Relationship Between Cost, Price and Value
To make sure we mean the same thing by “cost” and “price”, let’s repeat that:
Cost and price are not the same.
Cost is the amount that an organization spends to manufacture a product or to set up a service. It’s the amount spent on the inputs like raw materials, rents, taxes, salaries, etc.
Cost doesn’t include profit.
Price = Cost + Profit
When Profit is added to the Cost, it’s called Price.
All profit is derived from RISK.Peter Drucker
Profit is a reward for the risks taken in the business.
Profit is decided by taking below WHAT IFs (RISKS) into account:
- WHAT IF the customer changes their mind?
- WHAT IF they don’t like the work?
- WHAT IF something unexpected happens?
- WHAT IF something changes midway through?
After considering all the possible risks, the profit margin is increased which further increases the price of the product.
The seller determines the price, but the buyer determines value.
And, if buyers don’t see any value in the product, they will NOT buy it – as simple as that.
The Futur summarizes it beautifully:
When VALUE exceeds PRICE, buyers give you money.
🍕 Food for thought: When buyers ask for the cost, do they really mean cost, or do they mean price?