Pricing basics: cost-plus, value-based and discounts

Your price affects everything: contribution margin, break-even point and how customers see your offer. This lesson covers two basic ways to set a price and shows why discounts are more expensive than they look.

What you will learn

• How cost-plus pricing and value-based pricing work
• The difference between markup and margin
• How a discount reduces the contribution margin
• How many extra units you need to sell to make up for a discount

Explanation

Cost-plus pricing means you calculate your cost per unit and add a fixed percentage on top, called the markup. It is simple and makes sure each price covers your costs, if your sales assumption is right. It ignores what customers are willing to pay.

To include fixed costs in a cost per unit, you spread them over a planned number of units. This is called the full cost per unit. It only holds if you actually sell that number.

Value-based pricing starts from the customer: what is the offer worth to them, and what do their alternatives cost? You use your customer interviews and look at comparable products. Your costs then set the lowest price you can accept.

Markup is profit as a percentage of cost. Margin is profit as a percentage of price. They are not the same: a 60% markup does not give a 60% margin.

Worked example

Nordlicht Candles (fictional).

Assumptions: variable cost €5.70 per candle; fixed costs €546 per month; planned sales 150 candles per month; similar handmade candles in local shops sell for roughly €14–€22 (the founder's own observation). All amounts exclude VAT; payment fees and taxes are excluded.

Part A – Cost-plus price with 60% markup

• Fixed cost per candle: €546 ÷ 150 = €3.64
• Full cost per candle: €5.70 + €3.64 = €9.34
• Price: €9.34 × 1.60 = €14.94 → rounded to €15.00
• Margin on full cost at €15: (€15.00 − €9.34) ÷ €15.00 = 0.377 → about 37.7%, not 60%

Part B – Value-based check

Customers in interviews described the candles as personal gifts, and comparable products sell for up to about €22. The founder chooses €16, which is within the observed range and above the cost-plus price. This gives a contribution margin of €16 − €5.70 = €10.30.

Part C – Effect of a 20% discount on €16

• New price: €16 × 0.80 = €12.80
• New contribution margin: €12.80 − €5.70 = €7.10
• Drop in contribution margin: (€10.30 − €7.10) ÷ €10.30 = 0.311 → 31.1% less per candle from a 20% price cut
• Units needed for the same total contribution margin: before, 150 × €10.30 = €1,545. After: €1,545 ÷ €7.10 = 217.6 → 218 candles
• That is 218 − 150 = 68 extra candles, about 45% more sales, just to stay where you were.

Shortcut formula: Required sales increase = Discount % ÷ (CM ratio − Discount %) → 0.20 ÷ (0.64375 − 0.20) = 0.451 → 45.1%.

Limitations: the extra candles may also need more working time and could push you beyond your relevant range. The discount may or may not bring in that many extra customers; that is an assumption to test.

Common mistake

Practice activity

Rheinblick Coffee Cart (fictional) considers a 10% "early bird" discount. Calculate on paper:

• Normal price €3.50; variable cost €0.85; current sales 1,400 cups per month
• All amounts exclude VAT; ignore taxes and fees.

1. The discounted price
2. The new contribution margin per cup
3. The percentage increase in cups needed to keep the same total contribution margin
4. How many cups per month that would be

Key takeaways

• Cost-plus pricing sets a floor; value-based pricing looks at what customers are willing to pay.
• Markup is based on cost; margin is based on price.
• A discount cuts the contribution margin by a larger percentage than the price.
• Before offering a discount, calculate how many extra sales you would need.

Next step

In the final lesson, you will bring everything together in a one-page business plan.