Why everything you’ve ever been told about pricing is wrong (and why a totally different approach is warranted)

10 September 2025

I spend hours every month trying to reprogram the brains of our clients’ estimators (and their executive teams).

The problem is that their entire approach to pricing (and perhaps yours too) is built on a false assumption. The fallacious assumption is that their organizations set prices.

The bottom-up approach to pricing

If you assume that your organization sets prices, it’s understandable that you have evolved a bottom-up approach to the “calculation” of those numbers you present to customers whenever they request a proposal.

This bottom-up approach is seductive because it’s precise and deterministic. You can build a configurator that generates an “accurate” price (expressed to two decimal places) from the vast repository of data residing in your ERP system.

The process is simple. You start with your bill of materials and use that to derive raw-material costs. Then you use your production routing to calculate direct labor and to determine overhead allocation. Finally, you add your desired markup to arrive at the price.

This bottom-up approach is typically referred to as cost-plus pricing.

The fallacious assumption

Of course, you know that the assumption upon which the bottom-up approach to pricing is based is false.

You don’t set prices. The market does.

Your organization is a market participant, of course. But given the disparity between the size of your organization and the market at large, it makes sense to visualize the market as a discrete entity. This even applies if you’re bringing a new product to market. On day one, you might be the only vendor, but if you achieve any level of success, competitors will emerge and your pricing power will quickly dissipate (as Peloton discovered).

If the market sets prices, the idea that you can “calculate” the price of your offering is clearly wrong. And the entire bottom-up approach to pricing is fundamentally flawed.

The bottom-up approach results in lost profits, the perpetuation of sub-optimal business models, and the development of bad mental models in the heads of operators.

The top-down approach

The alternative is a top-down approach to pricing.

This approach starts with the estimation of the market price for the product you’re proposing to sell.

Now, your estimators will hate this idea because they lack a precise and deterministic framework for generating this estimate. But you need to convince your estimators that their preferences need to take a backseat to market dynamics.

Estimating the market price of your product is no different from estimating the value of your home or your business. There’s no calculator you can use to conjure up a perfect number. The process is a lot messier than that. You need to zero in on a fuzzy estimate, using a number of frameworks (capitalized earnings, prior transactions, liquidation value, etc).

The market price is the price at which you believe a transaction will occur. You are not calculating it or setting it; you are estimating it. This market price is not the result of your pricing process; it’s the key input. It’s not a fixed-point estimate; it’s a range. But you’ll use the central tendency as the basis for your reckoning, moving forward.

Once you’ve estimated the market price, you need to determine if you actually want to win the order at this price, and if so, under what conditions?

To determine this, you need to estimate whether this order—if won—will cause your business to be more or less profitable during the time frame under consideration.

You cannot (and should not) estimate this using the cost-plus calculus from the bottom-up approach because the cost-plus calculus fails to consider the economics of your organization during the time frame in which the order will be fulfilled.

So, to use a practical example, if a customer has requested a proposal for a custom machine to be delivered in January and you believe the market price of that machine is $35,000, you might conclude that this order will have a more positive impact on your organization’s profitability if you fabricate it from aluminum, rather than from less expensive galvanized steel. This is because you happen to have both aluminum in stock and underutilized fabrication capacity.

If this were the case, you might choose to price this job slightly below your estimated market price, but make your price conditional upon the receipt of a purchase order prior to (say) December 15.

In a higher volume (lower price) environment, the same calculus would apply, but you’d make decisions with respect to categories of transactions, rather than discrete transactions. You can see how airlines do this with their dynamic pricing models and Uber with its surge pricing.

A better feedback loop

In both cases, you would use data from these pricing decisions to inform the evolution of your organization. Just yesterday, I had a discussion with a client who had determined they should continue to outsource powder coating because their jobs would be less profitable if they brought it in-house.

I think I managed to convince them that:

1. Their jobs do not generate profit, and that profit is only an attribute of the organization as a whole
2. The cost-plus calculus does a truly horrible job of modeling organizational dynamics

They had not considered that:

1. Bringing powder coating in-house would dramatically reduce production lead times, and these shorter lead times would make their proposals more appealing (and, in some cases, might even enable them to charge a rush fee).
2. Given the nature of the powder-coating that they perform, they will likely be able to cross-train existing operators and exploit some of their excess labor capacity.
3. In-house powder coating would reduce their parts inventory, given that they could coat parts on an as-needed basis.

The issue here is that the bottom-up approach to pricing (the business equivalent of a zombie virus) had deposited the “cost-plus” calculus in the brains of the management team! It’s not that managers were unaware of the benefits of bringing powder coating in-house; it’s just that the cost-plus calculus had such a hold that these benefits were totally ignored when it came time to make a decision.

Eradicating the zombie virus

In my opinion, it’s only a slight exaggeration to refer to the bottom-up approach to pricing as a zombie virus.

Estimators and anyone else in your organization who’s reasonably proficient with Excel are easy targets for this virus because it makes their lives so much easier.

The fallacious assumption on which bottom-up pricing is based seems innocent enough at first glance.

But the practice of bottom-up pricing has an insidious effect on the organization. It starts with the generation of unrealistic prices that either need to be renegotiated by salespeople or that harm the organization’s profitability. And it proceeds to the development of a mental model that’s totally at odds with organizational (and market) dynamics. This, in turn, results in bad intuition and even more bad decisions.

Unfortunately, it’s incredibly difficult to eradicate this zombie virus from an organization. For many operators (and managers), cost-plus calculus has established itself as true north. If you ask them to make decisions on any other basis, they return to their cost-plus calculations for validation.

Once infected, these poor individuals actually believe that it’s better to be precisely wrong than vaguely right!

If you’re a business leader, it’s your job to eradicate bottom-up pricing and cost-plus calculus. It’s likely that cost-plus calculus has found its way into every corner of your organization, but pricing is ground zero.

You need to install a top-down approach to pricing and ban the use of any cost-based calculations (or cost-based arguments). In particular, you need to insist that the word profit is used only to refer to the organization and never to transactions, jobs, or projects.

The eradication of this virus won’t be easy, but it desperately needs to be done!