revolve around costs and reveals a more effective approach: value-based pricing, where customer perception and market dynamics take centre stage.

The Cost-Driven Trap

Imagine you’re about to launch a new product or service but are stuck waiting for perfect clarity on costs. Delays pile up as departments debate cost allocation methods, overhead apportionments, and lifecycle expenses. When a price is finally set, it’s often arbitrary—based on guesstimates or overly simplistic cost-plus formulas. Worse yet, this number might not reflect the market’s willingness to pay or the value customers perceive in your offering.

This cost-focused mindset can cripple a business, leaving opportunities for growth and profitability untapped.

Why Costs Are Not the Core of Pricing

1. The Complexity of Costs

Accurately calculating costs is far from straightforward. Companies face challenges such as:

• Direct Costs: Fluctuations in raw materials, labour, and supply chain dynamics make it hard to establish a reliable baseline.
• Indirect Costs: Allocating shared costs like utilities, equipment depreciation, and administrative expenses is imprecise and often arbitrary.
• Cost Allocation Across Portfolios: Overhead costs are distributed unevenly across product lines, skewing true cost visibility.

Even with mature costing systems, achieving precise cost clarity can take years and involve significant internal debates.

2. Why Cost-Plus Pricing Falls Short

Cost-plus pricing—adding a markup to production costs—misses critical factors that drive successful pricing:

• Customer Willingness to Pay: Customers base their purchase decisions on perceived value, not your internal costs.
• Competitive Dynamics: Ignoring competitors’ pricing strategies risks pricing yourself out of the market.
• Value Proposition: Intangible factors like brand reputation and customer experience often justify premium pricing but are overlooked in cost-plus models.

A SaaS startup struggled with cost-driven pricing, where Sales pressured Finance for detailed product-level cost calculations to set prices. This inward focus—“staring at their belly button” instead of adopting the customer’s perspective left money on the table, misallocated Finance’s efforts toward data requests instead of strategic tasks, and ignored the fact that customers cared more about value than internal costs. By adopting a value-based pricing strategy, the startup refocused on customer willingness to pay and trained Sales to highlight the platform’s unique benefits. This shift led to a 20% revenue increase, optimized Finance’s resources, and strengthened customer relationships by aligning pricing with perceived value rather than internal metrics.

 A customer’s perspective on cost-based pricing and price negotiations it leads to: “I rather pay for value than pay for commodity. Everybody was positioning themselves as a commodity player charging me, we’re going to be doing pennies for this transaction, pennies for that transaction and overcomplicating life if they charge me for value, it’s a much simpler conversation. But everybody [Providers] was cost-driven. Well, it’s a cost-plus pricing. That’s why I’m frustrated. I want to pay for the value that I get. I don’t want to pay for the commodity that you’re providing. Especially because the value I got was very different between providers”

3. The Power of Value-Based Pricing

Value-based pricing shifts the focus from costs to customer perceptions of value. This approach requires:

• Identifying the Next Best Alternative: Understand what options customers are considering, whether competitors or doing nothing.
• Quantifying Differentiation: Highlight how your product delivers tangible benefits—better outcomes, cost savings, or enhanced efficiency.
• Effective Communication: Clearly articulate the unique value you bring to the table.
• Pricing to Capture Value: Charge what your product is worth, not just what it costs.

By prioritizing customer value, businesses can unlock their true pricing potential and confidently set prices without perfect cost data.

The Role of Cost in Pricing

While costs shouldn’t drive pricing decisions, they do have a role:

• Setting the Price Floor: Ensure prices cover variable costs to avoid losses.
• Evaluating Project Viability: Assess whether new products or services can be profitable at target prices.
• Informing Strategic Discounts: Understand how price reductions impact margins and profitability.
• Maintaining compliance: Some sectors have legal obligations to link selling prices to cost structure.

Key Insight: Cost analysis is a tool for ensuring profitability, not the foundation of pricing.

Overcoming the Psychological Barriers to Pricing

For many businesses, moving beyond a cost-focused mindset requires overcoming internal and external biases:

• Fear of Charging What You’re Worth: Confidence in your product’s value is essential to avoid undervaluing it.
• Customer Anchors: Customers often compare prices to competitors, but effective communication can shift their focus to the unique value you provide.

Example: A manufacturing client feared losing customers by increasing prices. After implementing value-based pricing and training the sales team to communicate benefits, the client achieved a 15% revenue increase without losing market share.

A Holistic Approach to Pricing

By combining value-based pricing with strategic cost analysis, businesses can achieve a balanced pricing strategy that:

• Reflects market demand and customer willingness to pay.
• Protects profitability with clear price floors.
• Empowers confident pricing decisions, even without perfect cost clarity.

At KABEN, we guide businesses away from the cost-driven pricing trap and toward strategies that capture the full value of their offerings.

Ready to move beyond the limitations of cost-based pricing? Explore our What We Do page to learn how KABEN can help transform your pricing strategy.

Contact us today to discuss how we can help your business unlock its pricing potential.