In cost-plus pricing, a company first determines its break-even price for the product. This is done by calculating all the costs involved in the production, marketing and distribution of the product. Then a markup is set for each unit, based on the profit the company needs to make, its sales objectives and the price it believes customers will pay. For example, if the company needs a 15 percent profit margin and the break-even price is Rs 2.59, the price will be set at Rs 2.98 (Rs 2.59 x 1.15).
Cost plus also is used to price large development projects, particularly in government contracts. It is not always easy to predict the total amount of money needed to design or build an aircraft carrier or a new piece of military equipment, for example. Instead, companies estimate the amount of work needed and the time it will take to complete and then specify a how much profit they will charge over and above the final cost of the project. According to Federal News Radio, the U.S. government agencies spent $135 billion in 2008 on cost-plus type contracts.