Cost plus pricing adds a markup to what a product or job costs, value pricing sets the price by what the customer will pay for the result, and competitive pricing anchors to what rivals charge. Each produces a different margin: cost plus guarantees a margin on paper but ignores demand, value pricing can earn far more than cost justifies, and competitive pricing leaves margin to depend on keeping costs below the market. Most small businesses use cost to set a floor and customers and competitors to decide how far above it to go.

What are the main pricing methods?

ACCA’s guidance on practical pricing lists three influences on any price: cost, because the selling price should cover the cost of production; customers, because what they will pay depends on how sensitive demand is to price; and competitors, because where many sellers offer similar products, each has little freedom to set its own price. The three methods on this page each start from one of those influences. The best price usually comes from checking all three rather than relying on one.

The methods also differ in what they need. Cost plus needs reliable cost data, which means good job costing or product costing. Value pricing needs a clear understanding of what the customer gains. Competitive pricing needs current market information and a cost base that can live with the market price.

How does cost plus pricing work?

A markup percentage is added to a cost figure. The answer depends heavily on which cost is used. ACCA’s examples show the main options:

  • Marginal cost plus. With a variable cost of 120 and a 25% markup, the price is 150, a contribution of 30 per unit. Whether that covers fixed costs depends on volume.
  • Full absorption cost plus. Adding a fixed overhead rate of 40 to the same variable cost gives a full cost of 160; a 20% markup gives a price of 192 and profit of 32 per unit. This keeps fixed costs in view, which is why many trades and manufacturers use it. The overhead rate comes from overhead absorption rates.
  • Relevant cost. For a one off contract, only the future cash flows caused by taking the work count. ACCA’s example sets the minimum price at the extra cash spent plus the sale proceeds given up by using existing stock, ignoring sunk costs and staff who would be paid anyway. Any lower price leaves the business worse off.

ACCA’s verdict is that cost based methods are simple and widely used but entirely inward looking: having a formula for a price does not mean anyone will buy at that price, and cost can also understate what customers would happily pay.

Markup and margin are not the same

Markup is profit as a percentage of cost. Margin is profit as a percentage of the selling price. Illustration only. An item costing £60 marked up by 50% sells for £90; the profit of £30 is a 33.3% margin. To earn a 40% margin on the same cost, the price must be £60 divided by 0.6, which is £100. Confusing the two is one of the most common reasons a business earns less than it planned; see gross, operating and net profit for how margins flow through the accounts.

How does value pricing work?

Value pricing starts from the customer: what the outcome is worth to them, what the alternatives cost, and how much they would lose by not buying. Cost then acts as a floor rather than the basis. ACCA’s illustration is a cotton shirt that costs little to make but sells for far more once a fashionable brand’s logo is added, even though the logo costs next to nothing; cost plus would set a price below what customers are willing to pay.

In service businesses, value pricing usually takes the form of fixed prices for defined outcomes and tiered packages, with the scope written down so that extra work is priced separately. It requires confidence in delivery cost, because a fixed price that ignores effort can become a loss maker. The professional rules that apply when accountants use it are covered in value pricing for accountancy services.

How does competitive pricing work?

Here the market price is the starting point and the business decides whether to match it, sit slightly below it, or charge a premium justified by quality, speed or service. ACCA notes that where many competitors sell very similar products, all have to fall in line with the market price. Margin then depends on cost control: if a rival can produce more cheaply, it can undercut and still profit.

Two launch strategies are variations on this. Price skimming starts high to capture customers who will pay a premium, then lowers the price over time. Penetration pricing starts low to win market share quickly; ACCA explains that high volumes can lower unit costs because fixed costs are spread more thinly, which may make low prices profitable. Penetration pricing is risky for a small business without the volume to get there.

How do price changes affect margin and volume?

A price change does not just move revenue; it changes contribution per sale, which changes the volume needed to earn the same profit. ACCA explains this through price elasticity of demand: where demand is elastic, a price cut increases revenue because volume rises proportionately more; where it is inelastic, a price cut reduces revenue.

Illustration only. A product sells for £100 with a variable cost of £60, a contribution of £40.

Change New price £ Contribution £ Volume change needed to keep total contribution
Cut price 10% 90 30 Sell 33% more
Raise price 10% 110 50 Can sell 20% fewer

The asymmetry is the key point. A 10% discount needs a third more sales just to stand still, while a 10% increase can absorb a fifth fewer sales. This is why discounting to win volume often reduces profit, and why break even analysis should be run before any price change.

What rules apply to the prices you set?

  • No agreements with competitors. Section 2 of the Competition Act 1998 prohibits agreements and concerted practices that prevent, restrict or distort competition, and specifically names those that directly or indirectly fix purchase or selling prices. A prohibited agreement is void under section 2(4). Watching competitors’ published prices is normal; agreeing prices with them is not.
  • Consumer prices include VAT. The Price Marking Order 2004 requires a trader offering products to consumers to indicate the selling price (article 4), defined in article 1 as the final price including VAT and all other taxes.
  • VAT comes out of the price. The standard VAT rate is 20%, so a VAT registered business selling to consumers at £120 including VAT keeps £100. A business that becomes VAT registered and holds its consumer prices loses that margin, which should be built into pricing well before the VAT registration threshold is reached.

What mistakes come up most often?

  • Confusing markup with margin, so the business prices for a margin it never earns.
  • Using basic wages and direct materials as cost. Overheads and employer costs are left out, so the markup has to cover far more than intended.
  • Never revisiting prices. ACCA’s guidance concludes that pricing decisions need continuous review as products, technology, competitors and customer tastes change.
  • Discounting by habit. Small discounts on thin margins require large volume increases.
  • Pricing every customer the same when costs differ. Small frequent orders, rush work and heavy support all cost more to serve.
  • Ignoring the cash effect. Long credit terms and staged payments cost money; see working capital management.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.