Markup Pricing: How and When You Should Use It
Businesses rely on various pricing strategies to find the best price for their products to drive sales and maximize profits. After considering production, overhead and marketing costs, a company must then decide what percentage they’ll need to mark up the selling price to cover costs and make a profit.
What Is Markup Pricing?
The ultimate goal of every business is to make a profit. Markup pricing, or cost-plus pricing, is one method to achieve that goal by determining a product’s selling price. To make a profit and offset production costs, businesses must add a percentage of the costs, or a markup, to the products or services. In other words, the selling price minus the cost of the product equals the markup.
How to Calculate the Markup on an Item for Sale
Markup is typically expressed as a percentage. You can determine the markup percentage of a product by using the following formula: [(retail price – cost) ÷ cost] x 100 = markup percentage
For example, let’s say you own a small clothing boutique and would like to calculate the markup of a new line of dresses in your inventory. First, determine how much it costs to produce each dress. If each dress costs $20 for material, $40 in labor and $30 in overhead costs, then the total production cost is $90 per dress. You decide to sell each dress for $130.50.
To determine the markup percentage, the calculation would be [($130.50 – $90) ÷ 90] x 100 = markup percentage. After arriving at 0.45 for the functions between the brackets, you would take 0.45 x 100, which equals a 45% markup.
How to Calculate Selling Prices With Markups
Most businesses use markups to determine what price point to offer their products at. To determine the selling price for your product, you can invert the previous formula. Now, the formula becomes [cost ÷ (100 – percent markup)] x 100 = selling price.
For example, say a pottery company purchases a vase at wholesale for $50 and needs to sell it at a 60% markup. To determine the selling price, the company would calculate [$50 ÷ (100 – 60)] x 100 = selling price. After arriving at 1.25 for the functions within the brackets, the business would multiply by 100 to determine a selling price of $125.
When Should You Use Markup Pricing?
Markup pricing is one of the easiest pricing strategies. Your business can use markup pricing for purposes such as:
Meeting Profit Goals
Markup pricing is a great way to meet your profit goals. For businesses with many costs associated with production, such as in the manufacturing industry, it’s crucial to properly price items to offset production costs and all other business expenses. When you mark up the price, you guarantee that every sale covers those costs and achieves the amount of profit you need.
Determining Retail Price
As mentioned above, many companies use markup pricing to determine a retail price for their products. Markup pricing can help your business appropriately price units according to your profit goals and the highest market price it will go for.
Establishing a Pricing Strategy as a New Business
Once you have used basic markup pricing to start out, you can adapt your pricing strategy to meet your specific company’s needs. Often, more established businesses choose another pricing strategy, as markup pricing doesn’t always consider indirect costs and sometimes fails to consider market conditions like customer demand.
How Can You Use Markup Pricing in Your Business?
Many small businesses and e-commerce retail stores use markups when setting prices. However, many retailers also use markup pricing alongside a sale to attract new customers and maintain customer loyalty.
Your company can enjoy many benefits of markup pricing, such as:
Piquing Customer Interest
Marking up prices influences how your customers perceive the prices of products or services. Marking up the prices just before a sale increases the percentage customers save. Even if the customer is aware that you’re using this tactic, customers enjoy the perception that they’re getting a better deal.
For example, imagine you manage the inventory for a clothing store, and you have several boxes of jeans you just can’t seem to sell for $50. If you try reducing the price to $40, the 20% discount might encourage more customers to purchase the jeans. However, if you increase the price to $80 before reducing it to $40, customers may perceive the half-off discount to be more impressive and might be more encouraged to buy.
Changing Customers’ Mindsets
It may seem counterintuitive to provide discounts constantly. However, as aforementioned, marking up prices and then holding frequent sales can train your customers to wait until a sale instead of purchasing at your regular prices. Constantly advertising deals to your customers will help draw them to your store, as customers are attracted to sales tactics that imply they’re saving money.
Delivering What Customers Want
The ultimate goal of marking up and marking down your inventory is to fulfill customers’ desires. Data analysis is a crucial step in marking up and discounting your inventory. You can rely on inventory data to identify both items that aren’t selling and what their markup percentage should be. Inventory management software like Finale Inventory can even help you apply markups to your products automatically.
What Is the Difference Between Markup and Margin?
Markup deals with a set amount above the cost of the product and doesn’t always capture a realistic picture of a company’s actual profitability. Profit margin refers to the measures that are used to compute a company’s profits. Markup is the percentage increase to the price of a product or service to make a profit. Meanwhile, margin refers to the sales subtracted by the cost of the products or cost of products – total sales = margin.
In other words, profit margin constitutes the percentage of earnings that are profits. You can analyze your profit margins in depth by pairing your inventory costs and sales data with QuickBooks Desktop or QuickBooks Online accounting software.
A 40% markup won’t necessarily equate to a 40% profit margin because margins incorporate other costs of doing business besides the products themselves. This means that calculating margin can help you target the bottom line more effectively than just using a markup, making it easier to predict your business’s profitability.
There are two types of margin, gross margin and net margin.
Gross margin is a measure that demonstrates what percentage of revenue exceeds the cost of producing the goods your company has sold. If you use inventory management software, you can find your cost of goods sold within the inventory accounting module. Gross profit margin can help a company evaluate how successful they are at generating revenue. Gross profit margin is different from gross profit. While gross profit is expressed as an absolute dollar amount of profit a company earns, gross margin is a percentage taken from the total revenue that is considered profit.
Use the following equations to calculate gross margin and gross margin percentage:
- Sales price – unit cost = gross profit.
- [(Revenue – cost of goods sold) ÷ revenue)] x 100 = gross profit margin.
Net profit margin refers to the ratio of profits to total revenue. Net profit margin is typically used much more frequently than gross margin, as it is a crucial indicator of a company’s financial health and considers all business activities, not just the cost of goods sold. Net profit margin can reveal where a company could potentially be losing profits.
For example, a company’s operating costs could be growing faster than its revenue despite the appearance of increasing revenue, shrinking its net profit margin. By evaluating net profit margin, you can see if your current profit-generating practices are working and where you may need to make changes.
Use the following equations to calculate net profit and net profit margin:
- Gross profit – all business expenses = net profit.
- (Net profit x 100) ÷ revenue = net profit margin.
Increase Profits With Finale Inventory
To understand how you can use markup pricing, you need quick, reliable access to your inventory data. Finale Inventory is the cloud inventory management software you need to help you know how much and when to markup your inventory to maximize profits. Each paid plan is month-to-month with no set-up or start-up costs. Plus, each client is paired with a customer relationship manager who will provide consulting, training and customization to find the right strategy for your business.