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The Cost-Plus Model
Markup and margin-calculated pricing are both examples of cost-
plus pricing. In the former case, the cost is multiplied by one plus the
markup rate. For example, marking up an item that costs $20 by 30
percent works as follows: $20 x (1 + 30%) = $26. Alternatively, mar-
gin refers to the percentage or amount of the selling price that repre-
sents gross profit. For example, applying a 30-percent margin to a $20
cost base works as follows: $20 / (1 - 30%) = $28.57.
A benefit of cost-plus pricing for clients and distributors is that
both parties can agree upon the value of the products and services
the distributor provides as a percentage of sales. Cost-plus models
tend to work well when the product has been commoditized, but not
as well when the client may not know exactly which products they
are looking for during the contract or when value is attributed to the
distributor for bringing the client the right product and execution
suggestions to meet the client’s desired approach. For example, if
distributor A is willing to work for a lower margin than distributor
B, but distributor B brings more valuable ideas which in turn helps
the client achieve better results (more sales, higher margins,
increased brand awareness, increased employee engagement, higher
customer loyalty, etc.) and a higher rate of return on their promo-
tional product spend, then, in the eyes of the client, distributor B
may be providing better value, even if at a slightly higher price than
distributor A.
There are also a number of significant shortcomings in cost-plus
models. A few are listed below:
• “Cost” should be defined and understood. Cost may be defined to
include the materials or item costs for the product supplied as well
as in-bound freight, brokerage, duties, set-up costs, foreign exchange
costs and even overhead costs.
• Not all distributors have the same cost. This can be true of both the
item cost as well as the ancillary costs mentioned above. Assuming
this is a commodity discussion, a buyer may rather pay a higher
markup or margin to a distributor with a lower cost base as long as
the total cost of acquisition for the buyer is lower and the buyer’s
needs are properly met.
• Auditing the distributor’s compliance to pricing policies can be
time-consuming, inefficient and challenging for both parties.
• Cost-plus models may create a disincentive to “buy well.” For
example, if a distributor can buy an item for $10 and can sell the
item through a cost-plus business model, there may be no reason
for the distributor to look for that item from an equally reliable
supplier who sells the item for less. Even if the distributor finds
the same item for $9, the distributor could make more profit by
buying it at $10.
The examples above are very basic pricing concepts. Throughout
the industry, there are innumerable pricing models and methods that
allow this industry to foster, protect and celebrate creativity, competi-
tion and individualized client satisfaction.
The Reasonable Pricing Model
Another model is the “trust us, we charge a reasonable price”
model, which is surprisingly common even in procurement-driven
contracts. Typically these contracts focus more on the type of prod-
ucts, scope of services and service-level deliverables each party com-
mits to providing. These arrangements are common in e-store con-
tracts. Ultimately, the litmus test is whether or not the client’s needs
and expectations are met (if not exceeded) for the price paid for the
products, services and end results received. A downside to this
approach is that it is difficult for the client and the distributor to
institute a comparative process to ensure that reasonable value relative
to a fair market price has been exchanged.
In a hybrid model (discussed below), the “trust us” approach tends
to apply to spends under a reasonable threshold; for example, $5,000. If
a buyer asks, “Why should I trust you to charge a reasonable price?”,
the distributor’s answer may be fairly straightforward (but still perhaps
lacking a comparative process), such as: “Long-term client satisfaction
is my goal. If you discover that I have charged an unreasonable price,
you may take your business elsewhere. I am focused on the long-term
business relationship, so I will always keep my pricing sharp to ensure
you receive exceptional value commensurate with the price charged.”
Sounds idealistic, I know. However, idealism can blend with more
data-based models, and such hybrid arrangements may be appropriate
in some cases, particularly where a buyer has significantly larger proj-
ects or a long-term promotional plan.
The Competitive Bid Pricing Model
As previously stated, creativity, competition and client satisfaction
form a large part of the backbone of this industry. A competitive bid
pricing model can be helpful to provide buyers with validation that
they are receiving competitive pricing, it can keep distributors honest,
and it may create an incentive for distributors to buy well and main-
tain an efficient operating model. Many clients employ some form of
a competitive bid process on orders over a certain monetary amount,
which may depend on the client’s budget, procurement policies or
other factors affecting the client’s end goal. Generally, this method is
used when clients know the specific items they are looking for (i.e.,
they have been commoditized) or allows for discretion based on the
quality of the ideas presented. In the latter case, where multiple dis-
tributors present product options with pricing, the concept is that dis-
tributors are competing for an expenditure based on the quality of
their ideas, which is an additional value factor that distributors bring
to the table.
When competing on ideas, distributors are wise to invest their
time and resources in developing the most effective ideas for their
client and to request a reasonable level of protection that any unique
ideas they bring forward will not then be shopped around as com-
modity items. As opposed to the other models discussed in this arti-
cle, when competing on ideas the approach becomes more of a budget-
based model—“What can I, the distributor, provide within your
budget?”—than a cost-based model: “How much can I, the distribu-
PRICING
IN THE PROMOTIONAL PRODUCTS INDUSTRY
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PPB
• MAY 2015
THINK
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