Bottom-up pricing is more tedious than top-down pricing but it is more elaborate. Every company has a different cost structure based on the individual factors involved like labour, overhead, marketing expenses, office supplies, etc. All the costs are first classified as direct and indirect costs and the value of these individual components is calculated. The total cost is then calculated from the sum of the above and converted to a unit value. The desired profit is then added to this total cost and this final value is the price that is going to be paid by the consumer. In this way, elaborately calculating the costs will give an idea of what costs to drop when the demand is low, so that the price can be changed dynamically.
A major challenge of bottom-up pricing is the cost allocation. There a few costs which are not attributable to the individuals who pay for the product or service. In such cases, instead of a straight line method where all the costs are divided equally among all the programs, the company follows a more complex approach where it allocates the costs appropriately to various programs and individuals. The disadvantage with this approach is that these additional programs which might be community benefiting programs sometimes die out as they are not able to recover the cost. Not just the program, sometimes bottom-up pricing on the whole is not a very good idea is cost-recovery compared to top down pricing.
For example, for a product total indirect cost = ‘i’, total direct cost = ’d’, profit desired = ‘p’, total number of units sold = ‘n’, then according to bottom-up pricing approach, selling price of each product = (i+d+p)/n