Costing and Pricing, And Why Distinction Is Important

All too often, some managers use the terms “price” and “cost”, interchangeably. While many might not notice the difference in casual conversation, when managing a multinational organization with goals of expansion and market leadership, the details matter.

Price

When referring to price, you’re describing how much your products or services are worth to the consumer. It’s not how much you spend to provide them with the product or service, but how much they’d be willing to pay, while you keep your profit margins in check.

Cost

Cost, on the other hand, implies the amount that a company must spend to produce and sell the product to consumers. There are a variety of factors that will affect the cost of a good besides the manufacturing costs. There's research involved, marketing, and many more attributes that will increase the final cost.

In business applications, the cost of something always comes before the price. The goal for most businesses is to make a profit off of every unit that they sell. You probably have a profit margin in mind that will help fund every area of your business so you can grow at your desired rate. By having the cost in mind, you can determine the price to sell the products to consumers.

For this reason alone, it is crucial that managers know the distinction between pricing and costing.

The Return on Investment

Most of the crucial business decisions come down to return on investment. When you pay millions to open a new factory, you want to know that your money was well spent and will provide you the most return on the initial capital investment.

Value

While costs and prices are based on factual data, value is completely subjective. For instance, one person might spend $100 on a meal and feel that they received a satisfactory return on their investment. On the other hand, someone else might have that same $100 meal and feel that they were ripped off. Determining the value of a product or service can be challenging for business professionals since they can't factually determine the value a customer will derive from the product.

Value and price or cost bear no relation either. If you were to spend millions of dollars investing the research, development, and production of a smartphone that doesn't work very well, your customer wouldn't care about what it cost you, and they wouldn't derive any value from your product.

Alternatively, if you were to repurpose an old design and only spend a fraction to introduce a new feature on the phone, your customer might derive ten times as much value from that device even though it cost you much less to produce.

Summary

Materials, time, and effort all have no relation to the value of a product. They do, however, have an impact on the cost of a product, which has an effect on the price. Knowing the difference between all three of these economic principles will help you make better decisions in your purchases and investments. Whether you’re investing in products, services, or your people, by determining the cost and price, you can secure a better return on your investment.