Markup pricing advantages and disadvantages help companies and business owners quantify possible profits. Companies try to maximize on advantages of markup pricing and minimize the negative impacts of the disadvantages of markup pricing.
Markup Pricing Definition
Markup pricing is the amount to which a cost of a good or service can be added to cover both the profit margin and production overheads. Markup Formula = Proposed Selling Price – Cost per Unit.
Markup differs from profit margins in that profit margin is the difference between the actual sales and the cost of production. On the other hand, markup is the difference between the suggested retail price of goods and services to be sold and the production costs (including overheads).
It is crucial to understand the difference between the two terms as they utilize the same particular in financial statements. Markup defines the difference between the company’s proposed retail price (inclusive of profit) and the production cost. Therefore, the higher the markup, the higher the revenue for a company.
Markup Pricing Formula
To find markup, one has to deduct the cost of production from the proposed retail selling price.
| Markup = Proposed Selling Price – Cost per Unit |
Markup percentage is determined by dividing the markup obtained by the cost of production multiplied by 100%.
| Percentage Markup= Markup ÷ Cost * 100% |
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Markup Pricing Example
Luka owns a company that sells computer equipment and has recently raised retail prices due to decreased sales. He wants to find out the exact markup percentage on the goods sold. It costs him $100 to buy any materials used in production and the production process for one computer. He then sells the computer for $130. Let’s determine his markup percentage.
| Markup percentage = Markup ÷ Cost * 100 |
Markup = Selling price – Cost
= 130 – 100
= 30
Markup percentage = 30 ÷ 100 * 100
= 30%
The markup percentage of Luka’s business is 30%
Why Is Markup Used?
1. Determine the profitable selling price
Once a selling price has been set, the business needs to consider how much profit it will make. It involves setting the highest yet most reasonable selling price without going overboard.
2. Meet profit goals
Markup is used to maximize the profit of the company. After a good analysis and a good markup have been set, the company can determine at what price it can the most units and maximize its profits.
3. To determine fair and sustainable prices
A business can make steady profits over time by establishing retail prices. If these retail prices are reasonable enough vis-à-vis quality and prevailing market prices, a company might have the advantage of outperforming its competitors. Markup helps to determine the sustainability of retail price in relation to generating profits and providing value for customers’ money.
Markup Pricing Advantages and Disadvantages
Advantages of Markup Pricing
1. Convenient for bulk pricing
When retailers have a lot of products, they are required to set prices; they can use markup pricing as an easy solution. This could be done by setting a fixed markup percentage on all products.
Such markup ensures a business is on a steady revenue and avoids any losses attributed to unaccounted overheads. This is also beneficial as it will save a lot of time spent setting markup price per good and time spent on decision making.
2. Requires less information
Markup pricing is straightforward in the setting. This is because the only information you will need to set is the cost of production price. Required profit is projected, and markup pricing is decided.
3. Increases in profits
Markup pricing is also beneficial in ensuring a business is making profits from its sales. If you set up the right amount of markup, it can help offset any expenses incurred and aid in the generation of steady profits.
4. The calculation is simple
As illustrated above, it is relatively simple to calculate markup and markup percentages. The equation is easy and can be used by any business in markup pricing.
5. Helps to cover overheads
Markup helps a business determine pricing at which it will cover all its overheads and projected profits. After selling and earning profits, a company covers indirect costs and overheads incurred during production. Covering overheads helps a business establish sustainable charges for products and services.
Disadvantages of Markup Pricing
1. Markup pricing can be incredibly inefficient
This is because businesses often overlook operational costs. Some of these costs include; shipping costs, rents, and wages, among others. In addition, the business will focus on increasing profitability and forget about cutting costs. Negligence in considering cutting costs could cause future challenges for businesses.
2. Creates a culture of limiting profits margins
An organization that sets a standard markup percentage for all its output limits the profits earned at full potential. It may lose the chance to charge higher costs for some goods which have the potential to fetch more money than imagined.
3. Competitors pricing
When a business relies on markup pricing, it may end up charging unrealistically higher than competitors. This, in turn, may lead to a reduction in sales volume and hence an unstainable profit margin.
4. It fails to take consumers into account
It is from customers’ money that a business makes profits. Markup pricing, at times, fails to consider the consumer. In addition, customers do not care about the cost of production. They care about the value they get from the product they purchase. Therefore, their disregarding these facts costs them a lot of profits.
Differences between Markup Pricing and Profit Margin
1. Definition
As discussed before, markup refers to the amount to which a cost of a good or service can be added to cover both the profit margin and production overheads. Profit margin, on the other hand, refers to the sales minus the cost of goods produced. It is the revenue the business earns on the sale of goods, deducting the cost of goods sold.
2. Markup versus margin percentages calculations
Both margin and markup differ in terms of formula.
| Markup percentage = Markup ÷ cost of goods * 100% |
| Profit margin = Sales Revenue – Cost of Goods Sold ÷ Sales Revenue * 100% |
3. Scope
Businesses use markup to determine the amount of money they earn on a specific product relative to how much it costs to manufacture and avail such product to the market. It allows businesses to be able to make profits on each sale.
On the other hand, the profit margin is determined by looking at the total revenue and costs. It reveals how a business earns much total revenue.
4. Use
Businesses use markup to establish the best retail price for their products. This ensures that they sell their products at a profit covering the operational and production costs.
Margins are generally used to determine a company’s performance regarding the profitability of goods sold. They give a more accurate figure on the company earnings and the revenue the business gets.
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