in Lean, Marketing

Arashi cost Cost+ vs. Cost  Principle

Cost+ vs. Cost – Principle

I would like to keep this rather simple, as calculating costs is a complicated task and I’m not going to dig deep into this. So I just want to show you the differences between the two principles!

Let’s begin with the Cost Plus Principle! In the traditional approach of finding a Sales Price, we simply take the cost and then add the profit:

SALES  PRICE = COST + PROFIT

Toyota’s approach is completely different:

PROFIT = SALES PRICE – COST

Now you might ask: “Sorry but, you just switched “sales price” with “profit”. There is no difference!”

Really? Mathematically you might be right, but if we look at the two principles from a visual perspective, it will be much easier to understand:

 

cost principles Cost+ vs. Cost  Principle

Let’s say our product has production costs of 5$. Actually our profit is just some lousy 2$. What can we do to make more profit? Simple! We just rise the sales price and voilà, we have a profit of 5$.

The concept is to add profit to the cost to get the sales price irrespective of the market

This concept is very easy and is used widely among companies. It is commonly known as “Markup Pricing”. The total cost is calculated by adding fixed and variable costs on an average basis.

Let’s take a look at how Homer Bews Vanderblue stated after describing General Motors’ elaborate cost-plus price computations: “This price, once set, must stand the test of the market place in competition with cars produced by other companies. Merely having a cost guide to judgment does not assure that the market will pay a price that will return this cost (plus a profit), however carefully the Cost analysis has been made. – . . In practice the final quoted or Prevailing Price has generally been below Standard Price [full-cost price] and only occasionally above.” (The Pricing Problem in General Motors, 1938)

As you can see, he described the Cost Plus Principle (and much more) back in 1938, and still nowadays it is adopted widely.

But let’s take a look at Toyota’s Cost Minus Principle now:

The concept is to first fix sales price according to market &
then make effort to reduce cost to get profit

We do a bit of market research and look what price our competitors have set for a similar product, then all we do is reduce the costs we have. If we have a sales price of 10$, and we are able to further reduce our costs, we will be able to increase our profit to, let’s say, 7$. That’s it? Yepp, that’s it!

But how can Toyota reduce this costs? The answer is simple:

By eliminating waste and just producing what the customer actually is willing to pay for!

 

© Arashi Innovation

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