Most pricing decisions are made with incomplete information. Companies know their market price, their competitor’s approximate price, and their gut feeling about what the customer will accept. What they often don’t know is their actual cost to deliver.
That gap, between perceived cost and actual cost, is where margin disappears.
The Three Pricing Errors That Kill Margin
Error 1: Pricing to revenue targets, not cost reality
A sales team under pressure to hit revenue targets will discount to close deals. Without knowing the true cost-to-serve for a specific client or order type, the discount looks acceptable. It may not be.
Error 2: One price for all complexity levels
Standard pricing assumes standard delivery. But a client who requires bespoke configuration, dedicated support, or complex logistics is not a standard delivery. Charging them the same as a simple, low-touch client means you’re subsidising their complexity.
Error 3: Ignoring the indirect cost component
Gross margin looks healthy. Net margin does not. The gap is indirect costs – overhead, management, support functions – allocated to the product or client. If your pricing model only accounts for COGS, you’re flying blind on 30-60% of your cost structure.
What Cost-Informed Pricing Looks Like
The starting point is a fully loaded cost per unit or per client – including direct costs, indirect costs allocated via a defensible method (ideally TDABC), and a target margin.
From this base cost, pricing decisions become structured:
- Floor price: The minimum price that covers full cost. Anything below this is a guaranteed loss.
- Target price: Floor price + margin target. This is your default.
- Strategic price: May be above or below target for specific reasons (market penetration, client relationship, capacity utilisation). But it’s a conscious decision, not a default.
The discipline is knowing which category every deal falls into – and ensuring “strategic” doesn’t become the euphemism for “we couldn’t get more.”
The Capacity Utilisation Factor
One nuance that most pricing models miss: the relationship between pricing and capacity utilisation.
When you have excess capacity, the marginal cost of an additional unit is low – much of your fixed overhead is already covered. In this situation, accepting lower-margin business to fill capacity can be rational. But you need the model to tell you when you’re at full capacity, because at that point the economics flip: that “fill capacity” deal is now displacing higher-margin business.
TDABC gives you this visibility. You can see which activities are at or near capacity and which have slack – and price accordingly.
A Practical Exercise
Take your last 10 significant deals. For each one:
- What was the revenue?
- What was the COGS (if you know it)?
- What was the estimated indirect cost allocation?
- What was the resulting net margin?
If you can’t complete step 3 or 4 for more than half of those deals, your pricing process has a cost data problem.
The Profitability Health Check includes a Pricing Power dimension that assesses how well your current pricing process is supported by actual cost data.