What should a packet of crackers cost?: Lena's Bakery bakes its own crackers and sells them to the cafés it already supplies with bread. A café owner asks what a packet will cost her.
Where Lena does not start
- What other crackers sell for
- What the café might pay
Where Lena starts
- What a packet costs her to make
- Then she adds a slice on top for profit
That is cost-plus pricing (also called mark-up pricing): work out what it costs to make one unit, then add an extra amount for profit, the mark-up. The mark-up can be a fixed amount, such as $1.50 a packet, or a percentage of the cost, such as 150%. A mark-up can be more than 100%: it only means the profit on each packet is bigger than its cost.
Pricing a packet of crackers
The variable cost of one packet
Flour, butter, seeds and the printed packet: $0.60 for every packet baked. Variable costs rise with every packet made (3.3.1).
A share of the fixed costs
The crackers also take a baker's afternoon, oven time and space in the van: $140 a week. Shared over the 350 packets baked each week, that is $140 ÷ 350 = $0.40 a packet.
The unit cost
Unit cost (average cost) = total cost ÷ number of units made. Here $0.60 + $0.40 = $1.00 a packet.
Add the mark-up
Price = unit cost + mark-up. A 150% mark-up is 150% of $1.00 = $1.50, so the price is $1.00 + $1.50 = $2.50 a packet. In one step: $1.00 × 2.5 = $2.50.
All the costs, not just the ingredients: A loaf of Lena's bread uses about $0.90 of flour, yeast, salt and bag. That is not its unit cost: the bakers' wages, the rent and the ovens have to be paid out of the price as well.
Start from the unit cost: A mark-up on the ingredients alone would leave the bakery short. Cost-plus starts from the unit cost: the variable cost plus a fair share of the fixed costs.
When cost-plus fits
- Costs are known and fairly steady, so the price is quick to work out and easy to explain
- Every sale covers its costs, so each packet sold makes a profit
- Many products or one-off orders: one simple rule prices them all
- Business buyers, like the cafés, accept a price that follows the cost of flour
Where it goes wrong
- It ignores what customers would pay: $2.50 may be too little for crackers the cafés love
- It ignores rivals: if other crackers sell for $1.50, the cafés may switch
- The unit cost depends on how many are made, so the price moves when sales do
- Every rise in costs passes straight into the price, whether buyers accept it or not
The third problem is easy to miss. If the cafés order only 280 packets a week, the same $140 of fixed costs is shared by fewer packets: $0.50 each. The unit cost rises to $1.10, and a 150% mark-up takes the price to $2.75, just when the cafés are buying less. Cost-plus pushes the price up exactly when customers are drifting away.
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Opening day at Station Road: Lena's fourth shop opens in September 2026, opposite the railway station. Lena's wants commuters to try Priti's breakfast range, which nobody at the station has tasted yet.
The station in the morning
- 1,850 people pass every morning between 6.30 and 9.00.
- About one in eight already carries a coffee from Crumbline's stand in the station.
- At Crumbline, coffee and a pastry cost $3.50.
One way in is to start cheap. Lena's launches its coffee-and-croissant deal at $3, 50 cents below Crumbline, and can raise it once commuters have become regulars. A low price at launch, to win customers and a share of the market quickly, raised later, is penetration pricing.
Why it can work
- People try it. A deal cheaper than the one they already buy gives commuters a reason to change habit.
- Sales build fast. Busy mornings from the first week, and the new shop quickly learns what sells.
- Rivals have less room. Customers won early are harder for Crumbline to win back.
What can go wrong
- Thin margins at first. Every $3 deal earns less than a higher price would, and the shop has costs from day one.
- The rise can hurt. Customers who came for the $3 deal may leave when its price goes up.
- Rivals can cut too. If Crumbline drops its price, neither side makes much money.
The shop has a second low price. A plain coffee on its own is $1, although each cup costs Lena's about $1.20 to make: beans, milk, the cup and a share of the barista's time. Every cup loses 20 cents. A product sold below its cost to bring customers in, who then buy other things that are priced for a profit, is a loss leader.
How a $1 coffee can pay
The coffee brings them in
A $1 coffee is hard to walk past. Commuters who used to go to Crumbline stop at Lena's counter.
They see the rest
The pastries and the loaves are on the counter in front of them, at their normal prices.
They buy something else
A loaf to take home is $3, and after its $0.90 of ingredients it leaves $2.10.
The sums work, if enough of them do
One loaf sold for every ten coffees covers the 20 cents lost on each cup. A commuter who takes the coffee and walks on is a loss.
Two low prices, two different ideas: Penetration pricing puts a low price on the product itself, to win buyers for it, and raises it later. A loss leader is kept below cost to sell something else.
A loss leader only works in a business that sells many things. A shop with one product cannot make up the loss anywhere.
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80 cents more, and still a queue: Near Market Square, Goldcrust sells a sliced loaf for $2.20. At Kofi's counter in Lena's, a loaf is $3, and there is still a queue.
