Cost vs Price – The bottom line

For a consumer both the terms “Cost” and “Price” seems to be synonymous. Very often we see friends asking “What’s the cost of that Mp3 Player?” or simply put “What’s the cost”. While we use it inter-changeably, it has a huge significance for businesses.

Price refers to the amount of money that you have to give up to acquire a good or service. e.g. price of an iPhone 3GSwith 2 year contract is $200

Cost is the amount of money the that a manufacturer incurred to produce that good or service.e.g. Cost of an iPhone for Apple to manufacture it is $150

So, what’s this difference? As you can imagine it is simple and/or complex. It has the following components hidden in it and depending on the organization and the good it is selling.

  • Profit
  • Value Chain Costs
  • Supply Chain Costs
  • Govt. Regulation Costs
  • others..

Below is a very simplified demonstration of how the $ gets distributed. As you see the Price = Cost + others. Again, this gets more complicated when you do Cost based vs. Value based pricing.

So, why are we talk about it. As a manager when you talk about increasing the profits, you are basically talking about TWO things.

  • Decreasing the Cost (Cost of Goods Sold)
  • Increasing the Profit Margins (possibly by increasing the Price and NOT the Cost)

Note : Above graphic illustrations are completely “imaginary”. Clearly, the real allocations will/may vary.

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