Customers pay 80 cents more for something they believe is better
- Valley Grain flour
- Bread risen slowly overnight
- A name they trust (4.1.3, 4.2.1)
Setting a price well above similar products from rivals, so the product is seen as higher quality or more exclusive, is premium pricing. The high price is part of the message: a $3 loaf says something about itself that a $2.20 loaf cannot. It is a long-term choice, kept for as long as the product and the brand can back it up.
What it looks like
- A price above similar products from rivals
- Signals quality, value and exclusivity
- Backed by strong branding and marketing
- Kept for the long term, not just at launch
- A high profit margin on each sale, and fewer sales
Why it can pay
- More left from each sale: $2.10 over the ingredients at $3, against $1.30 at $2.20
- The price supports the quality image the customers already have
- Loyal customers keep paying, so a cheaper rival finds them hard to tempt away
- It helps cover high fixed costs, such as a night shift baking in small batches
What it risks
- Customers who choose on price buy the cheaper loaf instead
- The quality and the brand must be kept up, and that costs money
- Prices are easy to compare: the gap is right there on the square
- If the quality slips, the price quickly looks unfair
Not 'more revenue': A higher price does not mean more revenue. Premium pricing usually means fewer customers, so revenue can go down as well as up.
Its advantages are the margin on each sale and what the price says about the product, not the total money coming in.
What happens when a price moves? Suppose Marco raised the Market Square loaf from $3.00 to $3.50 to reach a profit target. Many regulars would pay. Others would walk to Goldcrust, now $1.30 cheaper instead of 80 cents. Say 133 of the 380 loaves a day stop selling:
| Market Square | At $3.00 | At $3.50 |
|---|---|---|
| Loaves a day | 380 (the 2026 forecast) | 247, if 133 customers switch |
| Revenue a day | 380 × $3.00 = $1,140 | 247 × $3.50 = $864.50 |
| Who is buying | Regulars and passers-by | Mostly the loyal regulars |
A price change moves sales: A rise and a cut both change how many people buy, but in different ways.
A price rise
- Usually means fewer sales.
- How many fewer depends on how easily customers can buy something similar elsewhere.
- A business that cannot sell more than it already does may end with less money, not more.
A price cut
- Works the other way: more buyers.
- But a premium name can start to look ordinary.
- The customers who come may be different people.
What if Goldcrust fought back?: Marco has a worry. Goldcrust is far bigger than Lena's, and could cut its price for a long time.
Goldcrust
- 400 bakeries
- Sales of $451 million
Lena's
- Three shops
- A fourth about to open
Marco's question: If Goldcrust cut the loaf at its Market Square bakery from $2.20 to $1.20, below what it costs to bake, and kept it there for a year, could Kofi's shop survive?
Pricing so low that rivals cannot compete and are forced out of the market is predatory pricing. The big firm loses money on purpose. It can afford to, because its other bakeries keep earning. Once the rival has gone, it raises its prices again, often above where they started, because nobody nearby is left to undercut it.
Predatory pricing in three stages
Cut below cost
Goldcrust's Market Square loaf drops to $1.20. Every loaf it sells there loses money.
Wait for the rival to go
Kofi's customers drift to the cheap loaf. A three-shop bakery cannot lose money for a year; a chain of 400 can.
Raise prices again
With the rival gone, the loaf goes back to $2.20 or higher. Customers now have nowhere else to go.
Illegal in most countries: Because its aim is to remove competitors and gain control of a market, predatory pricing is against the law in most developed countries, and a firm caught doing it can be fined.
It is also hard to prove. A big chain can say it is simply offering customers a good deal.
So when is predatory pricing appropriate? Almost never. It is open only to a very large firm facing small rivals, and even then it risks fines, bad publicity and customers who resent the higher prices later. Lena's could not use it: it has neither the size nor the cash to lose money for a year. Choosing a method means asking which one fits this business, this product and these customers.
| Method | It fits when | It does not fit when |
|---|---|---|
| Cost-plus | Costs are known and steady, and there are many products or orders to price, like the crackers | Customers or rivals decide what the product can sell for |
| Penetration | A new product enters a market where rivals already have the customers, like the breakfast deal | The product must look exclusive, or the business cannot live on thin margins for long |
| Loss leader | Customers who come in for one cheap item buy others, like the $1 coffee and a loaf | Shoppers buy only the cheap item, or the business sells a single product |
| Predatory | A very large firm faces a small rival, and even then it is usually illegal | The firm is small, or the law forbids it, as it does in most countries |
| Premium | The product is genuinely better or rare and the brand is strong, like Lena's loaf | Customers choose mainly on price, or the quality cannot be kept up |
Appropriate means right for this business: No method is right everywhere. Ask what the business sells, who buys it, what rivals charge and how long the business could afford to earn little.
Then say why the method fits the case, with a fact or a figure from it.
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